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Economic Update – Threat of rate hike recedes further

Roger Bootle’s response to June’s MPC meeting

  • The further signs that the recovery – both here and abroad – is struggling suggest that the MPC should be giving the economy as much support as possible. Markets now think that interest rates are unlikely to rise before next spring - and I continue to think that rates will stay on hold for far longer than that.
  • Optimists argue that the recent weakness in the economy is simply a soft patch. I find that argument hard to swallow. The economy is starting to feel the effects of the fiscal squeeze – and that squeeze is only set to intensify.
  • Admittedly, there has been much debate over the past week about whether the Government should react to the economic slowdown by scaling back its austerity measures. But although the Government should have a Plan B available just in case, the time to launch it isn’t yet. Mrs Thatcher’s first government had to endure two years of unremittingly bad economic news before things started to improve. Accordingly, I doubt that the Government will row back on its plans soon.
  • The recent economic weakness also reflects the fact that households are cutting their spending in response to the drop in their real pay – and with inflation rising again, real pay has further to fall. Now that Scottish Power has announced utility price rises, other energy suppliers will no doubt be quick to follow, pushing CPI inflation up to 5% in the coming months.
  • The hawks on the Committee still worry that this rise in inflation will destabilise inflation expectations and make it harder for the MPC to hit its inflation target further ahead. But fears of a wage-price spiral seem to me as overdone as ever. One of the main measures of pay settlements fell in April, to just 2%.
  • That’s not to say that the risk of an interest rate rise in the coming months has receded completely. It won’t be easy for the MPC to hold its nerve as inflation possibly surpasses the peak of 5.2% seen in 2008. But having stuck to its guns for this long, I doubt that the Committee will cave in now, when the recovery is on the verge of petering out altogether. I still expect interest rates to stay at 1% or below until at least 2014.
  • What’s more, if I am right in expecting the economic recovery to struggle to get back on track, the MPC might need to consider injecting some more support into the economy. Admittedly, Ben Bernanke recently downplayed the chances of “QE3” in the US in the near-term and, with inflation here still so high, I doubt that more asset purchases will come onto the agenda in the UK in the near future. But QE2 could well become a story for 2012.

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

This assessment 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 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 assessment.

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