The Bank of England have kept interest rates at 0.5% since March 2009. However, with inflation creeping above the target of inflation, there is increased pressure for the bank to raise interest rates. The Bank of England face a dilemma. On the one hand the recovery has been sluggish and slow. Unemployment is still high and the governments austerity measures – spending cuts and tax rises are likely to keep spare capacity in the economy.
On the other hand, headline inflation CPI is well above the government’s target of 2%. Despite inflationary pressure being due to cost push factors such as rising oil prices, rising commodity prices, the Bank will be concerned that these cost push factors will cause underlying factors to rise.
This dilemma has led to a split in the Bank of England. However, more members are coming around to the idea that interest rates will rise later in the year. The consensus is for rates to start rising in May / June, and perhaps reach 1.5% or 2% at the end of 2011. It depends on the strength of the economy and whether these ‘temporary’ inflationary pressures will dissipate.
Factors That have kept interest rates low for considerable time:
* Depth of recession and scale of fall in GDP
* Predicted rise in UK unemployment close to 3 million. Labour force survey gives unemployment of 2.5 million, but, this hides some underemployment (e.g. working part time)
* Budget Deficit rising to 12% of GDP means the government has taken steps to improve its fiscal position. The combination of higher VAT rates and lower spending has reduced confidence and consumer spending. This fiscal drag is likely to lead to economic growth below the long run trend rate. Therefore, in theory it is still hard to see inflation caused by demand pull factors. The underlying state of the economy means there is a lot of spare capacity and little inflationary pressure. This is one of the main factors which will enable interest rates to remain very low.
* In 2011, there has been temporary rise in inflation due to rising oil prices and tax rises, but, this does not reflect a fundamental increase in inflationary pressures. Wage growth is still low. (see: Real wages UK)
* UK housing market has shown signs of uncertainty. House prices rose in 2009 and 2010, but in late 2010 and 2011, we could see a further fall or at least stagnation in prices. see: will house prices fall again?
Factors which will push up Interest Rates
* Inflation has been stubbornly above target. Despite lack of economic recovery, inflation has been persistently above target. This has not led to wage inflation, but it has changed inflation expectations. With inflation running above 4%, there is much pressure to increase nominal interest rates.
* Scale of Quantitative easing (increasing money supply) increases potential for future inflation. As inflation rises, interest rates could rise sharply. However, the impact of quantitative easing has not been fully understood. Broad money growth still shows slow growth. It is likely quantitative easing will be brought to a halt soon.
* As economy recovers, the historic low interest rates could rise to prevent inflation, which has proved more persistent than expected.
* Rates of 0.5% are exceptionally low and are leading to a negative real interest rates.
* Also at this rate there is a danger of distorting economic activity, e.g. encouraging speculation.
The forecast for interest rates depends on how strong and robust the economy recovery is; at the moment, economic conditions are conducive to low rates for several reasons.
* Weak housing market
* ongoing credit crunch and reluctance to lend by banks
* Weak growth in 2010 and 2011
* rising unemployment – over 2.5 million
* Credit crisis reducing availability of credit
However, the persistence of inflation, raises scope for increasing rates.
Factors Influencing interest rates in 2011
* Real interest rates are actually negative. Real interest rates are (Nominal interest rates – inflation) = 0.5% – 4% = -2.5%.
* 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.
Fixed Interest Rate Predictions
Despite base rates staying at 0.5%, fixed rate mortgage deals have not reflected the low interest rates. This suggests the market expects interest rates to rise. But, also banks are trying to improve their profit margin and increase their reserve ratios.
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. Although the economy shows signs of tentative recovery, base rates are likely to remain low for a while. source mortgageguideuk.co.uk... For the latest updates PRESS CTR + D or visit Stock Market news Today
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