My MPC-ometer model has been suggesting an October rate cut for several weeks and recent data have confirmed the forecast. According to Reuters, only 21 out of 66 economists projected an October move in a Reuters poll last Wednesday but opinion had shifted by the end of the week, with 49 respondents expecting a cut, of which four forecast a half-point reduction.

The MPC-ometer was designed to answer the question “How will the MPC vote given incoming data and the current level of Bank rate?” Used in this way, the forecast is for either a 7-2 vote for quarter-point cut this week or – more likely – 1-5-3 (Blanchflower voting for a half-point again).

The trouble with this approach currently is that the model is unlikely to capture fully the impact of the seizure in money markets on the MPC’s thinking. One way of addressing this is to change the question to “How will the MPC vote given incoming data and the current level of three-month sterling LIBOR?” On this basis, the model predicts a unanimous vote for a cut and an evens chance of a half-point reduction. (This is based on today’s 6.27% three-month LIBOR fixing.)

Another issue is that the Committee will have an early look at the September CPI figures, which may show annual inflation moving above 5%. This would have a small effect on the above forecasts but a quarter-point cut would still be odds-on even using the model in the normal way.

While several MPC members may vote for 50bp, I suspect a majority will prefer a quarter-point cut with a follow-up move next month. Current economic risks stem less from the price of money than the complete breakdown in the plumbing of the financial system, a problem better addressed by direct official intervention, including the Bank of England intermediating money and credit flows – see previous post.

Central banks are assuming the role of clearing houses for interbank business. Instead of bank A borrowing directly from bank B, A now accesses generous official credit facilities while B places its excess cash on deposit with the central bank. The new role should ease pressure on the banking system but may prove difficult to reverse.

The latest Fed balance sheet figures illustrate the change. Reflecting various new lending initiatives, total Fed credit rose by $503 billion, or 51%, in the fortnight to Wednesday. Meanwhile, banks with excess cash placed an additional $90 billion on deposit at the Fed and are likely to have taken up part of the recent increase in Treasury bill issuance, with the Treasury onlending the proceeds to the central bank.

The Fed’s increased willingness to extend credit amounts to an implicit guarantee on interbank liabilities. Any bank unable to refinance its wholesale borrowing can bridge the gap using official facilities. In theory, the Fed is protected by collateral requirements but these are now loose and the value of the security in any fire sale is highly uncertain.

The combination of the Fed’s expanded intermediation role with an increase in deposit insurance from $100,000 per account holder to $250,000 implies the US authorities now stand behind the bulk of the banking system’s liabilities. The Irish government has been criticised for introducing a blanket guarantee of its banks’ borrowings but the effect of recent US actions is similar.

Having resisted using its own balance sheet, the Bank of England is finally emulating Fed-style intervention. Its total assets rose by £69 billion, or 58%, in the fortnight to Wednesday. The Bank today announced a further loosening of its collateral requirements for its weekly auctions of three-month funds to include asset-backed securities based on consumer and corporate loans and asset-based commercial paper.

My ECB-ometer model suggests a 37% probability of a rate cut this week, up from 34% last month. See chart.

Assuming no change in the inputs, a reduction before year-end is now viewed as almost certain.

The further move towards easing territory reflects falls in business confidence, inflation expectations, M3 growth, short-term bond yields and stock markets. The main factor holding the model back from predicting a cut this week is the absence to date of any explicit dovish signal from ECB President Trichet.

The statement issued after tomorrow's meeting is likely to refer to diminishing upside inflation risks and / or increased downside growth risks, giving a clear hint of a move in November or December.

I shall post the MPC-ometer forecast on Monday but initial indications are consistent with my expectation of a rate cut at next week's meeting.