Bye, Bye UK Rate Cuts

If we thought the Bank of England was walking a tightrope before, then the Bank's May inflation report says the rope is even tighter. Since the February report growth expectations have deteriorated and inflation expectations have strengthened.

On the growth side the Bank says the outlook for growth is now somewhat weaker than it was in the last report. Its central projection sees growth bottoming out at somewhere between 0.75 percent and 1.3 percent in the last quarter of this year.

Inflation is now seen spiking higher and for longer than in the past quarterly report. The Bank sees inflation staying above the 2 percent target for some time and its central projection says this situation could persist until early 2011. What's more, inflation will stay above 3 percent for several quarters necessitating the Bank to write a number of explanatory letters to the Chancellor. 

So on the face of it the answers have not become any clearer and things are just worse on all fronts compared to the previous quarter. But what this week seems to have shown us (the inflation report and the inflation data that has already been released) is that the economist community is having second thoughts about rate cuts from the Bank as early as next month. Capital Economics says a June cut now looks pretty unlikely and any further loosening will be modest in the foreseeable future. They call this seriously bad news for the economy.

Some economists may say we are heading for stagflation but as long as the "flation" is more evident than the "stag" it is hard to see how the BoE can cut rates. What will be interesting to watch over the coming months will be if the same (similar) government that made the Bank of England independent back in 1997 might now put pressure on the Old Lady to cut rates.

Brown's government is being blamed for the stresses in the economy: just who will Gordon Brown blame? (Apart from the Americans -- he and Alistair Darling have already been doing a lot of that.)

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