The MPC last week left policy unchanged but the judgement here is that incoming news warrants a reversal of August’s quarter-point rate hike. Monetary trends are worryingly weak, the global economy continues to slow and business confidence has fallen to a level historically associated with policy easing.
On the latter point, the CBI yesterday released its first-quarter financial services survey, which echoed earlier industrial and business / consumer services surveys in reporting a plunge in optimism. The distributive trades survey, surprisingly, is still showing some resilience but it has often lagged the other sectors historically – see first chart.
The second chart shows a simple average of the optimism balances across the four surveys, along with Bank rate. At -28, the average is the weakest since the 2008-09 recession and similar to the level reached in 1998, during the Russian / LTCM financial crisis. The MPC has always eased policy when the average has fallen to -8 or below. (In 2011, easing took the form of additional QE rather than a Bank rate cut.)
The MPC is reluctant to admit that the August hike was a mistake and is using Brexit turmoil as an excuse to hold fire. This risks allowing a negative confidence / spending spiral to develop, requiring more substantial policy action later. The proximity of rates to the effective lower bound strengthens the case for the MPC to act pre-emptively. A rate cut could be reversed swiftly in the unlikely event of a smooth Brexit and subsequent economic bounce.