Why interest rates could soon be falling

Analysts detected a doveish tone from the bank, which has a near impossible job given Britain’s febrile political climate and Brexit-related uncertainty, says James Moore

Which way will he jump? Brexit leaves Bank of England governor Mark Carney on the horns of a dilemma (Reuters)

Given the febrile state of British politics, and the chronic uncertainty (there’s that word again) created by Brexit, no one’s really sure in what direction that might be.

So let’s run through the scenarios.

A crash-out Brexit is theoretically illegal (at least from the British side) but don’t kid yourself. It could still happen. The bank’s rate-setting Monetary Policy Committee (MPC) has to plan for all contingencies and it is very definitely one of them.

In the event that this happens, it says movements in rates “would not be automatic and could be in either direction”.

On the one hand, the MPC faces the prospect of the pound falling down a hole and stoking inflation. On the other hand, there is a high likelihood that consumers, who’ve helped to prop the economy, will take fright, reducing domestic demand, and thus, inflationary pressure.

They’re already showing signs of nerves. The Office for National Statistics recorded a surprising 0.2 per cent fall in retail sales for August, although the three months to August (the better measure) delivered a modest 0.6 per cent rise.

It’s not just Brexit at work in the numbers. July got a boost from Amazon’s Prime Day, for example. It was over by August, contributing to the weakness in that month.

But Brexit fears among consumers are still running high and can be seen in other indicators. John Lewis, for example, slumped into the red in the first half of its financial year in part because of shoppers avoiding big-ticket items.

It seems a no-deal cut from the current 0.75 per cent would be more likely than not, in an attempt to stimulate demand and mitigate the fairly awful consequences.

How well that would assist an economy in the midst of a shock the likes of which it hasn’t experienced in peacetime remains to be seen.

What about a deal and a smooth exit? That may, says the MPC, lead to gradual but limited rises, assuming that the economy picks up and businesses turn on the taps out of relief as much as anything else. Such an outcome looks unlikely right now, but stranger things have happened.

And if the impasse continues? With a general election or even another referendum being possible next steps? The MPC issued some additional comments about ongoing uncertainties “in an environment of weaker global growth” and reduced domestic inflationary pressures, which caught the eye.

Watchers of the bank’s Monetary Policy Committee described those words as “doveish”. It’s saying, in other words, rates might come down.

At this point it’s worth noting the annual rate of inflation, which fell sharply to 1.7 per cent in August. That leaves it at its lowest in nearly three years and well below the MPC’s 2 per cent target.

It’s also worth paying attention to the fact that the MPC is a little out of step with central banks globally. Those in China, India, the US, Europe, at a time when people are fretting about the global economic outlook.

With Brexit up in the air, the MPC’s failure to follow suit is very understandable. They say a police officer’s lot is not a happy one. That’s no less true of an MPC member in the current situation. Against that backdrop, standing pat makes sense.

But the odds do seem to be increasingly favouring a cut. Bad luck, savers.