Outlook for Interest Rates

A few months back I looked at the prospects for interest rates in the UK. Since then market conditions have increased the likelyhood of lower rates - With some commentators suggesting that base rates could fall to 4%. Whilst a 1.5% fall would represent a significant loosening of monetary policy, the prediction is based on recent signs of weakness in the economy and, particularly, in the housing market.

Outlook for Interest Rates in UK 2008

Mortgage Approvals falls by 40%.

Recent evidence from the British Bankers Association (BBA) shows that mortgage approvals is 40% down on this time last year (44,831 in November). This shows the nervousness of banks in lending and also people’s reluctance to take out mortgages against prospects of falling UK house Prices.

House Price Falling

There are different measures of house price inflation in the UK. However, they all seem to be converging on a new trend for lower house prices. Data from November, by the Nationwide show that house prices fell by 0.5% - this has caused the annual house price inflation to fall to 4.8%. Falling house prices will almost certainly reduce consumer confidence and consumer spending. (link - house price fall at telegraph)

Credit Crunch

The impact of the global credit crunch is yet to be fully felt. This is because banks still are exposed to significant liabilities in the US sub prime markets. This is why the US government is considering preventing sub prime mortgage rates reverting to higher levels. The effect for UK consumers is that banks are much less willing to lend, especially to consumers with bad credit ratings, some warn this could lead to a rise in bankruptcies in 2008.

Overvalued Pound

As a result of an overvalued pound and large trade deficit, there is pressure for the pound to weaken. Lower interest rates would facilitate a weakening of the pound, helping exporters and the trade deficit. The pound has already started falling from its October peaks, on expectations of future rate cuts.

Talking ourselves into Recession

Many economists comment on how an economy can talk itself into recession. Even though growth is currently strong. Because expectations and the global outlook has changed people can start talking themselves into saving and not spending - thus causing a recession to actually occur. - lower rates will then be needed to avoid this downturn.

Propects that interest rates won’t fall

Despite all these factors, it would be a mistake to assume the UK, is facing a ‘crisis’ shoppers were still out in force over christmas. A slow down in growth from 3% to 2.1% is hardly a sign of an impending recession. The economy is in much better shape than say 1991, when the UK entered its last recession.

• Mean prediction for interest rates end of 2008 - 4.75%