The conversation will be more elevated than the usual chatter about what people did on their holidays. When the members of the Monetary Policy Committee gather at the Bank of England this week to set interest rates for the coming month, it will be their first opportunity to take the pulse of the economy since the start of the massive worldwide credit problems sparked by the American housing slump. Here is our monthly round-up of the issues.

The international economy

Global developments are sure to dominate this month’s discussion. Analysts have cut their forecasts for US growth this year and next as the housing crisis deepens: one study showed that US property prices were down by 3.2 per cent over the year and some forecast that ultimately they will drop by 10 per cent, the worst fall since the Great Depression.

Financial institutions have been reluctant to lend to one another as usual, as uncertainty prevails over who holds the now-worthless financial instruments linked to the downturn. Both the European Central Bank and the US Federal Reserve have intervened repeatedly to maintain liquidity.

In Britain, the credit squeeze has increased sharply the cost of inter-bank lending, effectively making it unnecessary, for the moment, for the MPC to raise Bank Rate should it wish to. There is also the risk of a widespread credit crunch that would damage the entire financial system.

Growth: good times may be gone

The squeeze may damage growth, too, but analysts differ over how much. Share values have taken a hit, but the MPC may note that they have only fallen back to roughly where they were at the end of last year, suggesting that the impact on consumer wealth may be limited.

GDP growth is starting from a high base, however. The Office for National Statistics reported that the economy expanded by an above-trend 0.8 per cent in the second quarter, in line with its previous estimate. The Bank suspects that the true figure may be higher, but forecasts that growth will fall back because of the five rises in interest rates since August 2006.

On the high street, retail sales were up by a robust 4.4 per cent in the year to July – but that was helped by steep discounting. Retailers’ prices turned negative at their fastest pace in more than a decade.

Figures out today show waning demand for consumer services. According to the CBI/Grant Thornton survey of the services sector, business confidence has fallen over the past three months, investment plans have been scaled back and sales have fallen in travel, leisure and personal care.

However, manufacturing is still enjoying a strong summer. EEF, the manufacturers’ group, will announce today that activity has strengthened in the latest three months. Its survey shows the highest output and order balances since the first quarter of 1995 and a rise in investment intentions.

Prices: coming under control

The big surprise of the month was the consumer price index, on which inflation fell from 2.4 per cent in June to 1.9 per cent in July, putting it back below the Bank’s 2 per cent target for the first time since March 2006.

That shift does not mean that the Bank can sit back: its rate decisions will take two years to have their full effect and the international environment is less deflationary than it has been in recent years. Yet the fall should keep inflation off the front pages and, in turn, soften inflation expectations.

Headline average earnings growth has continued to soften, falling to 3.4 per cent year on year in the figures for June. Since the Bank has a “comfort threshold” of 4.5 per cent for this measure, these figures are extremely doveish.

Rate verdict: no change

A month ago a rate rise was looking certain but fear has come to replace greed on the stock markets. In these nervy times, anything other than a vote to keep rates at 5.75 per cent would be too big a risk to contemplate.

The sound of silence

The Bank of England’s Monetary Policy Committee prides itself on its communications strategy.

However, whether it was the August holidays or a deliberate effort to avoid further provoking the markets, the panel’s nine members were conspicuously silent last month, giving almost no indications since the last quarterly Inflation Report, issued on August 8, as to the direction of rates and no public response at all to the credit squeeze.

At the start of August, though, Mervyn King, the Governor of the Bank of England, said: “I don’t think there’s any real evidence of a fundamental challenge to the economic outlook.” Mr King added: “Interest rates are not a policy instrument for protecting unwise lenders from the consequences of their past decisions.”

Andrew Sentance, the panel’s arch-dove, gave a lone insight into the surprise fall in inflation, saying: “From a short-term point of view, it is encouraging. But clearly there are still medium-term issues about levels of demand. No one monthly figure in particular is going to have that great an impact.”

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