UK: Economic Update – An August rate cut would be the first of a few
Roger Bootle’s response to July’s MPC meeting

• Today’s decision by the MPC to keep interest rates on hold at 4.75% makes a rate cut in August to 4.5% almost certain. I believe that this would be the first step towards much lower rates.

• It became clear that the interest rates cycle was about to turn downwards last month when it was revealed that two members of the Committee voted to reduce interest rates at June’s meeting. Since then, the discussion has probably been more to do with the timing of the first interest rate cut rather than whether one is warranted.

• The weakness of some of the most recent data meant that a cut in rates today would not have been too much of a surprise. Indeed, last week’s release of the National Accounts revealed that GDP growth in Q1 was revised down from a quarterly 0.5% to 0.4%. What’s more, the annual growth rate was revised down from 2.7% to just 2.1%.

• But there are other reasons why a cut at August’s meeting always looked more likely. For a start, waiting until August provides the Committee with another month’s data in order asses how sharp the consumer slowdown has become. This may be particularly useful at the moment given that some of the most recent monthly data have been harder than normal to interpret due to various distortions, such as the earlier timing of Easter this year and the collapse of MG Rover.

• Possibly more important, though, is that August is an Inflation Report month. Historically, the Committee is twice as likely to change interest rates at a meeting that coincides with the publication of the Inflation Report. This is because it allows the Committee to update its growth and inflation forecasts, which is quite a neat way of explaining why it is changing interest rates.

• What’s more, given that the minutes of June’s meeting showed that some members were concerned about surprising the markets, waiting until August to cut rates gives the markets plenty of time to adjust their expectations. The extra uncertainty caused by today’s events in London may also, at the margin, have added to the case for a delay until August.

• After the 0.25% rate cut I expect in August, it probably won’t be long before rates fall again, as the MPC moves swiftly to provide a boost to the weakening economy. With inflation pressures likely to remain well contained, the MPC will be free to cut rates as much as necessary. I believe that rates will fall all the way to 3.5% by the middle of next year – but they could go even lower.

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