Look For A Cut From The BoE

It is highly likely that the Bank of England will reduce the Official Bank Rate at its October 8-9 meeting and while a 25 basis point cut to 4.75% is the most likely scenario, it is well within the realm of possibility to see the bank move by 50 basis points.

The Bank of England's own Credit Conditions Survey for the third quarter, which was completed before the recent intensification of the global credit crisis, painted a dismal picture. Lenders reported a worse-than-anticipated reduction in secured credit availability to households and businesses over the period and anticipated a further decline over the next three months. Lenders also said default rates on loans to households and businesses were higher than expected and anticipated that the rate of defaults would increase.

Reports last week indicated that Britain had entered its first recession since 1992. The Chartered Institute of Purchasing and Supply said its purchasing managers' index fell to 41.0 in September, the fastest rate of decline since records began. The output, new orders and employment components saw unprecedented declines. Also, the Office for National Statistics (ONS) said the service sector, which comprises more than 75% of the economy, failed to expand for the first time in 6 years in the three months to July. In fact, excluding a special holiday period in 2002, the service sector has not been weaker since the ONS began tracking the data in 1995. Finally, Nationwide reported that house prices dropped by 1.7% in September, the 11th straight monthly fall. Average prices have now fallen by £23,000 since their peak in October 2007 and the 12.4% annual rate of decline was the largest since Nationwide first began the series in the early 1990's.

Four members of the "shadow" MPC, which meets under the auspices of the Institute of Economic Affairs, have called for a half-point reduction at this week's meeting. Three others voted for a 25 basis point cut and two voted to hold. However, one of the members who voted to hold is now saying a move should be made due to the most recent deterioration in credit conditions, which one said, "defy hyperbole".

"There was a widespread view that the major financial failures of recent weeks, and some easing in the price of oil, had significantly altered the output inflation trade-off facing the authorities," according to the minutes. However, members expressed concern that even aggressive cuts might have less impact than in the past. One member likened it to using a "peashooter against a tank."

"Sterling declined just over 20% against the dollar over a five month period during the last British recession in 1991 when output declined 1.4% in the year," said Matthew Carniol, chief currency strategist at TheLFB-forex.com. "While the pound has declined just over 16% from the 2007 high it's down by just over 12% from July, when the economy likely started to contract on a quarterly basis. The pound could actually wind up down around the 1.61 area by year's end, given that the market could price in recession of at least a similar magnitude by taking into account the current poor state of credit markets."

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