MPC: grounds for possible policy rate cut

According to the minutes from the 30 September meeting of the Central Bank (CBI) Monetary Policy Committee (MPC), published yesterday, the MPC voted unanimously in favour of the Governor’s proposal to keep the policyrate unchanged. This was unsurprising in and of itself, as we and other official forecasters had anticipated an unchanged policy rate. The CBI’s policy rate has been unchanged since November 2012, and the MPC has been unanimous in keeping it so ever since February of this year, when one member voted against the Governor’s proposal, preferring a rate hike of 0.25 percentage points.

The big news: milder tone from the MPC

The minutes of this most recent meeting feature a much milder tone than did the preceding ones. According to the 30 September minutes, the Committee was of the opinion that there were grounds for keeping interest rates unchanged and for lowering them. This is a new twist, as a rate cut was last discussed was in March 2014, following a relatively rapid disinflation episode. On that occasion, though, the MPC backed away from considering a rate cut at the May meeting, adopting instead a sterner tone and giving voice to the possibility of either keeping the policy rate unchanged or raising it. The June meeting continued in this vein, and in August, the discussion centred entirely on leaving the policy rate unchanged. 

Reasonably strong grounds for a rate cut

According to the minutes, the main argument in favour of a rate reduction was that the monetary stance had tightened more than previously expected, owing to more rapid disinflation. Furthermore, the outlook for the next few months was for more favourable developments in inflation than had been forecast in August. As a result, the current interest rate level could be too high. The Committee also pointed out that inflation expectations had moved closer to target in the recent term, although members agreed that it was cause for concern that they were still somewhat above target. 

Major consideration in upcoming policy rate decisions

In view of our forecast that inflation will fall further in the near future, raising the real policy rate and tightening < img alt="" src="/library/Myndir/Greining/Morgunkorn/141016_ihbe2.gif?proc=_Greining" style="float: left; border-color: #000000;" />the monetary stance, we expect arguments in favour of a rate cut to weigh heavily in the MPC’s next decisions. The next policy rate decision is scheduled for 5 November, which coincides with the publication of the CBI’s new inflation forecast. We think it highly likely that the new forecast will reflect the positive recent developments in inflation and the improvement in the near-term inflation outlook as compared with the CBI’s August forecast. 

Our forecast: unchanged policy rate through mid-2015

The minutes from the MPC’s last meeting state that, as inflation expectations were still above target, there were still grounds for keeping the policy rate unchanged in spite of the decline in observed inflation. By the same token, Committee members were of the view that strong near-term growth in domestic demand and growing tension in the labour market could generate increased inflationary pressures and necessitate an increase in nominal interest rates. Wage negotiations lie ahead, as does the expected disappearance of the output slack – that is, if our forecast and that of the CBI prove accurate. In view of this, we consider it most likely that the MPC will decide to keep the policy rate unchanged well into next year. We expect the next rate change to be an increase taking place in the second half of 2015.