The Bank of England published its Inflation Report today and we learned more about the outlook for interest rates.
Bank governor Mervyn King is clearly still very worried that inflation may fall too low. When asked why he pushed up the spend on quantitative easing last week, he said:
'Just look at the inflation projection. It's quite clear that on that basis we felt there were real downside risks to inflation.'
King also said that it was 'more likely than not' inflation will go below 1% this year.
What's more, an economist called Vicky Redwood at Capital Economics told FT.com this morning that monetary policy looks set to remain 'extremely loose.' In other words, the base rate will stay low, and quantitative easing may even be continued once the latest tranche of cash is spent within the next three months.
So what does that mean for us?
Well, I think it makes variable rate products such as tracker mortgages more attractive. Let's say you took out an Alliance & Leicester Base Rate + 2.59% mortgage today.
At the moment, you'd be paying an interest rate of 3.09% (base rate at 0.5% + 2.59%). Given King's comments, we might not see any rise in the base rate until well into 2010, and, who knows, the base rate might still be as low as 1.5% in spring 2011. So in 18 months time, you might be paying 4.09%. That's not much higher than what Nationwide is currently charging on a 2-year fixed-rate mortgage - 3.98%.
So if the above interest rate scenario came true, a tracker would have been the best bet - you'd have ended up saving money over the whole two-year period.
Of course, the risk is that inflation takes off more quickly, and interest rates then have to go up to choke off rising prices. You can't dismiss that possibility and, in fairness, King did add caveats to his comments. He said there are 'significant risks to the inflation outlook in each direction.' In other words, he doesn't know for sure what will happen.
And that's fair enough. We're not living through a normal economic cycle and the effects of monetary policy always take time to come through. So it's very hard for anyone to predict how things will pan out over the next year.
So if you're risk-averse, you may prefer the certainty that comes with going for fixed-rate products - both in mortgages and in the savings arena. But variable rate products look less risky than they did a week ago.