• Today’s decision by the Monetary Policy Committee to leave interest rates on hold at 5.75% shows that the Committee is in no rush to reduce interest rates. While I would not altogether rule out an interest rate cut at next month’s meeting, it seems likely that lingering inflation concerns will mean that interest rates do not start to fall until early next year.
• The longer the financial market turmoil has continued, the clearer it has become that it will have some impact on the wider economy. The high level of interbank interest rates has made it more expensive for companies and consumers to borrow. Meanwhile, the recent uncertainty regarding the safety of bank deposits will have dented consumer confidence. It is now abundantly clear that interest rates have peaked.
• The impact of the financial crisis, and any associated reduction in credit supply that has yet to come, will exacerbate the effect of the five rises in interest rates seen over the last year. GDP growth is likely to fall sharply from around 3% this year to just 2% next year. I think that this will eventually prompt the MPC to reduce interest rates to 5% by the end of next year.
• But while it is possible that the Committee will decide to boost confidence with a near-term interest rate cut, perhaps even as soon as next month, there are a few reasons why the MPC is likely to hold off from reducing rates for a little longer.
• To start with, even before the financial crisis, the MPC thought that the economy needed to slow in order to meet the 2% inflation target in two years’ time. Hence, to the extent that the financial crisis has done the MPC’s work for it, the Committee may need to see signs of a more marked economic slowdown before it starts to reduce rates.
• On top of that, the financial crisis is unlikely to have eradicated all of the MPC’s medium-term inflation concerns. Admittedly, CPI inflation was below 2% in both July and August. But the recent increase in oil prices means that inflation is likely to rise in the coming months. What’s more, money supply growth and inflation expectations remain uncomfortably high.
• Finally, the cut in interest rates in August 2005 that is widely blamed for reigniting the housing market may make the MPC more wary of reducing interest rates quickly this time round. After all, the latest data show that housing market activity has only just started to slow.
• It is clear that recent events have dramatically altered the outlook for interest rates. I think that rates will eventually need to fall to 5%. But, while a near-term cut is certainly possible, I doubt that the MPC is in a rush to reduce rates. Rates may not start to fall until next year.

Roger Bootle, Economic Adviser to Deloitte (Tel: 020 7823 5000)

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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