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No Rise In Interest Rates - MPC

In August the Bank of England’s Monetary Policy Committee (MPC) voted to hold UK interest rates at 5.75%, the level set the month before. The 5.75% rate was the highest since March 2001 and represented the fifth rise in twelve months, having taken the base rate from 4.5% last August.

Minutes from the meeting in August 2007 showed that the MPC voted 9-0 to hold rates, saying that members “had no firm view” on whether rates needed to rise further to keep inflation under control.

Until recently most experts were tipping a further rise to 6% - sooner rather than later. However, stock markets have been in turmoil in response to credit and debt fears, sparked by the collapse in the US sub-prime market in which funds have become worthless and other institutions have borrowed against these funds. This caused more than a 10% fall in the FTSE 100 index in just a few days. That was the first sign that maybe interest rates would have to stay at 5.75%. This week’s inflation news has provided another. The Consumer prices Index (CPI) was down to 1.9% in July – below the government’s stated target of 2%. Since the MPC looks to get inflation as close to 2% as possible, it may be running out of reasons to hike the rate again.

It is the MPC that sets the base rate. The minutes from this month’s meeting said that the short-term outlook for inflation “was still clouded with uncertainty, particularly about the path of household goods, food and utility prices”. It was also noted that more upward effects were also expected from recent oil price rises; however, some rises have already made their way through to retail prices.

Last week’s Quarterly Inflation Report from the Bank had hinted that a further rise in UK rates might be needed to control inflation. A week has been a long time in the financial markets, and many parameters have changed.

The 9-0 MPC vote was the first unanimous vote since May (rates went up by 0.25%) With the “no firm view” quote it appears that the MPC is hedging its bets about future rises. With the volatility of markets at the moment, who can blame its members?

As food was one of the main causes of the fall from 2.4% to 1.9%, the impact of recent flooding across the country will be critical in determining future food prices. Another factor was furniture prices, which are unlikely to be held down for ever.

The impact of the last two rate rises has yet to be felt by mortgage holders, and especially those who have been on low fixed rates for the past two years. A high new interest rate on their mortgage could well stop their spending in its tracks.

Stock market falls will have hit some investors’ confidence and that could start an economic downward spiral, irrespective of how low inflation is.

Finally, these days people seem to want to spend while they can, hankering after the good life. The word that inflation is down to 1.9% might breed a false sense of confidence and send them out onto the high street again.

Tom Smith
17th August 2007

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