Business-Insider

Don't be surprised to see the BoE pro actively reduce rates at this week's meeting. Tighter credit conditions and a slowing housing market are projected by a number of economists (and by the BoE itself) to constrain investment and consumer demand at the same time that inflation (as projected by the OECD) is projected remain close to the 2% target over the next two years. BNP Paribas noted that "as opposed to the past when the BoE tended to make policy changes in the same month as the Inflation Report release, three of the last four interest rate moves came outside of Inflation Report months."

BNP also noted that "the composite of the two Chartered Institute of Purchasing and Supply (CIPS) surveys provides a pretty accurate sneak preview at the likely growth rate of GDP, months ahead of the official release. The fall in the
CIPS surveys to date points to a slump in the growth rate, from around 0.7% 0.8% q/q over the last eighteen months, down to around 0.3% q/q in the coming few quarters". But there are even more ominous indicators.

According to BNP, "the quarterly CBI financial services survey released 3 months ago proved to be an accurate leading indicator that the services sector CIPS was likely to plunge (as it did). The latest update to that survey was released on Monday and suggests the fall in the CIPS services survey has at least another 5 points to go. During past crises or sharp downturns, the fall in the CBI series is a pretty good guide to where the CIPS will go. In the context of
growth, expansion of 0.3% q/q is probably the best we can hope for in the early quarters of 2008 – more likely we will get readings closer to zero".

The BoE said in the December minutes that “the prospects for demand both globally and domestically are somewhat weaker than previously anticipated” and that “to keep inflation on track to meet target over the medium term the committee judged that it was necessary to reduce interest rates”.

J.P. Morgan sees weakness in the first half of the year followed by a "slight pickup" in the second. "In contrast to the
2004-05 downturn, the most reliable and timely indicator of current growth momentum—the service PMI—has
already fallen sharply below its average". They believe the MPC’s "willingness to move policy rates lower will be important in limiting the behavioral shifts associated with slower growth for both households and corporates."

A serious threat faces U.K. consumers from falling house prices after several years of ten to twenty percent gains and there's evidence that consumer confidence is eroding because of muted real disposable income growth and heightened debt levels. Mortgage re-sets have increased payments and a sharp slowdown in government spending which had helped to support growth is occurring. The deficit has risen to over 6.0% of GDP, which means that fiscal stimulus will be difficult to implement and that the economy will be more dependent of fast action from the BoE.

Bloomberg notes, "there was a 61 percent chance the Bank of England will lower its benchmark interest rate a quarter-percentage point from 5.5 percent today, according to a Credit Suisse index of probability derived from overnight indexed swap rates".

"If the U.K. enters a series of interest-rate cuts, more people will believe that the credit crisis will continue to move eastward and hit Europe next,'' said Mark Meadows, a strategist at currency-trading company Tempus Consulting Inc. in Washington. "People are getting anxious and buying back dollars against Sterling and a little bit against the Euro.''

The WSJ presented an interesting perspective: Chancellor of the Exchequer Alistair Darling said at a news conference that Britain's relatively low inflation rate meant the Bank of England could cut rates again.

"Inflation is amongst the lowest in the [Group of Seven leading industrial nations], and that gives us the flexibility to face the present times," he said. "That has enabled the Bank of England to cut interest rates and gives it room to make further reductions -- if it believes it would be right to do so."

It would seem that all available evidence points to the need for the BoE to lower interest rates by 25 basis points in both the first and second quarters of 2008. The Bank has acted pro actively before and because the risks to growth would seem to outweigh those for inflation, a move by the BoE at this time appears to be justified.

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