Three-way headache for rate setters

Posted by admin on 23 July, 2008 under Business news | Be the First to Comment

The Bank of England has told us it faces the toughest economic challenge in decades.

Now we know it is split three ways over what to do about it.

The old joke says that if you ask five economists the same question you will get six different answers.

It is not such a laughing matter when there are three different answers from the experts striving for the correct response to such troubled times for the economy.

More acute

There has been only one other three-way split in the Monetary Policy Committee’s 11-year history.

And that was in May 2006 when the UK’s economic problems were not nearly as acute as now.

The minutes of the July meeting of the MPC reveal how members were tugged in different directions.

The rapid acceleration in inflation was troubling enough.

But the possibility that the economic slowdown would turn into something worse was weighing equally heavily on the meeting.

The minutes acknowledge that the decision to hold rates at 5% was a “difficult” one.

These minutes lay bare the painful dilemma facing the MPC.

Inflation is heading north and well away from the target of 2%.

Cutting interest rates now would appear at odds with the Bank’s inflation fighting remit.

But acting tough now runs the risk of pushing the economy into recession and dragging inflation below its target a year or so down the line.

Anchored expectations

One member, Tim Besley, a well known inflation hawk, voted for a quarter percentage point rise in rates.

For him an immediate increase was needed “to keep medium-term inflation expectations anchored and ensure the Committee’s credibility”.

The Bank’s David Blanchflower has continued his calls for a rate cut

But another, David Blanchflower, with a long track record as a dove, felt the “activity data had been uniformly gloomy…and activity now seemed likely to contract sharply in the near term, possibly for several quarters”.

The other seven members of the MPC opted to hold rates.

They noted that inflation was likely to move higher and growth slow more markedly than they thought at the time of the May Inflation Report.

They also argued that a rate change would be easier to communicate at the time of the next Inflation Report, due in August.

More to come?

So stand by for another knife-edge interest rate decision next month.

By then there will be more data on the extent of the economic slowdown and the Bank will have updated its inflation forecast.

The economic climate could well have worsened but there may yet be another three-way split.

News reported by The BBC