UK Interest Rates On Hold as Bank of England is Paralysed by Fear of Inflation

Interest-Rates / UK Interest Rates Jul 10, 2008 - 01:25 AM GMT

Best Financial Markets Analysis Article The Bank of England Monetary Policy Committee is expected to keep interest rates on hold for a third month at 5% at today's meeting despite widespread calls for a rate cut in response to a collapsing housing market and an economy that is fast falling off the edge of a cliff, which is accompanied by more distress in the banking sector that saw Bradford and Bingley teetering on the brink of collapse earlier this week which resulted in the FSA leaning on the big UK banks to bailout the mortgage bank by agreeing to buy unsold stock at the rights issue price of 55p, against yesterdays close of 43p.

Why is the Bank of England Paralysed Into In-action ?

In one word INFLATION !

The call amongst industry and the city is for Interest rates to be CUT, but they WON'T due to surging food and fuel inflation that is being passed on down the chain to the consumers and hence resulting in inflation as measured by the CPI BUSTING through the Banks upper limit of 3% to presently stand at 3.3% and destined to march higher in the coming months towards 4%. Under these circumstances the Bank of England for at least the next 3 to 5 months is paralysed from acting in either direction for fear of either igniting a wage price spiral as workers demand higher wages to cope with the rising costs of living and hence employers passing on these costs to the consumer thus the spiral begins towards double digit inflation rates or tipping the economy into a deep dark recession on par with the early 1990's.

If the Bank of England succeeds in preventing the wage / price spiral from taking hold then the current inflation surge will prove temporary due to the deflationary impact of the continuing deleveraging of the $500 trillion derivatives market. Which is most evident in the inability of prospective borrowers to to obtain credit as the banks continue to announce ever larger losses and accompanying write downs with demands for cash injections either from the government, the market, or from cash rich sovereign wealth funds. Therefore this paves the way for deep cuts in UK interest rates starting mid 2009, however first the Bank of England needs to successfully steer the country through the current stagflationary environment.

However a spanner in the works is via the increasingly incompetent Gordon Brown Government which seems hell bent on pressing the electoral self destruct button. The government has lost its backbone and is seemingly incapable of saying NO to those that ride on the New Labour gravy train by agreeing to cash hand outs of several billions in order to try and buy votes. We have seen this in the May elections when the government gave away £3 billion ahead of the elections in response to the 10% tax band fiasco, and is likely to give away several billions more to placate vocal and rebellious public sector workers. The consequences of spending money that the government does not have is inflationary i.e. it completely undermines the Bank of England's strategy of keeping interest rates on hold to try get through the current inflation surge without triggering a wage price spiral. Well the government through its fiscal and spending policies IS fanning the flames of a wage price spiral.

The UK Is experiencing the perfect storm of DEFLATION as the housing bear market erodes home owner equity by several thousands of pounds every month, and INFLATION in the input and output prices surging to 20 year highs, therefore pushing the economy towards a Stagflationary recession during 2009.Whilst 2008 remains on target to achieve the Market Oracle forecast of 1.3% GDP growth for the year as of December 2007.

What the Bank of England Should Do!

The best strategy under current circumstances is for short sharp pain, meaning that the Bank of England should RAISE interest rates to send a signal to the Market and the workforce that any inflation busting pay rises will be countered by Interest Rate Hikes. This would have the twin effect of a. Lifting sterling and this reducing inflationary pressures on import prices and b. To nip stagflation in the bud, so as to ensure that the Bank of England is in control and ready to CUT interest rates following an earlier peak in inflation. Therefore eliminating some of the uncertainty of whether the Bank of England will be able to prevent the wage price spiral contributing towards a prolonged period of stagflation during 2009 which would prevent interest rate cuts as the BOE would be following events rather than creating the conditions for recovery.

Market Oracle Track Record of Calling Monthly Interest Rate Decisions

Month	Market Oracle Forecast	Actual MPC Decision	Outcome
July 08	No Change	Pending
Jun 08	No Change	No Change
May 08	No Change	No Change
Apr 08	0.25% Cut	0.25% Cut
Mar 08	No Change	No Change
Feb 08	0.25% Cut	0.25% Cut
Jan 08	No Pre-call	No Change	-
Dec 07	0.25% Cut	0.25% Cut
Nov 07	No Change	No Change
Oct 07	No Change	No Change
Sept 07	No Pre-call	No Change	-
Aug 07	No Change	No Change
Jul 07	0.25% Increase	0.25% Increase
Jun 07	No Change	No Change
May 07	0.25% Increase	0.25% Increase
Apr 07	No Pre-call	No Change	-
Mar 07	No Pre-call	No Change	-
Feb 07	0.25% Increase	No Change
Jan 07	0.25% Increase	0.25% Increase
Dec 06	No Pre-call	No Change	-
Nov 06	0.25% Increase	0.25% Increase
Overall Rate Forecast Accuracy			93%

By Nadeem Walayat

Nadeem Walayat has over 20 years experience of trading, analysing and forecasting the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 150 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors before engaging in any trading activities.

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Comments

Bob B
10 Jul 08, 05:18

I say cut rates

They should cut because the current inflationary spike is imported and they have no control over it. The commodity price bubble won't last forever and indeed a sharp reversal before the end of the year is entirely probable, given the slowing of the global economy. Second round effects are not likley in a situation where every sector of the UK economy is contracting. The economic data over the past month indicates an acceleration in the slowdown and a sharp slide into recession is now on the cards and the time to act is now, not next year, when the hole may be so deep, the Bank of England will be largely redundant.

Bob B

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