Interest Rate Predictions

Interest rates are at record lows because the economy is experiencing its deepest recession since the 1930s.

The Bank of England have kept interest rates at 0.5% in April and May

Factors which will keep interest rates close to Zero in the future.

• Depth of recession and scale of fall in GDP
• Predicted rise in UK unemployment close to 3%
• Budget Deficit rising to 12% of GDP means the government is under pressure to improve fiscal position. This will require higher taxes and lower spending. This fiscal stance could damage recovery and is deflationary. Therefore if taxes rise, it is more likely interest rates will stay low.
• Inflation predicted to fall below the governments target of 2% and stay close to 1%. With falling oil prices, deep recession and high levels of spare capacity, inflation is forecast to fall sharply in 2009. It is expected inflation will fall to below the government’s target of 1%. This raises the ugly potential of deflation - something the MPC will be very keen to avoid RPI measure shows a high level of deflation -1.2% (RPI measure includes mortgage interest payments)

Factors which will push up Interest Rates

• Scale of Quantitative easing (increasing money supply) increases potential for future inflation. As inflation rises, interest rates could rise sharply.
• UK housing market could be bottoming out leading to slow recovery.
• As economy recovers at end of the year, the historic rates could rise to prevent inflation.
• Signs of rising oil prices

The forecast for interest rates depends on how deep and lasting the recession proves. At the moment, economic conditions are conducive to low rates for several reasons.

• falling house prices
• ongoing credit crunch
• Negative economic growth of -4%
• rising unemployment - over 2 million
• Credit crisis reducing availability of credit
• MPC inflation report forecasting inflation of 0.7% and possibility of deflation in 2010

Factors Influencing interest rates in 2009

• Real interest rates are actually negative. Real interest rates are (Nominal interest rates - inflation) = 0.5% - 2% = -1.5%.
• Sub Prime Mortgage Crisis - The effects of the mortgage sub prime crisis are still being felt in the UK, in particular there is a shortage of mortgage credit. The main effect of the sub prime mortgage problems are to make mortgage lenders less willing to give risky loans. It has also affected consumer confidence. The effect of these two factors are to reduce house price growth and consumer spending. This reduces inflationary pressures and makes it easier to enable interest rate cuts.

Predictions for US Interest Rates

As for the US, interest rates have already been cut to 0% - 0.25%, but, this may be insufficient to stave off the problems arising from the US Housing Market. However, with rates at 0.25% there is little more that they can do.

See also:

• Difficulties with predicting interest rates
• Interest rates explained