Borrowing and Future Interest Rates

Next year, the government will have to borrow at least £175bn. If economic forecasts prove worse than Treasury predicts, borrowing could be even higher.
The large scale government borrowing has raised the prospect of future tax rises and spending cuts.

What this means is that in 2010 and 2011, the government will bring in tax increases such as (putting VAT back to 17.5% and 50% income tax) Also future public spending will be limited. The combined impact of higher taxes and lower spending will be implemented during a period of weak economic recovery. There is a danger that the policies necessary to reduce the government’s debt burden could push the economy back into recession.

With output and global trade falling so much, tax rises could have an adverse impact on spending and further deflate the economy. Therefore it is more likely that the MPC will be keeping interest rates low for a long time.

I expect the economic recovery to be weak so combined with higher taxes, there will be pressure for monetary policy to remain reflationary.

The prospect for interest rates also depends on the impact quantitative easing has. If quantitative easing causes inflationary pressure to occur sooner than expected, then interest rates will rise. But, if quantitative easing fails to create inflation because of the depth of the recession, we could be seeing a long period of very low interest rates (similar to Japan in the 1990s)