Interest Rate Predictions

The median forecast for interest rates in the UK, is to remain unchanged by the end of 2008, despite a slowing economy and collapsing housing market

Basically, the MPC face a dilemma. Their main target is low inflation (2%). However, rising oil prices are pushing up inflation above the target. Therefore, in theory they should be thinking about raising interest rates to prevent inflation getting into the system. However, although inflation is rising, the economy is slowing. Slower growth is because of:

• Falling house prices
• Lack of consumer confidence
• Rise in living costs reducing disposable income
• Credit crisis reducing availability of credit

Because the economy is slowing there is pressure on the MPC to cut rates to prevent a recession. Yet, the MPC don’t want to cut interest rates because they are worried about rising inflation.

Interest rate decisions may depend on which they think most important - preventing inflation or preventing recession. - It may be that the MPC give a higher priority to low inflation.

Any prediction about interest rates needs to be filled with caveats about other potential outcomes. This is a blog post entitled - Difficulties with predicting interest rates

Factors Influencing interest rates in 2008 / 2009

• CPI Inflation is close to the government’s upper target of 3%. There has been a rise in cost push inflationary pressures - for example, oil, food and energy prices. This rise in ‘core inflation’ has made the MPC reluctant to cut rates. In fact many argue that the real inflation rate is higher than the official figure. People feel prices are rising much more than the official statistic of CPI = 3%. This is partly because the CPI ignores volatile energy prices and some housing costs.
• Real interest rates are relatively high. Real interest rates are (Nominal interest rates - inflation) = 5% - 3% = 2%. Therefore although interest rates are relatively low by historical standards, real interest rates are not. Therefore, there is scope for a small % cut and still there will be some tightening of monetary policy.
• Sub Prime Mortgage Crisis - The effects of the mortgage sub prime crisis are being increasingly felt in the UK. The 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.

• Global Economy. - Many feel the US economy could be entering a recession, or at least a slow down. This will have the effect of reduce growth in the UK and reducing global inflationary pressures.
• Housing Market. - After a decade of constant growth the UK Housing Market is turning. - Many now predict house prices could fall quite substantially. If house prices do continue to fall, you can almost guarantee the bank will be able to cut interest rates. Lower house prices reduce spending and therefore, put downward pressure on inflation
• Previous Rises Previous increases in interest rates are likely to have more of an effect as people come to the end of their fixed rate period.
• Overall I predict interest rates will not fall in the UK in 2008. However, I think they should fall; it is more important to prevent recession than worry about inflation going over 3%

Predictions for US Interest Rates

As for the US, interest rates have already been cut by 2%, but, this may be insufficient to stave off the problems arising from the US Housing Market. However, with rates at 2% there is little more that they can do.