I had intended to make my own modest comments about the recent cut in the Bank of England base rate but did not get there before the announcement and was travelling to Australia post-announcement. Since arriving here, I have been suffering from the brutal jet lag that only travelling half way around the world with small children can induce.
Anyway, I have also had the chance to catch up on the podcasts of some of the business radio programmes I enjoy and it was interesting to note that sentiment seem to swing from no expectation of a cut to its seeming inevitability in just a few days. Economists, and those putting themselves forward as economic pundits (perhaps, there is no difference) are an odd lot, they seem to revel in being negative. For them, it makes much better copy if they propound all of the reasons why the outlook for inflation, in particular, is poor and appear to have little faith in those steering the economy, or trying to, to make the correct decisions. For the wannabe policy makers, the risks of being optimistic are too high and they have the benefit of being able to apply hindsight to events after the fact.
The real policy makers face very different risks; they are charged with keeping inflation under control and ensuring economic stability. Their mistakes are measured in real human suffering and there is little comfort in being able to explain away mistakes after losing their jobs or in facing a parliamentary committee.
The Monetary Policy Committee of the Bank of England apparently faced their most difficult decision last week with inflation still presenting a threat and the economy facing the unknown dislocating effects of the unfolding credit crunch. To my mind, and I think to theirs, the decision to cut was a good deal easier than the pundits would have us believe, the real question was by how much. A modest cut would present little real inflationary pressure in the short run whilst allowing them to signal to consumers and businesses that the period of rising rates was most definitely over. Also, in the real world, the rate at which many borrow is determined by the now famous London Inter Bank Offered Rate (Libor), which dictates the cost of borrowing for many lenders, and this was almost one percent higher than base rates, very much higher than usual. The credit market, therefore, was applying the brakes to economic activity much more strongly than the Bank considered appropriate and, therefore, a modest cut on their part would not represent a major loosening of monetary policy when delivered through to the consumer.
Also, had the MPC waited for a clearer indication of where things were going, they would start to look as if they were mere passengers rather than the macro economic managers they are paid to be with a consequent lessening of their authority and ability to direct expectations of future inflation.
My guess is that rates have further to fall, simply because keeping them high would run the risk of a recession or a large house price fall (which amount to the same thing in many people’s minds) and if either of those were to occur, many would have prefered a modest spurt of inflation.
