Prospects for Interest Rates in the UK May 2007

Today, Thursday 10th May, the Bank of England increased interest rates to 5.5%. This is the highest rate since October 2001. Interest rates have increased by 2% since a low of 3.5% in 2003.

The main reason for the increase in interest rates were:

  1. CPI Inflation increasing to 3.1%. This is just above the government's target, last month the governor of the Bank of England had to write a letter of explanation to the Chancellor.
  2. House Price inflation increasing to 10%. Despite recent rises in interest rates, it doesn't appear to have stopped the buoyant housing market. However, much of this increase in prices stems from a shortage in supply.
  3. The old RPI measure of inflation is even higher at over 4%

Why Interest rates in UK may have now Peaked.

  • Inflation is forecast to fall.
    Recent rises in inflation were due to cost push factors such as rising energy prices. With gas prices now falling from a temporary peak, this is likely to push inflation back within target.

  • The economy is not in a boom and bust situation.

With economic growth of around 2.6% it is very close to the long run trend rate. This means there is little scope for inflationary pressure from growth constraints.

  • The exchange rate has been very strong.

Against the dollar it has reached $2 to £1. The strong exchange rate helps to reduce inflationary pressures. If interest rates continue to rise, it will cause further problems for hard pressed exporters.

  • High levels of debt in the UK:

This mean that small increases in interest rates will have a big effect. Even a quarter % rise in interest rates adds £14 onto a £100,000 mortgage. With mortgage interest payments accounting for a record % of disposable income, interest rates will start to have the desired effect soon.

  • Time Lag of interest rate rises.

Interest rates have been increased 4 times since last summer, it seems they have had little impact on reducing inflationary pressures. But, it is estimated that interest rate increases take 18 months to have a full effect, therefore, in the coming months previous interest rate rises will start to have an effect.

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Anonymous Zally said...

The rates have risen today... The increased rate may impact the rising inflation as it is intended but my fear is that people will lose their homes as a direct result too.

The resulting market adjustment, will leave a lot of mortgage borrower short changed. There is now a distinct possibility that the property market may crash..

Having said that, following the problems with the American housing sector.. it was only a matter of time and I think that time has come..

May 10, 2007 at 8:49 AM  

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