• Today’s decision by the Monetary Policy Committee to leave interest rates on hold at 5.25% shows how the Committee’s inflation fears are limiting its ability to respond to the economic slowdown. While interest rates will be cut further, the slow pace at which they are falling will make the economic downturn that much sharper and that much longer. The result will eventually be even lower rates than otherwise. 4% is not a silly figure.
• It has become clearer that the economy needs a further dose of policy medicine. With the Nationwide recording the fourth fall in house prices in as many months in February, the news on the housing market has worsened. And with many lenders now refusing to provide mortgages to borrowers without a deposit of 10%, further falls in house prices are on the cards.
• What’s more, the housing slowdown appears to be taking its toll on the wider economy. Consumer spending growth slowed from a quarterly rise of 0.9% in Q3 to just 0.2% in Q4. And the GfK survey found that consumers are currently less confident than at anytime since January 1995.
• Admittedly, retail sales were fairly robust in January. But the weak tone of February’s CBI Distributive Trades survey suggests that this might have been a last hurrah. Finally, investment fell outright in Q4, suggesting that previous interest rate rises, the credit crunch and the deteriorating economic climate have made companies less willing, or less able, to spend.
• But the Committee’s ability to support the real economy is restrained by the deteriorating outlook for inflation. Admittedly, CPI inflation rose only modestly from 2.1% in December to 2.2% in January. But this is very much the calm before the storm as the recently announced utility price hikes are set to push inflation up to 2.6% in February and further towards 3% later.
• And price pressures towards the start of the inflation pipeline have strengthened markedly. The oil price has risen above $100 per barrel and the latest fall in the pound will put further upward pressure on import prices. Manufacturers are already raising their selling prices at a record rate of 5.7% per annum. What’s more, with the public’s inflation expectations still high, the danger that further rises in inflation will become ingrained in the system is growing.
• As such, inflation fears mean that the MPC will continue to cut interest rates only gradually. I think that they will be left on hold in April before falling to 5% in May. Such a slow pace of policy loosening will exacerbate the economic downturn. I think that GDP growth will slow to around 1.7% this year and about 1.5% next year, condemning the UK to its weakest period of growth in 15 years. Interest rates might therefore need to eventually fall all the way to 4%.

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

Ends

Notes for 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 07887 955 875 or 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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