BoE and ECB to Keep Interest Rates on Hold | ForexGen

The Bank of England and European Central Bank are likely to keep their key interest rates on hold on Thursday at 5.0% and 4.25%, respectively, as inflation rates in both regions continue to greatly exceed the official 2% target. The worsening backdrop for economic growth in both regions has not gone unnoticed but stable interest rates are vital if the two central banks are to succeed in bringing inflation back under control. The monthly US employment report will be under scrutiny on Friday as participants evaluate whether the rebound in Q2 gdp growth to 3.3% annualised can be sustained in Q3 and Q4. We forecast a rise in the unemployment rate in August to 5.8%. Interest rates in Australia could be cut on Wednesday for the first time since 2001.

Aside from MPC member Blanchflower's comment last week that 'interest rates should be cut' and the downward revision to Q2 gdp growth to flat from +0.2%, we don't think UK economic trends have shifted enough since the Inflation Report in August to believe that a move in the BoE base rate is imminent. If anything, the fact that Mr. Besley stuck by his view last month of a need for higher interest rates testifies to the different views on the MPC as it worries about the course of inflation. A stronger than forecast gain in retail sales in July, +0.8%, and a 2-month high for the FTSE-100 last week are likely to convince the Bank that leaving interest rates at 5.0% is the best contribution it can make to ensure that inflation falls back to target. Whilst economic conditions in general remain tough and below trend gdp growth means that spare capacity in the economy should rise, the uncertainty of where CPI inflation will eventually peak against a backdrop of still very vigorous M4 money supply growth and a 12-year low for sterling (trade weighted) leaves no room for complacency.

The MPC decision will be preceded by the key PMI surveys of manufacturing on Monday and services on Wednesday. The decline in both indices below 50 in Q2 was quite accurate in forecasting stagnation in economic growth. Given the ongoing concerns that tight credit and high inflation could tip the economy into recession - not our forecast - this week's data should offer some indication whether conditions are stabilising or deteriorating further at the end of Q3. More pivotal with regard to the near-term inflation outlook is the direction of prices. Last month, PMI surveys for the first time in three months signalled that output price pressures could soon stabilise.