Rate cut clamour misses the point
Simon Ward
2 Comments
With full data now available, both my MPC-ometer and ECB-ometer models suggest rate cuts tomorrow of 50 basis points, though with risks tilted towards more.
Models can break down under extreme conditions. Markets are priced for a full-point UK move and 75 bp from the ECB. It would take a brave central bank to disappoint expectations under current circumstances.
At least in the UK’s case, however, the model’s suggestion that a 50 bp cut is sufficient appears sensible given the 200 bp move in the prior two months, a 7% decline in the effective exchange rate since the November meeting and massive fiscal loosening announced in the Pre-Budget Report (with plans for later tightening predicated on a highly-optimistic economic forecast).
A headline-grabbing big cut in Bank rate may give the impression that the MPC is “doing something” but efforts would be better focused on direct actions to boost money and credit growth, including “underfunding” and Bank of England purchases of private paper. In the US, the Fed’s initiatives in this direction are bearing fruit, with narrow money M1 picking up and the three-month LIBOR / OIS spread of 180 bp well below the UK level of 250 bp.
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Reader Comments (2)
Your final paragraph summarises the situation perfectly. If the BoE can't find ways to reduce the LIBOR/OIS spread, a rate drop wont create the desired stimulus.
However the way your model is apparently strongly influenced by the exchange rate in predicting the size of cut seems flawed - especially in these abnormal circumstances. When the unexpected (and in my view late) 1.5% cut came, note that Sterling didn't fall at all in immediate response, but instead devalued gradually over the subsequent weeks. The market is trying to predict the long term value of Sterling (i.e. demand) rather than being driven by base (or even interbank) rates. The falls over the last few days are more about publication of poor indicators than discounting today's cut.
It would be better to have a 100 point cut now, so that the market is thinking about future increases, rather than going back to the usual dripfeed, which with the benefit of hindsight is always shown to have been too little too late.
Just some thoughts. Thanks for your excellent journal.
Thanks for your comments. I hope you are right about a 100 bp cut offering support to sterling, given the vulnerability of the banking system to a withdrawal of overseas funds.