Cut the rate...

Cut the rate...

Financial markets' reaction to news that one of the Bank of England rate setters, Tim Besley, voted to raise interest rates earlier this month is as predictable as it is probably wrong.

Markets were spooked into thinking that maybe the Bank would still raise interest rates soon, or at least would not cut them for ages. They seemed to forget, of course, that another member, David Blanchflower, had voted for a cut at the same meeting.

These were the same financial markets, remember, that until recently were pricing in two or even three interest rate rises. Now they have moved back to just about pricing in the next move to be a cut some time later in the year. The predictive power of these markets, perhaps more than ever, is in doubt.

The problem is that a lot of the traders on City dealing floors are not old enough to remember anything other than a Labour government, let alone what a recession feels like.

The minutes, in reality, expressed the state of high anxiety among the monetary policy committee's nine members about when and how to support a rapidly flagging economy when at the same time inflation is rising.

This is why they have left rates steady at 5% for the last three months, having reduced them from 5.75% between last December and this April. The minutes acknowledged that the decision had been a "difficult one".

"Keeping Bank Rate at 5% when the economy was slowing was arguably already sending a strong signal of the MPC's.....continued below

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commitment to reducing inflation," the minutes said. In my view that means that the difficulty was about whether to hold rates steady or cut them.

Then there was a very interesting statement. "A rate change this month would be a surprise at a time when credit and other financial markets remained fragile, and any change in rates would be better communicated alongside the Bank's August inflation report."Now you could read the word "change" as meaning either a cut or a rise. For me, though, this is a clear hint that a cut in rates could come as soon as August.

Why? Because over the coming fortnight the MPC members will be doing their quarterly inflation and growth forecasts. The outlook for growth is likely to be awful. The data have been pointing for some weeks to rapid weakening in activity. And today we have a record low in mortgage approvals to remind us how bad the housing market is and a five-year low in business confidence reported by the CBI. Confidence is now down at the sort of levels we saw after 9/11 and during the Asian financial crisis of 1998.

So the growth projection in the inflation report will have to be sharply lower than the May one. That will almost certainly lower the inflation forecast in 18 months to two years' time - the MPC's preferred time horizon.

Blanchflower argued in a Guardian interview earlier this week that the MPC could do little about inflation in the coming months - a point also made by Bank governor Mervyn King last week.

With oil prices now sliding below $126 a barrel, it is possible that the projection will show inflation, which currently stands at 3.8%, back below its 2% target in two years' time. In which case there is only one thing the committee can do - cut rates.

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