The “MPC-ometer”* forecasts an easing of policy at this week’s Monetary Policy Committee meeting – its output is consistent with either a quarter-point cut in the Bank rate to 0.25% or a £75 billion expansion of gilt purchases.
The model, admittedly, predicted that the Committee would ease last month, when only David Miles voted for action. It is, however, sometimes early – for example, it forecast that QE2 would start in September rather than October last year. The MPC’s inaction last month seemed inconsistent with the May Inflation Report, showing a mean projection for CPI inflation in two years’ time of 1.8% based on unchanged policy.
Most of the model’s 12 inputs have shifted in favour of ease over the last month. GDP was revised lower, business and consumer surveys weakened, average earnings growth slowed further, CPI inflation moved lower, consumer inflation expectations eased, credit spreads widened and stock prices fell sharply.
The MPC-ometer was estimated on data since the Committee’s inception in 1997 so represents its historical “reaction function”. A failure to ease this month would suggest that either this reaction function has shifted (e.g. in response to the sustained inflation overshoot of recent years) or the MPC believes it is effectively “out of ammunition” at current super-low interest rates / gilt yields (although the latter view has yet to be voiced by any Committee member).
*The “MPC-ometer" is a statistical model designed to predict monthly Monetary Policy Committee decisions based on incoming economic and financial data. The model’s dependent variable is the weighted-average interest rate vote of the Committee’s members. For example, if five members want to raise official rates by 25 basis points (bp) while four prefer no change, the weighted-average vote is +14 bp (five-ninths of 25). If it is assumed that votes are either for no change or a move of 25 bp – reasonable under “normal” economic and financial conditions – then the model forecasts an actual rate change when the weighted-average prediction is greater than +12.5 or less than -12.5 bp. QE is incorporated by treating £100 billion of gilt purchases as equivalent to a 35 bp cut in Bank rate – this fits the data since QE started in March 2009. The MPC-ometer’s 12 inputs were selected on the basis of statistical analysis and can be grouped into indicators of economic activity, inflation and financial market conditions. The inflation sub-set is largest, comprising the latest headline annual increases in consumer prices and average earnings as well as several measures of expectations. Activity indicators include GDP growth and business / consumer confidence while credit spreads and movements in share prices and the exchange rate are used to gauge financial conditions. Importantly, the model also includes the prior month’s average interest rate vote to capture any revealed bias.