Timing is everything. If Mervyn King had delivered his 'calm down dear' speech just after the publication of the MPC minutes rather than just before, we'd be looking at a far different set of near term interest rate expectations in the UK market today.
As it is, the market has raced back to fully price in two quarter point cuts by year-end. Of course, we need to remember that King's speech (in which he basically outlined some good reasons to keep rates on hold for a while yet) did take place after the crucial MPC policy meeting where, it turns out, two members voted for an immediate rate cut - a move in which King himself was clearly not interested.
The 7-2 vote split was a big surprise to the market (and to us), with short sterling futures quickly returning to price in a near term cut (probably August), with another quarter point move discounted after that. We still believe this is premature.
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The Bank has shown consistently that it will act in response to the data flow. So should negative news dominate the coming month or so, the MPC will cut rates and we'll be wrong. But just as we thought it was wrong to predict a hike on the basis of Tucker and Large voting for it in February and March (with Large still going for a 25 basis points (bps) rise in May), we think it is wrong to get too excited about a near term cut. The only important thing is the data. And we continue to expect somewhat better consumer sector reports to negate a rate cut in the near term. We still forecast a 25bps rate cut in November.
Two MPC members voting for a cut is quite a turnaround in the space of a couple of months, when two voted for a quarter point increase. It is clearly a significant development along the road to confirming the next move in rates to be down. But there are a number of interesting points we think are worth drawing out here with regard to timing. King's comments last week contrived, in our view, to draw into focus some of the upside risks to inflation and the potential for a mini-revival in consumer spending in the coming months. The market reacted, predictably, by pushing out its expectation for a near term hike; not that there was anything especially new in what King was saying, but his decision to articulate such risks was the important thing - and was probably motivated by a reluctance to see the market going too far down the rate cut road too soon. And given that King will have been acutely aware of the market's impending reaction to the release of the 'dovish' MPC minutes last week, his comments are given even greater clarity.
Of the two MPC members who voted to cut rates, the most important is Charlie Bean. Marian Bell's term ended with the June meeting. David Walton replaces her on the MPC from next month and his focus is likely to be on finding his feet in terms of the Committee's dynamics rather than seeking to differentiate himself in his first meeting. Charlie Bean's departure from the 'core' Bank view is more relevant than most because as the Bank's Chief Economist, he is responsible for the official forecast. Of course, outside of the quarterly forecasting cycle, Bean's conclusion for policy will not have the same impact as it might have if it had been backed up with a revised Inflation Report forecast, so in our view we are still left looking at the data flow if Bean is to be able to carry the rest of the MPC with him next time around. And that regard, our analysis of households' income growth, of the evidence on mortgage borrowing (which has improved for the past five months) and durable goods spending (especially household goods, which has rebounded, as we pointed out last week) still suggests to us there's enough in the tank to finance reasonable consumption growth over the coming months.
We cannot deny that the risk of an August cut is clearly present, but that's the point of making a worthwhile call - there's a chance of getting it wrong.
By Steven Andrew, economist for F&C Asset Management Economics Weekly
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