British economy may not be galloping ahead but at least it's stable, writesKevin Daly
In the midst of ongoing global economic weakness and equity market turbulence, the UK economy has appeared an oasis of stability. The Office for National Statistics' (ONS) preliminary Q2 release suggested that the economy expanded by an impressive 3.7 per cent annualised.
This follows two quarters of slow but positive growth. Unemployment - as revealed by yesterday's labour market statistics - remains stable at 5.1 per cent. This rate has not been higher than 5.2 per cent or lower than 4.9 per cent since December 2000.
Consumer expenditure has held up relatively well and, as consumer confidence remains well above its historical average, there is little suggestion that a collapse is imminent. Reflecting this domestic strength - and in part feeding it - is the continuing strength of house prices. The Halifax house price index was up 20.8 per cent year-on-year in July, similar to the 21 per cent reported by the Nationwide. Add to this the contribution to growth from the British government's ambitious spending plans for health and education, and one can see why the speculation was that a UK rate hike was imminent.
Yesterday's release of the minutes of the August 1st meeting of the Bank of England's Monetary Policy Committee (MPC) demonstrates how much and how quickly the mood has changed. The vote itself was quite innocuous - a unanimous vote for unchanged rates. Deputy Governor Mr Mervyn King rejoined the majority, having voted for a hike in July.
However, the shift in the rhetoric was substantial. For the first time in several months, the MPC discussed the case for a rate cut: low inflation, falling equity prices and a fragile global recovery were all factors in favour.
The arguments for leaving rates on hold - rising inflation in the forecast and continuing increases in house prices - were, at this stage, seen as more compelling. No case was made for higher rates.
Developments since August 1st suggest that the arguments in favour of a cut are likely to become increasingly persuasive.
RPIX inflation - the rate that the MPC targets - rose from 1.5 per cent to 2 per cent in July but is still well below the official target rate of 2.5 per cent. To get inflation back to target, the MPC cannot afford any renewed weakening in economic activity. Yet last week's shocking June industrial production data removed at a stroke any evidence of a recovery in manufacturing output.
Recent business surveys suggest a recovery in the third quarter is unlikely to be forthcoming. Given this evidence of weakness, it is likely the UK MPC will cut interest rates 50 basis points to 3.5 per cent by the end of the year.
Kevin Daly is an economist with Goldman Sachs.
