August 3rd, business news BBC Radio 4, 6.15

Vocabulary

This morning, did the Bank of England get it badly wrong over interest rates, and how giving shares to employees could hit company profits?

One of the City’s leading economic teams has warned that the Bank of England’s surprise cut in interest rates was a cut too far. The Bank’s monetary policy committee cited weaker global economic growth and the strength of Sterling when it made the quarter point cut yesterday. But economists at Barclays Capital said they fear the domestic economy driven by consumer spending is stronger than the Bank realises and it may be forced to make an abrupt U-turn. Of course City economists may be feeling a bit sore this morning as none of them in a poll by Reuters predicted the interest rate cut. So what does the monetary policy committee know that the rest of the City appears not to? Well, who better to answer that question than a former member of the committee, Sir Alan Budd, who is on the line now.

Good morning, Sir Alan.

Good morning.

What do you think has changed? What do you think has weighed particularly with the members of the monetary policy committee?

I think it is the two features they mentioned in their press release, that they are worried about the weakness in the world economy and they are worried about sustained strength of Sterling. I think it is important to remember this is a month in which they do a complete new forecast.

They think very, very thoroughly about the way in which the economy is heading, and they obviously decided in the course of the month that the economy wasn’t growing as fast as they’d previously thought. They probably had given up hope that the exchange rate might fall in the near future and so those, the combination of those two factors makes them think that it’s safe to cut interest rates.

Of course one of the key elements of that forecast is what they expect to happen to inflation in two years’ time. Do you think they’ve got some new projections on inflation as well, which has influenced the decision?

Well, I think as part of their forecasting process. They will have come up with a lower forecast on the basis of unchanged interest rates so they change interest rates and you will notice when their forecast is published in a week’s time that we meet exactly 2.5 per cent in two years’ time, which is what they are always trying to achieve.

So that if they kept interest rates where they were that figure in two years’ time would have been significantly below 2.5 per cent. Is that what they’re saying?

It would be below it. Not necessarily significantly below, but it would have been below it and their task is to keep inflation as close as possible to 2.5 per cent. Not below it and not above it.

Do you think the Bank has essentially conceded that we do have a two-speed economy and it’s better to keep the fast bit going if you like than to end up in a recession.

They have always conceded that there is a two speed economy and they have been very worried about it but they have to look at the economy as a whole, they can’t set policy, unfortunate as it may seem, just to help manufacturing, but they have obviously decided that if you put the whole economy together, then it does justify, the potential slow-down does justify a cut in interest rates.

When we look at the behaviour of other central banks, like the Federal Reserve in the United States, for example, they also see their role sometimes as being a champion of growth of cutting interest rates to make sure that the global economy continues to grow. Do you think the Bank in its own modest way has also said, yes we’ve got to do our bit to keep the world economy out of recession.

They’ve always denied that in the past and the sour truth is that what we do isn’t going to have as much effect on the world economy as what the Federal Reserve does. I think they concentrate on their own task. That’s the best thing for them to do, and they … If it helps the world economy along, so much the better. But I don’t think that would have been their primary objective.

OK, so what about this warning from some economists this morning that the Bank may have gone too far, may have to reverse this cut?

Yes, that’s fair enough, but the great strength of the monthly policy committee is that it looks at these matters each month and it has never shown that it’s afraid to change its mind. If it thinks it’s got it wrong, it’ll change. A quarter per cent cut is pretty small. They’ll see how it runs, but they say if they think the information changes, then they’ll happily reverse that. Well, that’s what they’re supposed to do.

Do you think the decision to cut was unanimous among the members of the committee?

I should be very interested to see that. I … I … That’s difficult to know and I think I won’t even guess. It could well have been unanimous. They might have decided that the evidence was overwhelming, but we may find that one or two of them resisted it and didn’t vote for the cut.

Of course, there was a big contrast yesterday: the UK cut rates, the European central bank in the Euro zone didn’t cut rates. There seems to be a big contrast in monetary policy developing between the UK and the rest of Europe. Would you agree to that?

I do agree with that. They have a rather different way of looking at things. I happen to think that our way is better. The European central bank is always very worried about what is happening to inflation at this particular moment and finds it difficult to cut interest rates when inflation is above what appears to be its target. The monetary policy committee has this forward looking method, which I think is much better, and they don’t want to worry so much about what is inflation today, but where is it going to be in a year or so’s time, and if the economy’s weak, then they can respond by cutting interest rates. The European central bank finds it much harder to do that.

Sir Alan, thank you very much for joining us this morning.