Did the MPC get it right?

Kevin Crowley considers the MPC's decision to cut interest rates by 25 basis points to 5.25% last week

Responding to slowing domestic consumption and ongoing turmoil in the global credit markets, the Bank of England's monetary policy committee (MPC) voted to cut interest rates by 25 basis points to 5.25 per cent last week. Will the decision provide a much needed boost to our stumbling economy, or only serve to fuel inflation? Kevin Crowley investigates.

Banking

As the MPC's cut was widely anticipated - all 60 economists surveyed by Reuters predicted it correctly - the short term effects on global credit markets will be minimal. In fact, the leading share index fell 2.6 per cent on the day of the decision because the cut had already been priced into the market for some time. However, bankers will be more concerned about the prospect of the US Federal Reserve cutting rates by 50 bps this week in an attempt to soften the fallout from the credit crunch. Last month the Fed slashed rates by 125 bps.

Verdict: Wait and see

Manufacturing

Industrial production broadly stagnated during the final quarter of last year and output has now fallen during three out of the last four months. If anyone needed a rate cut today then it was the manufacturing industry. But George Buckley, chief UK economist at Deutsche Bank, believes this will not be enough to stave off recession in the sector "during the course of 2008". He added that some industries like chemicals and basic metals, which account for about a fifth of total manufacturing output, are already in recession. Meanwhile David Kern, economic adviser to the British Chamber of Commerce, accused the MPC of not being bold enough. He said: "Today's move, though vital to sustain confidence, is not adequate on its own. The recent dramatic rate cuts in the US highlight the importance of early action. Threats to growth are much more acute now than risks of higher inflation and we would have welcomed a bold UK move to five per cent today."

Verdict: Too little too late.

Employment

In December, the Confederation of British Industry switched its prediction from a fall in 2008 unemployment to a rise of 1.7 million. The economic slowdown expected this year will force companies to cut their costs, the most immediate of which is their workforce. Richard Hyman, managing director of Verdict Consulting, last week predicted that retailers would slash 100,000 jobs over the next two years in an attempt to manage their outgoings. Adam Lent, the Trades Union Congress's head of economic affairs, agreed with the MPC's decision to cut rates because it will stimulate growth. He said: "Today's cut was the correct call. The biggest threat to the economy is not higher inflation, but lower growth. Homeowners will be pleased at the prospect of lower mortgage payments and UK manufacturers will look forward to paying less when they want to borrow to invest."

Verdict: Good call

Housing

After rising in value by over a third since 2003, house prices have stagnated since August, according to Halifax. The availability of cheap credit over the last few years have meant that many mortgage holders borrowed up to five times their income and now fear slipping into negative equity (when your property is worth less than your mortgage). They, more than anyone, will be relieved that their payments are likely to fall, especially at a time of surging energy bills. Michael Coogan, director general of the Council of Mortgage Lenders, said: "This is good news for the quarter of UK borrowers on tracker rates who will see an imminent reduction in rates."

Verdict: Good call

Retail

Now is not a good time to be a High Street retailer. Figures compiled by the British Retail Consortium (BRC) show that like for like sales grew by just 0.3 per cent over Christmas, the worst showing for three years. And it appears that the credit crunch has finally begun to unnerve shoppers: a survey by Nationwide released last week showed that consumer confidence has dropped to its lowest point in nearly four years. Krishan Rama, a spokesman for the British Retail Consortium, believes the MPC got it right. He said: "We're hoping for as many rate cuts as possible this year to ease pressure on the consumer." But he warned: "Conditions are certainly going to be tough for retailers this year, especially in the first half, chiefly due to higher energy costs and a slowdown in consumer consumption."

Verdict: Good call

Conclusion

It is not surprising that all five sectors welcomed last week's decision as the Bank of England clearly needed to take rigorous action to assuage the downside risks to the growth outlook. However, the MPC has its hands tied by the looming spectre of inflation, which it expects to rise "possibly quite sharply" in the coming months. This is mainly due to increasing energy and food prices, which are both rising globally. The MPC's task is complicated by the government's public spending largesse and resulting budget deficit, meaning that it cannot pump in money to stimulate the economy. As the MPC's primary objective is to keep inflation as close to two per cent as possible (the consumer price index was 2.1 per cent in December), we can expect it to be reluctant to heed calls for another 25 bps next month.

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