• The Monetary Policy Committee today decided to leave interest rates on hold at 4.5% for the tenth consecutive month, and rates are likely to remain there for the rest of the year too.
• Admittedly, the Committee has recently moved closer towards a rate hike as David Walton voted for an immediate interest rate increase at May’s meeting. And the term of Steve Nickell, who voted to reduce interest rates in each of the previous six meetings, ended last month.
• Some of the latest data has been supportive of higher rates. Indeed, there remain upside risks to inflation as the previously announced electricity and gas price hikes have yet to feed through fully into the inflation data. Furthermore, the most recent news on activity has been reasonably strong with retail sales having increased by an average of 0.6% in each of the three months to April, compared to the average rise of 0.2% seen last year.
• However, activity might not be as strong as these figures suggest as the pick-up in retail sales has been partly due to a surge in demand for high definition televisions in the run-up to the World Cup. With the World Cup now imminent, such an effect is likely to have peaked.
• What’s more, the last month has seen a trio of asset price movements that have weakened the economic outlook further out. The fall in the number of mortgage approvals from 114,000 in March to 106,000 in April and the modest monthly rises in the Nationwide and Halifax house price indices in May suggest that the recent resurgence in housing market activity may be past its peak. Together with equity prices currently sitting some 7% below the high reached in May, it is likely that consumer spending growth will not be as strong as the Committee thinks.
• And on top of that, the sterling trade-weighted index has risen by 2% since May’s MPC meeting. If this level were to be sustained, it is likely to reduce GDP growth and have a downward impact on CPI inflation over the course of the next two years due to lower exports growth and import prices.
• The upshot is that the events in the financial markets over the last month suggest that if the MPC were to re-run its economic forecasts they would probably show that the 2% inflation target can be met without higher interest rates.
• As such, although acute risks remain, I think that talk of higher interest rates is a bit premature. And if the global economy weakens as I expect, it is still possible that UK interest rates will need to fall next year as the MPC seeks to support domestic demand.

Roger Bootle
Economic Adviser to Deloitte

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