Britain: The Bank of England Navigates a Split Economy

The Bank of England kept interest rates steady on Dec. 5, even after the Federal Reserve and European Central Bank cut their target rates. The hold-tight stance of the BOE shows the finesse needed to manage a slow-fast split economy.

British real gross domestic product grew at a 0.8% quarterly rate in the third quarter, or by 1.8% from a year ago. Fast-spending consumers accounted for most of the growth. Their real purchases rose 0.9% last quarter and 3.7% over the past year.

Consumer spending is being buoyed by strong labor markets. The jobless rate remained at a 27-year low of 3.1% in October, and salaries are up by 3% in the past year. Finances are also getting a boost from home values, which in November jumped by 29% over the past year, according to a major British mortgage lender.

Consumers are tapping into this rapid buildup of wealth. Home equity loans rose by 10.6 billion pounds ($15.9 billion) in the second quarter, according to BOE data. The uptrend in borrowing is one reason real GDP is expected to rise an additional 0.7% this quarter.

Mervyn King, set to become the BOE governor in June, 2003, has expressed concern about the housing market. If prices collapse, Britain could fall into recession. Conversely, if home prices continue to surge, consumer inflation, already at 2.1%, could worsen.

In the meantime, manufacturing remains the slow side of the economy, in part because of falling exports to the U.S. and the euro zone. October industrial production was down 1.2% from a year ago. The November purchasing managers' index weakened. And pricing power is nil among industrial companies. Producer prices fell 0.2% in November, after no change in October.

The economy's split has the BOE in a bind because a rate cut designed to help out manufacturing would also lower mortgage rates and boost home prices further. For now, analysts are expecting that inflation fears will win out and that the BOE will hike rates sometime in the first half of 2003.

By James C. Cooper & Kathleen Madigan

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