The immediate policy decision
The news on UK-weighted world demand had been slightly on the downside over the past month – with prospects for the euro area looking a little weaker than expected at the time of the Inflation Report, although growth in the United States remained stable. In the United Kingdom, GDP growth in 2005 Q1 had been revised down, broadly as expected at the previous meeting following the weak March industrial production data. The latest indicators, particularly CIPS services, pointed to output growth continuing to be close to trend in Q2.

A succession of weaker surveys suggested that, on balance, the risks to the near-term Inflation Report output projection were perhaps slightly more to the downside. But those surveys tended to be drawn largely from manufacturing. There were fewer indicators on the stronger, and much larger, service sectors – where analysis continued to be heavily reliant on the CIPS services survey. In terms of expenditure, the latest data and surveys had also highlighted the risk that investment and export growth, taken together, might not fill the gap left by slower consumption growth. But more evidence was needed on the volatile investment and trade
components of GDP, and the Quarterly National Accounts and annual Blue Book data were due to be published shortly.

There was little news on labour market quantities, and what news there was hinted at a slight
easing of labour market conditions. Regular pay growth had slowed. Import prices in Q1 had risen broadly as expected. There were some signs of an easing in the rate of increase in input and output prices in both the official data and surveys. Earlier increases in prices were moving further along the supply chain into the distribution sector. Consumer price inflation remained close to target and there had been no significant news in the April and May outturns.

For most members, the evidence warranted no change in official interest rates this month. There were a variety of arguments, on which different members placed different weights. For those members, although recent indicators pointed to slightly weaker growth in the near term, the outlook for inflation had not changed sufficiently since the May Inflation Report to justify a change in interest rates.

The two most important risks identified in the May Report had concerned the outlook for consumption and the reasons for the rise in CPI inflation. Both of these risks remained unresolved.

Although there was no new information on the latter, on the former there were signs that household spending growth might have stabilised, albeit at a low rate. The indicators did not provide conclusive evidence of whether the slowdown in consumption was a temporary adjustment, concentrated primarily in durables and semi-durables spending, or whether this was the beginning of a wider slowdown in private sector spending. So there was not enough evidence to decide between the competing hypotheses discussed at the previous meeting, nor to move away from the central projection made at the time of the Inflation Report.

There had been a fall in market interest rate expectations over the past month. That amounted to a loosening of monetary conditions and would consequently tend to support activity. But there was time to gather further evidence on the depth and extent of the slowdown in consumption to see if lower interest rates were warranted. A reduction in interest rates at this juncture would be a significant surprise, and would run the risk of the inference being drawn that the Committee believed that the situation had deteriorated more than it, in fact, thought.

And if the latest consumption indicators, in fact, presaged a return to stronger domestic demand growth, a reduction in rates now might accelerate the recovery in consumption growth and lead to inflationary pressures.

For some other members, the evidence over the past month was enough to warrant a reduction in interest rates of 25 basis points this month. The further weakness in the euro area pointed to weaker UK-weighted world demand. Domestically, the composition of GDP growth in Q1, together with the latest monthly indicators, a slowdown in unsecured lending and tighter credit conditions, amounted to some downside news to the outlook for activity. Nominal GDP growth had been slowing, while the labour market had shown signs of easing.
This, and the recent slowing of producer price inflation, suggested that demand pressures were less than previously thought. As a result, it now seemed more likely that much of the recent increase in inflation had reflected higher oil and other commodity prices passing through the supply chain, rather than the pressure of excess demand on supply capacity.

Although output growth had so far been fairly resilient in the face of weaker consumption, GDP
growth was likely to be weaker than in the May Inflation Report central projection, notwithstanding the shift in market interest rates. Inflation might therefore be below target in the medium term. While there were arguments in favour of waiting for more information before taking action, that risked the slowdown in consumption becoming more entrenched. A small reduction in rates now might obviate the need for a larger reduction in interest rates at a later date.

The Governor invited members to vote on the proposition that the repo rate should be maintained at 4.75%. Seven members of the Committee (the Governor, Rachel Lomax, Sir Andrew Large, Kate Barker, Richard Lambert, Stephen Nickell, and Paul Tucker) voted in favour. Two members of the Committee (Charles Bean and Marian Bell) voted against, preferring a reduction in the repo rate of 25 basis points.

They are also available at:
(http://www.bankofengland.co.uk/publications/minutes/mpc/pdf/2005/mpc0506.pdf).