Memorandum submitted by Roger Bootle,
Capital Economics
1. While February's Bank of England Inflation
Report was probably a little less hawkish than some commentators
had feared, it certainly did not close the door on the possibility
of a further rise in interest rates in this cycle.
2. Indeed, as the Chart shows, the MPC's
forecast for CPI inflation was pushed marginally higher compared
to that presented in the last Report, largely reflecting the higher
starting point. As a result, inflation is expected to be slightly
above the 2% target in two years' time and rising modestly thereafter.
3. But this forecast is based on the expectation
of continued very strong growth in the economy, with GDP expected
to expand by close to 3% this year—somewhat higher than
in the November Report and higher too than the latest consensus
forecast. In particular, the MPC has kept its fingers tightly
crossed that the slowdown in the housing market will have very
little, or no, negative effect on the growth of household spending.
4. There are clear downside risks to this
view. The MPC may be too sanguine on the housing/spending link.
Should spending growth slow even modestly as house price inflation
falls, this could lead to the need for lower interest rates later
in the year.
5. Elsewhere in the Report, the Committee
sounded reasonably relaxed about the labour market, suggesting
that there were "scant" signs of a tightening in the
market and noting that wage pressures were being contained by
stronger productivity growth. Meanwhile, the outlook for exports
was thought to have weakened.
6. Overall then, the Report gave a pretty
neutral signal on interest rates. There is still a clear possibility
of a further hike if the data—particularly those relating
to housing—remain robust over the next few months. But if
the housing data soften as I think more likely—and this
slows household spending growth—then rates could begin to
fall in the early summer and could drop much further later in
the year than the markets are currently expecting.
9 March 2005
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