Our MPC-ometer model suggests a narrow 5-4 vote for a 25 b.p. cut at this week’s meeting. According to a Reuters poll, only 15 of 56 economists expect a change this month. However, the Sunday Times Shadow MPC has voted 5-4 to ease, with four of the majority group seeking a move of 50 b.p. or more.

There are three main reasons for expecting a change. First, the November Inflation Report was dovish, with the MPC’s inflation and growth forecasts reduced significantly from August. Assuming unchanged 5.75% official rates, inflation is now projected at 1.74% in two years’ time, down from 2.08% in August. The 26 b.p. shortfall from the target is the largest negative deviation in any Inflation Report since the MPC’s inception in 1997. The alternative scenario based on market expectations shows inflation on target in two years assuming a 50 b.p. rate cut by the third quarter of 2008. Meanwhile, annual GDP growth is forecast to fall from an estimated 3.5% last quarter to just 1.9% by the third quarter of 2008, down from 2.6% in the August Report.

Secondly, economic news since the November meeting has been slightly weaker than expected on balance. GDP growth in the third quarter was revised down from 0.8% to 0.7%, with the details showing stagnant business investment – previously expanding strongly – and a large rise in stocks. Housing market indicators continue to soften: the four main price indices have all now registered monthly falls, while mortgage approvals for house purchase slumped 30% by value in October from a year before. Exports are at risk from slowing demand in continental Europe, with the latest Eurozone purchasing managers’ survey showing new business at a two-year low.

Thirdly, money and credit markets have weakened significantly since the November meeting. A Merrill Lynch index of yields on sub-investment-grade UK corporate bonds has risen by 50 b.p. since 8th November, breaching 10% for the first time since 2003. The key three-month interbank rate has climbed 35 b.p. over the same period and currently stands at an 80 b.p. premium to Bank rate, the highest since Northern Rock imploded. Longer-term rates have risen by considerably less (six-month is up by 20 b.p.), suggesting the surge in the three-month rate partly reflects year-end funding pressures and may therefore prove temporary. Nevertheless, financial conditions are clearly tighter than assumed when the MPC finalised its forecasts, arguing for bringing forward official rate cuts that the Inflation Report indicated would be needed in due course.

The vote is likely to be close because inflation indicators are currently still flashing warning signals. Consumer inflation expectations and price-raising plans in business surveys remain elevated, while energy price gains have contributed to a sharp acceleration in producer input costs. Regular pay growth appears subdued at an annual 3.7% in the three months to September, according to the traditional average earnings index measure, but the alternative average weekly earnings series is significantly higher, at 4.7%. Exchange rate weakness is also a concern, with the effective rate down by nearly 2% since the Inflation Report forecast was finalised. However, the MPC has historically been prepared to ease policy despite unsatisfactory inflation indicators if activity data and / or financial market conditions have shown sufficient weakness. The MPC-ometer combines the various factors using weights derived from an analysis of past decisions and suggests the balance has now tipped in favour of action.