Interest rates will stay low

by Ed Bowsher on 10 February 2010  |  1 comment
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The Bank of England's latest inflation report just strengthens my view that interest rates will probably stay low for some time to come.

The Bank of England's quarterly inflation report is always an interesting read as it tells you what the economic boffins at the Bank of England are thinking. And the message is clear today - a big rise in inflation looks unlikely and that means the base rate will probably stay low this year. I wouldn't be surprised if the base rate was still at 0.5% at Christmas. 

Here's the money quote from Mervyn King at his press conference today: 

"It seems clear that at present there is significant spare capacity in the economy that will act to dampen inflation." 

Now I should add that King added lots of caveats and made it clear that no one could make firm forecasts at the moment. That's fair enough, but when you look at the overall balance of risks, I think it's clear that the commentators who have been harping on about inflation have been focusing on the wrong issue.

Our biggest problem is that the economy is still very weak. We're far more likely to see a double-dip recession than double-digit inflation. 

Stopping the double-dip 

So how can we prevent a second recession? 

Well, low interest rates can hopefully stop the economy going back into reverse and King clearly hopes that the falling value of the pound will boost UK plc. (If the value of the pound has fallen against other currencies, our exports become cheaper and British businesses should be boosted.) 

Yes, there is a risk that the falling pound will spark inflation - a cheaper pound will mean that imports become more expensive - but I think there's enough spare capacity in the economy to keep the lid on rising prices even if the pound does fall further. 

What does that mean for you and me? 

If, as I expect, the base rate stays low, rates on easy access savings accounts and short-term mortgages will probably stay low too. But, as I've said before, the picture may be different with longer-term interest rates. 

The Bank of  England has much less influence over long-term rates and these will primarily be driven by the market's perception of how well the UK government is doing on reducing its deficit. If the markets don't think the UK government is doing enough to reduce its debts, they will demand a higher reward for lending to the UK. That will push up long-term interest rates across the board. In other words, products like five-year mortgages could get more expensive. 

The next few years are going to be tough. Recovering from the biggest financial crisis in 70 years was never going to be easy. Just don't let anyone scare you about inflation taking off....