OxBowBusiness

What the MPC REALLY talks about

The mpc meets on Thursday of this week (9th March) ... you have heard of the mpc haven't you? You know, the Monetary Policy Committee of the Bank of England ... the committee that sets UK interest rates. Well, what do they talk about every month? After all, all we hear is that interest rates stayed the same, or not; and in general who said up or down or stay. But what do they really talk about as they arrive at their decision?

Let's take a look at the MPC meeting held on 8th and 9th February 2006 shall we? The answer's yes, we shall!

The minutes are freely available at the Bank of England's Web Site and the link for that is given at the end of this post.

In addition to talking about its projections for output and inflation, the MPC discussed:

• developments in financial markets
• the international economy
• money, credit, demand and output
• costs and prices

Developments in Financial Markets: one thing that comes across clearly here is that the committee members are taking their lead from the people who influence the financial markets. They say things like, Sterling money market instruments implied that interest rate expectations were broadly flat over the next year or so ... Both UK and US long-term implied forward interest rates had been little changed on the month ...

They also admit that they don't know everything: they say such things as, There had been a rise in long-term forward rates in the euro area, the reasons for which were unclear. (emphasis added)

The International Economy: several paragraphs under this heading are devoted solely to the USA and we shouldn't be surprised by that as it is the most important single economy in the world. The Euro area and Japan are also given star billing: again quite rightly. Oil and other energy sources are a key factor and feature here too.

The minutes illustrate the sorts of background reading that members do when they discuss the Purchasing Managers Index (PMI) and the European Commission industrial confidence [data].

Money, Credit, Demand and Output a total of five paragraphs of discussion under this heading. Interestingly, we can see again what it is that members of the committee are reading for background ... things that you and I might read. Take a look:

Data from the Office for National Statistics (ONS)
The CIPS/RBS services business activity index
The CIPS/RBS manufacturing index
The BRC- KPMG Retail Sales Monitor
CBI Distributive Trades Survey
The average of the lenders’ house price indices [they don't mention their sources here]
The annual growth rate of the M4 monetary aggregate [again no mention of sources]

Costs and Prices the committee began by talking about the unemployment rate increasing to 5.0% in the three months to November and noted that it is at its highest since 2003. They then suggest that The slackening in the employment rate might have reflected the beginning of an unwind in the labour hoarding that had been a possible explanation for the low productivity growth recorded recently.

Then they concluded that If that were the explanation, it was possible that employment growth could remain subdued for at least another quarter or two.

Pay settlements came next, followed by a discussion about average earnings growth. That, probably naturally, let to the thought that they ought to discuss

• overtime and other elements of non basic pay
• productivity
• profits
• activity

Finally in this section the said that an advance estimate of CPI inflation for January had been provided to the Governor ahead of publication. This had indicated that inflation was 1.9% in January. There were also revisions to the past data. In particular, the December inflation rate had been revised down from 2.0% to 1.9%.

The February GDP growth and Inflation Projections The central projection for CPI inflation, on the market based assumption about the path of official interest rates, was for it to remain close to the 2% target throughout the forecast period, as a declining contribution from the prices of energy and imported consumer goods was offset by a gradual increase in the pressure of demand on capacity.

The Committee’s best collective judgement was that the key risks to the central projection related to:

the outlook for consumer spending;
the prospects for net exports;
the sustainability of low long term interest rates;
the margin of spare capacity;
the evolution of energy prices and their impact on inflation.

There was a range of views among members, but the Committee judged that, relative to the central projection, the overall risks were to the downside for growth and broadly balanced for inflation.

Stemming from the above, then, The Committee’s projections for GDP growth and CPI inflation conditioned on a constant interest rate of 4.5% were similar to those based on market rates, reflecting the broadly flat interest rate profile implied by the market yield curve for the next two years.

Which led them to their decision for the month ... in the following section, there are a lot of arguments but they have been signficantly condensed in the minutes and I have condensed them even further here.

The Immediate Policy Decision Against this backdrop, there were a number of arguments in favour of leaving the Bank’s official interest rate unchanged, to which different members attached different weights.

So how did they arrive at their final decision ... what did they take into account?

• global growth
• demand growth in the UK’s primary export markets
• consumption
• the housing market
• post tax labour income
• saving rate

That was followed by discussions on:

• GDP growth
• the housing market and consumption again
• inflation
  
• consumer price inflation
• energy prices more generally
• prices of energy and imported consumer goods
• demand on capacity
• energy prices yet again
  
• GDP growth
• capacity utilisation
• spare capacity in the economy
• consumption
• investment
• inflation

Finally, the vote The Governor invited the Committee to vote on the proposition that the repo rate should be maintained at 4.5%. Eight members of the Committee ... voted in favour [one] voted against, preferring a reduction in the repo rate of 25 basis points.

The minutes are freely available on the Bank of England Web Site.

Duncan Williamson

posted by Duncan Williamson @ 7:17 PM