Interest rates are high enough, say economists

The Economy: CBI finds sharp decline in business confidence ahead of Bank meeting

THE BANK of England's Monetary Policy Committee is set to keep interest rates on hold this week, according to City economists, although the weaker pound and worrying trends in earnings growth mean the decision is likely to be finely balanced.

New evidence of faltering manufacturing confidence released today by the Confederation of British Industry will increase the pressure on the MPC to hold fire on rates.

The CBI/Pannell Kerr Forster quarterly survey of SMEs - small and medium- sized enterprises - found that manufacturing SMEs were cutting jobs because of sharply falling orders, output and business confidence.

Over the last four months, SMEs reported the largest fall in orders since October 1991, according to the CBI. Business optimism fell at the fastest rate since January 1991.

Last week, evidence of sharp declines in confidence throughout the manufacturing sector prompted the CBI to call for a rate cut for the first time in almost three years. Andrew Buxton, chairman of the CBI's economic affairs committee, said: "The risk of a sharper slowdown outweighs the risks of higher inflation."

At its latest meeting, the shadow Monetary Policy Committee - a collection of academic and industry economists - also came to the conclusion that rates were high enough, although the committee stopped short of calling for a rate cut.

The minutes of the meeting, released today, show that the majority of the shadow MPC wanted to keep rates on hold. The committee also raised concerns about the Government's new generous spending plans, saying they would lead to higher interest rates over the medium term.

Data released over the last month has given plenty of ammunition to the "doves" who believe interest rates should be frozen. There have been a variety of surveys showing falling business confidence, a weak set of inflation figures and evidence of slowing growth.

However the "hawks", who want rates to rise, can still point to worrying trends. Private sector earnings grow strongly, while the recent depreciation of sterling - which closed at DM2.909 on Friday - could also stoke inflation.

When the MPC surprised the City in June with a 0.25 point increase in base rates, earnings growth and a bout of sterling weakness helped tipped the balance in favour of a rate rise.

Marion Bell at the Royal Bank of Scotland commented: "For the August meeting, a rate hike remains possible, with a further acceleration in average earnings growth likely to play on the MPC's mind. The concerns of the Bank seem to centre around average earnings growth and a sharp depreciation of sterling."

The other key factors in the equation are the Government's new spending plans and the national minimum wage. The Bank has yet to take either of these issues into consideration in its quarterly forecasts.

It is currently part way through preparing its August inflation bulletin when the impact of the policy changes will be taken into account. Some believe that if the Bank's analysis shows the policy changes have jeopardised the chances of meeting the inflation target, rates could go up again.

Economists at HSBC said: "On balance, we expect no change, but the new public spending plans and weakening sterling present upside risks."