Interest Rate Predictions

The MPC are responsible for setting interest rates. In theory, their only target is low inflation. - CPI inflation of 2% +/- 1.

Therefore, the determination of interest rates depends primarily upon the prospects for inflation. In setting interest rates, the MPC will consider various economic statistics which give an indication of inflationary pressure in the economy. These will include:

1. Economic growth / compared to the long run trend rate. If growth is above the long run trend rate (2.5%) then it is likely that inflationary pressures will increase.
2. House prices. Falling house prices will reduce consumer spending and therefore inflationary pressures
3. Exchange Rate. A devaluing currency will increase inflation because of cheaper exports and more expensive imports
4. Spare Capacity. The % of firms who say they are operating close to full capacity
5. Levels of Investment.
6. Cost push inflation. e.g. prices of commodities and energy prices.
7. levels of consumer confidence.

Although, the MPC is supposed to only concentrate on inflation, in practise they will take into account levels of economic growth. The prospect of recession, may tempt them to cut interest rates even if it means inflation may rise.

Predictions for UK Interest Rates

The MPC are still concerned about inflationary pressures, e.g. rising price of oil and other commodities. They have been reluctant to cut rates from 5.5%

However, not all in the MPC support the hawkish stance on inflation. Prof David Blanchflower has said:

“Worrying about inflation at this time seems like fiddling while Rome burns.”

This is an interesting quote because it shows that targetting inflation is not always the highest priority for economists. In the medium term it is most likely interest rates will fall because of the following reasons:

Why Interest Rates are likely to Fall in UK

1. Slowdown in housing market will feed through into lower consumer spending and lower growth. If house prices fall alot, a big cut in interest rates could be needed
2. US interest Rates falling. The UK and US interest rate cycle often move together. Cuts in US interest rates may encourage the UK to follow suit.
3. Fall in mortgage approvals. A key sign to the strength of the housing market; the fall in  mortgage approvals suggests lower house prices during 2008.
4. Low consumer confidence resulting from house prices, stock market falls and global credit crunch (e.g. Northern Rock)
5. Credit crunch may get worse.

• UK rate cut vital - Article at Guardian