Interest Rates in UK - What Will Happen in 2007
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On January 17th 2006 the MPC raised interest rates to 5.25%. The decision to
raise interest rates, was seemingly justified a couple of days later, when
inflation rose to an 11 year high of CPI 3%. This is on the edge of the
governments inflation target of 2% +/-1. Although inflation is low by historical
standards the MPC will be keen to move inflation back to its inflation target
and maintain the strong credibility of monetary policy. Thus with inflation
currently above its target the likelihood of interest rates rising is quite
strong. Higher interest rates will dampen demand and hopefully keep inflation in
Therefore changes to interest rates will depend a lot on inflationary trends.
There are several factors to suggest that inflation could continue to be a
1. Higher energy prices are likely to be an issue. Continued rising demand
from India and China is putting pressure on commodities causing prices to rise.
In particular this means the lower manufacturing prices we have been enjoying
from China will become less significant. Inflation is also starting to creep up
in other industrialised countries, although not as much as UK.
2. UK housing prices have continued to rise at a rate above inflation.(9%) in
2006. The MPC isnít directly influenced by house prices, but rising house prices
tend to feed through into higher inflation because people have more wealth and
confidence to spend.
3. The minor increases in interest rates may not be enough to reduce spending
in the economy. It is true they will impact on those with very high mortgage
payments, but there is a significant sector of the economy which are not
effected by interest rates very much (e.g. people who have paid off most of
their mortgage). Therefore interest rates may have to rise by more than expected
to reduce inflation.
Having said that some economist argue interest rates are close to peaking.
1. Firstly rises in interest rates often have a time lag delay effect.
Therefore the recent rises from 4.5% to 5.25% may start to have more of an
effect on consumer spending and confidence in the coming year.
2. House prices may be close to peaking. House prices have persistently
defied many peopleís predictions and continue to rise above the rate of
inflation. However there is evidence of buy to let buyers starting to cash in on
their profits. Many first time buyers are increasingly priced out of the market.
If house prices did stop rising or even started to fall this would have a very
significant impact on reducing spending making further interest rate rises much
3. Although inflation is close to 3% much of this latest rise can be
attributed to one off factors such as rising excise duties and rising energy
prices. If these factors are stripped out then CPI inflation is close to its
target. However having said that if we look at the old measure RPI then
inflation is much higher 4.4%. This figure includes housing costs and is
considered by some economists to be a more accurate reflection of what is
happening in the economy.
About the Author
R.Pettinger is an Economics teacher at Oxford and writes frequently on the UK
economy and mortgages. He edits a site about Mortgages including a guide to
different types of mortgages.
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Article Published/Sorted/Amended on Scopulus 2007-03-25 20:01:56 in Economic Articles