• Today’s decision by the MPC to cut interest rates from 5.75% to 5.5% is the first step in a prolonged period of monetary easing that could see rates fall very sharply. I previously thought that rates would drop to 5%, but I now think that they could eventually be cut all the way to 4%. 
• It has been clear for some months that the economy is slowing. The latest CIPS/RBS business surveys have pointed to a significant easing in activity in the fourth quarter. More worryingly, the housing market is looking very fragile. In recent weeks, Nationwide, Halifax, Hometrack, the RICS and Rightmove have all reported house price falls. Moreover, the number of new mortgages approved for house purchase fell from 100,000 in September to 88,000 in October – the lowest level in just under two years.
• On top of that, the recent resurgence in financial market turmoil – most significantly the sharp rebound in three month interbank (LIBOR) interest rates to nearly 1% above the base rate – has made it more expensive for companies to borrow. And there is growing evidence that companies are less willing to supply credit to consumers. In other words, the credit crunch is biting.
• The fact that price pressures are rising may suggest that today’s rate cut is a one-off or, at the least, that rates are unlikely to fall again soon. Indeed, the oil price has risen towards $100 per barrel. And there is evidence that firms have started to pass higher costs along the inflation pipeline. Producer output price inflation jumped from 2.8% to 3.8% in October – its highest rate in 12 years – while the business survey prices balances are consistent with further rises. Moreover, the rise in petrol prices above £1 per litre has pushed CPI inflation back above the 2% target rate, from 1.8% to 2.1% in October. And inflation is likely to rise further in the coming months.
• However, the rise in interbank interest rates means that the risk of a very sharp and prolonged economic downturn is growing by the day. Accordingly, I doubt that the MPC will hold off from cutting rates again for long. After all, the slowdown in economic activity that is well underway will go some way to containing price pressures. I think there is a good chance that interest rates will be cut again in February. And if the financial market turmoil continues, a move in January would not be out of the question.
• Either way, the growing likelihood of a prolonged period of below trend economic growth means that interest rates are now more likely to fall further and faster than I previously thought. I now think that they will be cut to around 4.5% by the end of next year and perhaps to 4% in 2009.

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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