Readers Question: with economic scare, do you advise to invest? how do you predict inflation and interest rates will affect business?
In the UK, interest rates have only fallen slightly since the start of the global credit crisis. The Bank of England has reduced rates from 5.75% to 5.25%. The Bank is still worried about inflationary pressure (CPI inflation recently increased to 2.6%) Also the RPI rate suggests underlying inflation (the rate people actually face) is higher at over 4%
There is an increase in cost push inflation, due to factors such as: rising energy prices and rising food prices. This makes it difficult for the MPC to cut rates and still achieve the government’s inflation target of 2%
However, I still feel that interest rates will fall over the next 12 months. Falling house prices will definitely reduce consumer spending and this will reduce economic growth and therefore inflation. With low confidence and falling spending, the MPC might be able to cut rates to 4.75% or 4.5% by the beginning of 2009. If the housing market really starts to crash as some economists predict, we could even see interest rates fall to under 4%. However, at the moment I don’t think a housing crash is the most likely scenario
Credit Crisis and Interest Rates
However, although the Bank may cut base rates, business may not see interest rates fall. This is because the commercial banks take advantage of the credit crunch to raise their own interest rates. Therefore, commercial lending rates may increase due to shortage of funds, even though the bank cuts the base rates.