What does 2011 have in store for the PropVestor: Part three: Interest Rates

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Interest Rates

Philip Shaw, Investec economist
We have recently revised our in-house inflation forecasts with the view that the CPI measure will rise a little above 4% towards the middle of this year, and a risk that this could be 0.5% or so higher than this should the 2.5% increase in VAT be fully passed through.
The committee’s credibility is at stake. But raising the Bank rate from its current 0.5% risks sending the recovery into reverse. We argue that one solution could be to keep interest rates steady, but to start to reverse some of the quantitative easing.

David Kern, British Chambers of Commerce
The MPC’s decision to leave interest rates and the quantitative easing programme unchanged this month was widely expected. We support this decision, but it is important that the MPC perseveres with the existing policy approach, at least until the middle of the year. Recent calls for early increases in rates are ill-advised and should be rejected.
The UK recovery is fragile and risks of a setback are serious. Pressures on businesses and individuals will intensify over the next few months, but we urge the MPC not to over-react to temporary increases in inflation. As long as wage increases remain modest, and disposable incomes continue to be squeezed, it remains highly likely that the surge in inflation will be reversed, and sharp falls can be expected in the final months of 2011 and in 2012.
It is likely that interest rates will need to increase later this year. But the MPC must wait until the economy has absorbed the initial impact of the austerity plan. Premature interest rate increases, while fiscal policy is still being tightened, risk derailing the recovery and could make it harder to implement deficit-cutting measures.

Lee Hopley, EEF chief economist
The debate around the impact of forthcoming austerity measures and above-target inflation will have changed little for the MPC over the past month. For now, however, the balance of risks still supports keeping interest rates and asset purchases on hold. But, if we begin to see price pressures starting to flow through to major wage increases, the case for raising rates will become stronger.

Scott Corfe, CEBR economist
The announcement comes amid a media environment becoming increasingly concerned about the rising cost of living and consistently above-target consumer price index inflation – especially in the light of recent price increases that followed the VAT rise to 20%. Since January 2010, annual CPI inflation has been at or above 3.0%, the upper end of the Bank of England’s target range, prompting some concern that the Bank is losing credibility over its commitment to its central 2% inflation target.
Despite this, we remain wary of being overly hawkish on inflation in the short term. With price growth being primarily driven by government policy (VAT increases) and short-term commodity price shocks, rather than an overheating economy, raising rates now seems premature. Excluding indirect taxes such as VAT, annual consumer price inflation was only 1.6% in November – hardly indicative of out-of-control underlying inflation. Once the impact of VAT on prices drops out of inflation measures in 2012, we anticipate a significant fall in inflation to a level comfortably within the Bank’s target range.
Our central economic forecast suggests 2011 will be an extremely difficult year for the UK, with notable downside risks to growth as the government’s programme of fiscal consolidation gets well under way. With the housing market continuing to falter and question marks looming over the ability of net trade to compensate for weak domestic demand, a rate rise now would be the wrong policy at the wrong time.

Howard Archer at IHS Global Insight
Albeit with reduced confidence, we are retaining our view that the Bank of England will hold off from raising interest rates until the fourth quarter. This reflects our belief that growth will slow appreciably in the first half of 2011 and that a soft labour market will prevent higher inflation expectations feeding through to lift wage growth significantly. However, given current mounting inflation risks, we fully acknowledge there is a growing likelihood that the MPC could act earlier than the fourth quarter, and possibly even before midyear. The MPC could well decide that a small near-term interest rate hike would support its credibility by sending out the message that it is serious about its inflation mandate, but would not have a major dampening impact on growth.
Even if interest rates do rise sooner rather than later, the probability remains that they will move up relatively gradually and remain very low compared with past norms, as monetary policy will need to stay loose for an extended period to offset the impact of the major, sustained fiscal squeeze. Consequently, we retain the view that interest rates will only rise to 2% by end 2012.
Meanwhile, we think further quantitative easing is highly unlikely given the inflation risks.

Christina Weisz, Currency Solutions director
Despite the continuing problems with inflation figures, which are coming in month on month well above the 2% target, any potential interest rate rise to counteract the inflationary problem that the Bank faces is complicated by the ongoing introduction of budget cuts, austerity measures, the VAT rise and threat of rising unemployment. All of these have prevented a clearer picture of economic growth to come to the fore.
These developments make it difficult to ascertain whether the economy is strong enough to cope with a rate rise until the next wave of statistics flood in.

PropVestment
Higher inflation, further extenuated by the VAT rise, may mean the BOE decide to raise interest rates, even though this may significantly disrupt the weak recovery. This is an uncertain factor, and could mean rates stay unchanged for 2011 or could rise significantly.

opinions sourced from the Guardian

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