News Review: Economics


It’s only a matter of time before interest rates rise


by Fionnuala Earley, UK consumer economist, Royal Bank of Scotland


the big question we were hoping the Bank of england’s inflation report would answer is when the monetary Policy committee will start to increase interest rates. inflation has been at 3% or above for over a year now - at least one percentage point over its target. in more normal times the


mPc would have had little hesitation in increasing the bank rate, just as it did when prices were rising quickly in 2004 and again in 2006/7. But back then the economy was in better shape – and growing a bit too quickly as well, so a rise in interest rates could kill two birds with one stone. today the mPc’s options


are more limited. it is only responsible for inflation, but it has to take account of the effect of interest rates on economic growth. With growth as weak as it is, it risks inflation undershooting its target if it raises rates too quickly. the shock 0.6% fall in


gdP in the final quarter of 2010 will have sent a shiver down the mPc’s collective spine. even taking into account that much of this was due to the extreme weather, at best the economy stood still. and looking ahead there will be more drags on growth as public spending cuts and higher personal taxation will bite from april. all this argues


against an early increase in rates. But inflation increased


to 4% in January, forcing another open letter from the governor to the chancellor. in it the governor said he expected inflation to pick up even more over the next few months to somewhere between 4% and 5%. this would seem to argue for an earlier rise in rates. in more normal times this would surely be the case.


Different strokes So how will it all play out? the inflation report analysis sticks with the argument that the three factors responsible for the current high level of inflation (Vat; higher import prices because of the fall in Sterling in 2007 and 2008 and the recent increase in commodity prices) are temporary and their effects will wane. Without these three things


inflation would probably have come in below the 2% target. But it is small comfort that inflation hasn’t been generated by domestic demand, and it doesn’t make the decision much easier in practice. the mPc knew that inflation had increased to 4% when the decision was taken to hold rates. the minutes of the


February meeting make it clear that there are real differences of view on the committee. three members now want an early rise in rates and one wants more quantitative easing. But the majority is still cautious about squashing the recovery and wants to wait longer before taking any action.


How long this will carry


on for is the next question. Price rises have been highest among essential goods and services. on top of this wages are rising by less than inflation, so the real spending power of income is being squeezed too.


May Day if the drivers of current high inflation do not begin to wane there is a risk that consumers will begin to believe inflation is here to stay and they will demand higher wages. this would feed into higher prices and could lead to a wage-price spiral more familiar with the 1970s than the relatively


House prices are falling, transactions levels are still at historic lows, consumer confidence is waning and VAT has increased. On top of this households are preparing for higher personal tax and the cuts in public spending ahead. But, among all of this there is some good news. In spite of the severe


recession, mortgage arrears and possessions have stayed remarkably low and are still falling. Data from the Council of Mortgage Lenders show there were 24% fewer repossessions and a 13% fall in mortgage arrears in 2010.


This was backed up by Ministry of Justice data which also show a fall in the number of claims issued for repossession and for claims resulting in an order for possession.


stable conditions we have got used to in recent years. For now it looks like the


mPc will hold the base rate steady at least until may. if they get it right and the economy continues to recover the housing and mortgage markets should fare relatively well. Providing unemployment and/or interest rates do not increase sharply, low numbers of forced sales coming onto the market should mean that house prices fall only modestly in 2011. But we should still be prepared for it to take a long while for market conditions to get back to normal.


A&P FIGURES A SILVER LINING FOR HOUSE PRICES


There are some more difficult economic times ahead so we should be cautious about expecting arrears and possessions to continue to improve at this rate but providing interest rates or unemployment do not increase very sharply, they should remain low – especially compared to the early 1990s.


That is good news for


many reasons but for the housing market it’s particularly welcome. Fewer forced sales means less downward pressure on house prices because of the effect on supply and because forced sellers are more willing to take a discount. On top of this, low levels of arrears and possessions are good for confidence and that’s really important for housing market performance too.


mortgage introducer MARCH 2011 13


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