The Case for Lower Interest Rates

With US interest rates being cut to 1%, many are asking how low UK interest rates could go. Looking at the economic statistics, there is an overwhelming case for lower rates. These are some of the factors the MPC will be looking at when considering rate cuts.

1. Inflation forecast to Fall.

• Lower oil and petrol prices will reduce the cost push inflation factors that have caused current inflation to be high. The recession will cause a big fall in demand pull inflation factors as firms cut prices to retain custom.
• Wage restraint. The UK Labour market is increasingly flexible and wage restraint has meant real wages have shown their slowest growth for a while.
• Inflation expectations have fallen. The current inflation of 5% has not cause inflation to become ingrained in people's expectations. Lower inflation expectations make low inflation more likely. The below graph shows people's expectations of inflation have fallen.

2. Business Confidence has evaporated

Business confidence has fallen throughout the year. The levels of business pessimism are at very high levels. From Jan to Oct, business pessimism has fallen from -16 to -60

This pessimism is reflected in levels of employment which are falling sharply. Some point out that the rise in unemployment is being masked by many eastern European workers leaving the economy and returning to Poland / Czech e.t.c.

3. Credit Crunch Affecting Business.

We have heard a lot about the credit crunch making mortgages more expensive and difficult to get. But, the lack of lending is now starting to constrain business investment decisions. This will affect growth in the next 12-24 months. Business investment relies on borrowing from banks. But, the state of banks means they are reluctant to lend. Lower rates, will facilitate normal borrowing.

4. Falling House Prices.

Falling House prices creates a powerful negative wealth effect reducing consumer spending and economic growth. The government is increasingly concerned about negative equity which is a real problem in a period of rising home repossessions. See: problems of UK Housing Market

5. Official recession and Rising Unemployment

The economic slowdown has been remarkably swift, as this graph shows

Unemployment often lags behind an economic slowdown, but, it is rising fast