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The BoE cuts interest rates for the first time since July 2003Economics Weekly: Economic Research and Analysis
The BoE cuts interest rates for the first time since July 2003
As widely expected, the Bank of England (BoE) cut the base rate by 25bp to 4.50% last week. This was the first change in the base rate since rates last rose to 4.75% in August 2004 and the first cut since July 2003, when rates fell to 3.5%. The debate now moves on to how the BoE views the outlook for the economy and inflation over the next two years. A profile that the Bank will publish next week in the latest edition of the quarterly Inflation Report, from which sterling and gilt investors will try to derive where base rates are headed in the coming months. It is our view that last week's rate cut was predominantly a precautionary measure, and not the start of a prolonged period of monetary easing. On the condition that we see no further deterioration in household spending, a strengthening global economic backdrop, a decline in the sterling trade weighted exchange rate and the rally in equity markets will in our view underpin the UK economy in the quarters ahead. The publication of the Inflation Report on Wednesday and the associated press conference, chaired by governor King, will reveal how the Bank believes the economy and inflation could evolve in the period ahead.
UK data this week are limited and front-loaded. Producer prices for July are due this morning and should show a further squeeze higher in input prices on the back of higher oil prices and a 1.2% depreciation in trade weighted sterling. The annual rate should ease back however, from a record high of 12.1%, assuming past revisions are not significant. Output prices are expected to reverse the declining trend of the past two months, with the annual rate forecast to have accelerated to 2.5%. The ODPM house price index should show a third successive fall in annual price growth. The BRC retail sales monitor will be released overnight on Tuesday and may show that conditions on the high street remained tough in July, with the terrorist attacks in London possibly having depressed activity further. UK foreign trade data have been disappointing of late, but could show a smaller deficit if last week's signal from the manufacturing PMI is confirmed and exporters have been able to capitalise on weaker sterling and firmer global economic activity.
In the US, the Federal Reserve is overwhelmingly expected to raise interest rates by 25bp on Tuesday for a 10th consecutive meeting, lifting the fed funds rate to 3.50%. The FOMC statement will be subject to careful scrutiny after a slew of strong economic data since the last meeting in July. A more upbeat assessment on the level of output, consumer spending and the labour market, but a less conciliatory tone on inflation, could send ripples through currency, bond and equity markets worldwide. The latest US foreign trade figures for June will be released on Friday.
In the euro zone finally, first estimates for Q2 GDP will be published in Germany, France and Italy. A disappointing set of numbers have already been priced in, and are unlikely to elicit a meaningful reaction. However, brighter forward looking surveys and solid industrial output data from Germany suggest the euro zone economy is gradually turning, and poised for a stronger performance in Q3.
Jeavon Lolay, Senior Economist
Kenneth Broux, Economist
Trevor Williams, Chief Economist
Lloyds TSB Bank,
London EC3R 8BQ
0207 283 - 1000
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