Economic Update – Still far from clear that rate rise is needed

Roger Bootle’s response to April’s MPC meeting

  • Given that another raft of fiscal tightening measures hit households yesterday when the new financial year started, the Monetary Policy Committee (MPC) did the right thing today by leaving interest rates on hold. I still think that the economy is in no fit state to deal with tightening fiscal and monetary policy.
  • That is not to say that the next few months will be particularly comfortable for the Committee. With oil prices now over $120 per barrel, and more utility price rises potentially looming, the MPC was right to warn last month of the risk that inflation might get to 5%.
  • But the factors driving up inflation remain largely temporary. And there is still no reason to think that the high rates of inflation will cause inflation expectations and pay growth to spiral out of control.
  • Households’ long-term inflation expectations have actually eased off in the past couple of months. And Incomes Data Services revised down its estimate of the median pay settlement in February from 2.8% to 2.5%. And although it reported that settlements for April were generally coming in at 3% or above, I would not be surprised if this gets revised down too in due course. After all, April is a key month for public sector pay settlements – which will be close to zero.
  • Meanwhile, the latest news on economic activity has supported my fears that, beneath all the weather-related distortions, the recovery has not been faring well. Admittedly, the services recovery picked up pace in March. But the news on the consumer sector has been unambiguously awful. Retailers are struggling left, right and centre. And the next wave of the fiscal consolidation has just hit consumers. Although many households benefited from the rise in the personal tax allowance, the net effect of this week’s changes was to reduce household incomes.
  • Even the industrial sector, which has been roaring away, appears to have cooled a bit. Meanwhile, the combination of the rise in oil prices, turmoil in the Middle East and Japanese earthquake has left the outlook for global demand looking highly uncertain.
  • But will the Committee have the nerve to keep policy unchanged as inflation climbs higher? It was something of a relief that no-one else joined the Committee’s three hawks in voting for higher interest rates at last month’s meeting. And my hunch is that the vote was 6-3 again today. However, it is next month’s May meeting – coinciding with the Inflation Report – which will be the key crunch time.
  • Obviously much depends on the data over the next month but I think that the Committee now has enough evidence of a slowdown in the economy to persuade it to leave policy unchanged.
  • The MPC should certainly think twice about raising interest rates simply as a “gesture” of its anti-inflation commitment. If the rise were seen as an admission by the MPC that it has got it wrong about the inflation outlook, it could be interpreted as the start of a much bigger policy tightening. And that could have very damaging effects on sterling, the housing market and confidence.

Roger Bootle, Economic Adviser to Deloitte (Tel: 020 7823 5000)

This assessment contains general information only and is not intended to be comprehensive nor to provide professional advice.  It is not a substitute for such professional advice and should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business.  Deloitte LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from acting as a result of any material in this assessment.

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