• Today’s decision by the Monetary Policy Committee to leave interest rates on hold at 5.75% was no surprise and suggests that the first cut in rates is probably some months away yet. Nonetheless, I think that a sharp slowdown in economic activity will eventually prompt the Committee to cut interest rates to 5%. 
• The last few weeks have seen the first real signs that higher interest rates and the summer’s financial crisis are starting to take their toll on economic activity. The activity balances of the manufacturing and services CIPS/RBS surveys both fell sharply in October, the latter to its lowest level in four-and-a-half years.
• Moreover, it looks as though consumers have become less willing to spend on the high street. In October, the reported sales balance of the CBI’s Distributive Trades survey fell to its lowest level in a year, while the annual growth rate of like-for-like sales values, as measured by the BRC, eased back from 3% in September to 1%.
• This could be an early indication that consumers are finding it harder to secure credit. Indeed, it has been reported that the number of consumers rejected by credit card companies has risen by a fifth in the past six months. A similar tightening of mortgage lending criteria may be behind some of the further fall in the number of mortgages approved for house purchase from 108,000 in August to 102,000 in September. What’s more, according to the Halifax, house prices fell for the second month in a row in October.
• However, the MPC believes that the economy needs to slow in order to meet the 2% inflation target in the medium-term. And it is not yet obvious that activity is slowing by more than the Committee thinks is necessary.
• On top of that, the news on inflation has remained strong. Admittedly, CPI inflation held steady at 1.8% in September – the third consecutive month below 2%. But the increase in the oil price to a shade below $100 per barrel means that in the coming months inflation will rise comfortably back above 2%. What’s more, the prices balances of the various business surveys have remained close to their historical peaks, while inflation expectations are still uncomfortably high.
• That all said, I think that activity will eventually slow sharply. I expect that a fall in GDP growth from around 3% this year to about 2% next year and an easing in price pressures will prompt the MPC to cut rates to 5% by end 2008. But the first cut may not come until February, and even that is dependent on a sharp easing in activity in the coming months. 

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

Ends

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