Memorandum submitted by Roger Bootle,
Capital Economics
1. February's Bank of England Inflation
Report had a rather less dovish tone than might have been expected
after the extremely benign January CPI inflation figures.
2. Despite the sharper than expected fall
in inflation over recent months, the MPC's projection has actually
risen a little compared to the November Report and now holds very
close to the 2% target throughout the 2 year forecast period.
(See Chart.) But the forecast is still based on what I see as
a very optimistic scenario for the economy, with GDP growth expected
to be above trend this year and close to 3% in both 2007 and 2008.
3. This is well above the consensus forecast
for 2006 of 2.1% and relies on a very favourable combination of
average growth in consumer spending—after a number of years
of above average spending growth and a corresponding build-up
in household debt—recovering business investment, and a
stronger contribution from net trade.
4. The MPC itself admits that the risks
to this scenario are on the downside. This is presumably a concession
to those members, like Steve Nickell, who have felt for some time
that the Committee's growth forecasts have been too high.
5. But it is the central forecasts for growth
which presumably feed into the inflation projections. In that
sense, it is possible that the projections, as well as the general
tone of the Report, rather under-represent the more dovish faction
on the Committee. The same goes for the accompanying press conference
which, of course, is mainly conducted by arch-hawk Mervyn King.
6. That said, the news in the minutes to
the February MPC meeting that Steve Nickell was again the sole
voter for a cut in interest rates indicates that the dovish faction
is currently very small. Nor were there any real indications that
any other members seriously considered voting for an immediate
cut in rates. This makes the chances of a rate reduction in the
next month or two pretty low.
7. But it does not rule out a further easing
of policy later in the year. Ultimately, it is the economic news
which will determine where interest rates go. If the economy disappoints
the MPC's optimistic central forecasts, as I expect, while inflation
pressures continue to fade, then even the hawkish insiders will
find it hard to resist the arguments for a further loosening of
monetary policy.
8. Indeed, some important news since the
meeting has come out on the soft side of expectations. In particular,
the huge drop in retail sales in January (although all the usual
caveats about one month's numbers apply) questions the view in
the minutes that "the weakness of consumption growth in the
first half of 2005 appears to have abated" and that "the
latest indicators . . . pointed to GDP growth strengthening a
little in Q1". In contrast, I think growth is now very likely
to slow in Q1.
9. With underlying inflation pressures also
likely to ease further over the coming months, I still believe
that interest rates are likely to fall twice this year to 4%,
with May perhaps now the most likely date for the first cut.
28 February 2006
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