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• Today’s decision by the Monetary Policy Committee to leave interest rates on hold at 5.75% largely reflects the recent financial market turmoil and the sharp fall in inflation. But these developments do not mean that a further rate rise is out of the question. I think there is still a fairly good chance that interest rates will be raised to 6% before the end of the year.
• The market volatility of the last month will only prevent a further rate rise if the MPC deems that it has significantly dented the outlook for activity and price pressures. Indeed, the Committee said as much in a statement released alongside today’s decision. But while some impact can be expected, I think it will be small.
• Admittedly, equity prices remain about 5% below July’s peak. But the rebound in recent weeks has left them around 3% higher than at the turn of the year. Accordingly, households’ financial wealth is unlikely to have been materially affected. In any case, household spending is more sensitive to changes in housing wealth, which has continued to increase as house prices have risen further.
• The bigger threat is that households and companies may now find it more expensive to borrow. Indeed, three month market interest rates, which are a benchmark for some mortgage rates and corporate loans, have risen by 0.75% over the last month. But money market interest rates are likely to fall back once confidence returns to the banking sector.
• In any case, the latest data suggest that the economy is in a good position to cope with any fallout from the financial markets. National Statistics confirmed that the economy grew by a solid 0.8% in Q2. And the more up-to-date CIPS/RBS business surveys recorded a strengthening in activity in the manufacturing, construction and services sectors in August.
• What’s more, the inflation concerns that led the MPC to raise interest rates five times in the last year, and to signal in the Inflation Report published at the beginning of August that another rise was likely, have not gone away. Admittedly, CPI inflation fell sharply from 2.4% in June to 1.9% in July – below the 2% target rate for the first time in 15 months. But inflation expectations, money supply growth and most survey measures of businesses’ selling prices remain uncomfortably high.
• Overall, if the market chaos persists and the economic data weakens, it is possible that interest rates have already reached a peak. But if the market turmoil continues to fade, the MPC will turn its attention back to the underlying economic fundamentals. And at the moment, they suggest that interest rates might yet need to rise to 6%.

Roger Bootle, Economic Adviser to Deloitte

Ends

Notes to editors
This press release has been prepared by Roger Bootle, Economic Adviser to Deloitte.  If you have any questions regarding the views in it, please contact Roger Bootle directly on 020 7823 5000 or via email on business@capitaleconomics.com.

This press release contains general information only and is not intended to be comprehensive nor to provide professional advice.  It is not a substitute for such professional advice and should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business.  Deloitte & Touche LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from acting as a result of any material in this publication.

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In this press release references to Deloitte are references to Deloitte & Touche LLP which is among the country’s leading professional services firms, providing audit, tax, consulting and corporate finance services. Deloitte & Touche LLP is the United Kingdom member firm of Deloitte Touche Tohmatsu (‘DTT’), a Swiss Verein whose member firms are separate and independent legal entities. Neither DTT nor any of its member firms has any liability for each other’s omissions. Services are provided by member firms or their subsidiaries and not by DTT. Deloitte & Touche LLP is authorised and regulated by the Financial Services Authority. The information contained in this press release is correct at the time of going to press.