Is the Bank of England preparing to cut Base Rate?

It’s Inflation Report time again, so out come the crystal balls.

 Back in April I made the radical, if slightly tongue-in-cheek, forecast that base rate would increase in early 2013 based on the comments coming out of the MPC at the time. Like any good coward I made sure to qualify it with the standard line: if it doesn’t work out that way, I can always claim something changed in the meantime. Unfortunately it appears my esteemed editor cut that caveat (let’s hope that’s a  lesson learned!) but my word things certainly have changed.

 Since then we’ve had Greece doing a regular Eurokey-cokey (in, out, in, out), Spain moving from a worry to a disaster, the UK becoming a safe haven(!), sterling rising to the extent that it’s almost worth going on holiday again, tanking GDP, inflation dropping at a pace beyond Sir Mervyn’s wildest dreams, yet more QE, TWO new extraordinary funding measures, and an innings defeat at the Oval. All of which (ok, possibly not the cricket) contributing to a much more dismal outlook now than we had just a few months ago.

 The August Inflation Report, just released, has more or less given up on any growth this year – notwithstanding a presumed positive contribution from the Greatest Corporate Sponsorship Event On Earth – down from the 0.8% growth they’d forecast as recently as May. Inflation likewise is expected to fall to around 2% by the end of this year and then more than likely drop below the 2% target later next year, and possibly for some time after that.

 Of interest are, as ever, the assumptions feeding this forecast – the implied market rates. This is what money markets appear to be pencilling in and are used as the basis of the Bank’s ‘what-if’ model. The latest chart looks like this:


There’s a radical shift there – in May the markets had base rate drifting upwards over 2013-14 but now they are suggesting a cut from, well, any time now basically.

 To repeat, the numbers in that table underly the forecasts in the Report – so the implication is that even the Funding for Lending Scheme and a 0.25% cut in base rate still mightn’t be enough to get inflation up to where it should be. That’s about as close as they come to saying “we’re definitely going to do it”.

 However Mervyn King has already gone out of his way to counter such hasty conclusions suggesting that further cut to Base Rate could be counterproductive, and in any case it’s far too early to say what impact Funding for Lending will have. But as some commentators have pointed out, if FLS fails to stimulate the economy (and make a further cut unnecessary), the cheaper funding would make banks better able to tolerate any base rate cut – and the associated reduction in income.

 That said, another 6 months or so should give time to see how FLS pans out and that would tally with the market rates placing a drop from 0.3% to 0.2% in Q2 next year. If there were to be a Base Rate cut, the expectation seems to be around the time of the May 2013 Inflation Report, so at least I was right about something. Maybe.


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