Interest rate monitor: May decision

What will be going through the minds of the MPC when it makes its interest rate decision on Thursday? Sarah Routledge examines the UK economy.

On Thursday the Bank of England's monetary policy committee (MPC) announces the outcome of its monthly meeting deciding whether to lower, hold or raise interest rates. We assess the current economic situation to work out what might be running through the heads of its nine members in the run-up to April's meeting.

April's decision

Last month the MPC opted to reduce interest rates from 5.25 per cent to five per cent in a decision that split the committee. Six members of the MPC including the governor, Mervyn King, as well as Rachel Lomax, John Gieve, Kate Barker, Charles Bean and Paul Tucker voted in favour of a 0.25 per cent cut.

But three members voted against, with Tim Besley and Andrew Sentence voting to keep the rate steady at 5.25 per cent and David Blanchflower asking for a bigger cut to 4.75 per cent.

A deterioration in the global markets persuaded the committee that a cut was needed to support the economy, as the credit crisis deepened, and no-one proposed raising the rate. But the members who voted to keep the rate steady reiterated their concerns that inflation would rise faster than anticipated unless measures were taken to control it.

The UK economy

Retail

Sentiment is still down on the high street after a disappointing Easter. Official figures from the Office for National Statistics (ONS) found total sales volume fell by 0.4 per cent between February and March, the largest decrease since January 2007 when it fell 1.7 per cent. Food sales, which have been robust up to now, fell 0.1 per cent.

For April, the Confederation of British Industry (CBI) asked high-street retailers how sales compared to last year and 52 per cent said sales were down, compared to 25 per cent who said sales were up. Overall, this signals the weakest trade environment since November 2005 and is only expected to improve slightly in May, according to the industry body.

Property

The housing market continues to attract hysterical headlines, as surveys confirm sharp falls in price and mortgage availability continues to tighten. Nationwide Building Society said prices fell 1.1 per cent in April, the sixth consecutive monthly fall, and dragged annual growth into the red – with prices down one per cent since April 2007. The annual fall is the first for 12 years, Nationwide said.
Although figures are not yet available for April, official house price data from the Land Registry has shown house prices in England and Wales fell by 0.4 per cent in March. And topping predictions of house price falls, a member of the Bank of England's monetary policy committee has warned house prices in the UK could be set to fall by a third over the next two to three years.

Manufacturing

Prices at factory gates climbed 6.2 per cent from a year earlier, compared with 5.9 per cent in February, as a rise in petrol taxes pushed up manufacturing costs.

According to the ONS, if the changes in taxes on tobacco and alcohol announced in the Budget had been passed on in full, the index would have increased a further 0.3 per cent in March.

In addition, the UK's GDP slowed to 0.4 per cent in the first quarter of 2008, compared with 0.6 per cent in the previous quarter. Both the production and service industries saw a slowdown in comparison to the fourth quarter of 2007. Total production output decreased by 0.1 per cent in the first three months of the year, compared with 0.2 per cent growth in the fourth quarter, mostly due to a fall in mining and quarrying production.


Consumer confidence

The outlook of UK consumers fell to its gloomiest since November 1992 in April, research has shown.

The GfK NOP consumer confidence index now stands at minus 24 points - compared with minus six points a year ago.

In addition, Lloyds TSB Corporate Markets found despite official labour market data remaining strong, confidence in the health of the UK job market dropped sharply. Some 47 per cent of those polled said employment prospects in the UK were set to improve, 39 per cent thought they remained stable. A total of 21 per cent felt less secure in their jobs, with the index falling five points.

Inflation

The rate of inflation in March has remained unchanged at 2.5 per cent as increasing energy bills were offset by high street discounts. Retail figures from March show a drop in sales as consumers feel the credit crunch bite and shops have been discounting stock aggressively in order to bring consumers back. But an increase in transport costs - especially air fares - and energy bills kept upward pressure on the index, with the overall inflation rate remaining flat as a result.

This week's decision…

…will probably be to hold. The Bank's committee was clearly split on the last decision and no doubt there will be further disagreements this time. David Blanchflower, the member pushing for a larger cut, made his feelings clear in a speech last week when he said houses will lose a third of their value over the next few years unless interest rates are cut.

But in the latest financial stability report, governor Mervyn King urged banks not to panic and to continue lending as normal. It is likely more cuts are on the way, with most analysts expecting the base rate to drop to 4.5 per cent by the end of the year, but with Mr King favouring a softly-softly approach, May rates seem set to remain at five per cent.