LONDON, Feb.11 (MktNews) - Following its shock decision to ease monetary policy last week, the Bank of England has some explaining to do. Wednesday's Inflation Report is likely to make clear that the prospects for gro]wth deteriorated sufficiently enough over the past few months to warrant risking a cut in interest rates.
A number of commentators described last week's cut in the repo rate to 3.75% as a gamble. With house price inflation at levels not seen ]since the late 1980s, personal debt at record levels and consumer spending still firm, it wasn't a surprising conclusion.
While the BOE would never use a word such as gamble to describe its interest-rate decisions, the bank will probably admi]t that there are risks to its rate-easing strategy. It will stress, as it has done in the past, that the risks of not cutting rates were greater. As always, the main focus will fall on the BOE's forecasts for both inflation and growth over t]he coming two years. It is the growth forecast that will probably see the laregst revision this time around.
In a statement accompanying the latest cut in interest rates, the BOE said that "the prospects for demand, both globally and domestica]lly, are somewhat weaker than previously anticipated." In the November Inflation Report, the BOE forecast growth to rise above 3% on the year in early 2003 before falling to just under 2.5% in 2 years' time. This has proved too optimsitic. T]he latest estimate for GDP in Q4 showed growth running at 2.2% on the year. Growth in Q1 this year is likely to be closer to around 2.5% on the year.
The global economy has also been a little weaker than expected than at the time of the Nove]mber report, which will dampen growth prospects ahead. The BOE, though, will have a more difficult job explaining the new-found weakness it sees in the UK economy. While it will point to weakness in the forward-looking survey eviden]ce such as the latest CIPS services and manufacturing surveys, most of the official data, with the exception of the investment figures, have been firm.
The continuing strength of the housing market and the fact that the latest cut in interes]t rates will only serve to exacerbate the current imbalances in the economy will no doubt be a highlight of the press conference following the report's publication. On inflation, the BOE will not surprisingly publish a forecast showing RPIX ]inflation on track to hit the target in two years' time. Of more interest will be the risks around the forecast and the profile over the coming two years. In the November report, the BOE projected inflation to rise above target to just un]der 3% in the short-term and remain there throughout much of 2003, before falling to target in two years' time. Risks were seen slightly to the upside on inflation.
The short-term outlook has hardly changed. RPIX currently stands at 2.7% and] could tick-up to 3% over the coming months. Further ahead, the MPC probably judged at the February meeting that RPIX would fall below target in 2004 and remain there until the end of the 2-year forecast horizon. Given the cut in the repo rate, the f]orecast presented in the Inflation Report is unlikely to change significantly from November. And given the low level of rates and the continuing strength of the consumer sector, the risks around the forecast will probably remain to the upsid]e.
Where will the Inflation Report leave the monetary policy debate? Interest rate markets rallied sharply following last week's cut in the repo rate and are now pricing in another 25-basis-points easing by June. While there remains a] risk that the BOE will cut interest rates again in the short-term, especially if the global economy fails to meet expectations, the BOE must have some concerns about fuelling the consumer sector too much and adding to economic imbalances.
F]or this reason it seems unlikely the BOE will want to give any signals that interest rates are likely to be cut further over the short-term. And by keeping the risks to the inflation forecast on the upside, the bank will effectively be ]saying don't expect any cuts soon.
Still, there is one large caveat. The November Inflation Report contained a similar message, and the January minutes strongly pointed to rates on hold over the short-term. And still the BOE cut interest rate]s. ///www.marketnews.com