Interest Rates On Hold In May

Posted on: 12 May 2008 by Gareth Hargreaves

The Bank of England maintains the bank rate at 5 per cent.

The Bank of England's Monetary Policy Committee voted on 9th May 2008 to maintain the official Bank Rate paid on commercial bank reserves at 5.0%, after the previous reduction of 0.25 percentage points on 10th April 2008.

"The Monetary Policy Committee is caught between a slow growth rock and a high inflation hard place," explains Henk Potts, Equity Strategist at Barclays Stockbrokers.

"UK economic growth is clearly moderating; consensus forecasts are for growth of just 1.6% this year compared to the 3% expansion recorded in 2007. However, outside the housing market and survey data, there is little hard evidence of a marked slowdown in UK aggregate demand.

"Headline inflation is likely to remain elevated for most of 2008, while CPI inflation is currently running at 2.4% and is set to move higher over coming months thanks to higher energy prices and the recent depreciation of sterling. However, it should start to moderate into 2009 as the softer growth backdrop reduces capacity pressures in the economy, and commodity price inflation wanes.

"Despite the upside risk to inflation, we expect the Bank of England to reduce interest rates gradually over the coming quarters, with rates finishing the year at 4.25%."

"The RICS is disappointed that the MPC chose to leave the base rate on hold," says Simon Rubinsohn, Royal Institution of Chartered Surveyors chief economist.

"While the RICS appreciates the risks associated with the recent pick up in inflation and acknowledges the danger of it moving into 'letter writing' territory during the second half of the year, the tone of recent data and surveys suggest that the threat of a sharp slowdown in economic activity is the more pressing issue for the authorities.

"Housing transactions have collapsed, consumer confidence has sunk to its lowest level since 1992, the service sector appears close to stagnation according to the latest CIPS survey and the retail sector is under immense pressure.

"There is now a high probability of growth falling short of the Bank of England's expectations as set back in February. This will create the spare capacity to lower inflation in the medium term.

"Significantly, the latest report from the REC (Recruitment and Employment Confederation) highlights the threat to employment from the deteriorating economic climate.

"The RICS believes that the Bank needs to take further pre-emptive action over the coming months starting with the June meeting in an effort to decisively counter the impact of the credit crunch. The RICS believes that the Bank should cut the base rate to 4.5% in June if there is no improvement in the data over the next month."

Ray Boulger of leading independent mortgage adviser, John Charcol, advises, "At this stage of the interest rate cycle trackers normally make most sense for borrowers who don't need or want the protection and security a fixed rate mortgage offers. However, because lenders generally have increased tracker margins above Bank Rate by more than they have increased fixed rates the choice is not so obvious at present. Anyone who believes Bank Rate will average no more than 4.5% over the next few years and is prepared to back that judgement will probably favour a tracker, but at present the majority of borrowers are choosing fixed rates.

"Just as important a consideration is how long to lock into a deal for. With lenders' margins over the cost of funds at unprecedented high levels there is a good argument for not locking into a deal for too long, but this has to be balanced against the risk that conditions in the mortgage market will deteriorate further and that it may be difficult to obtain a better deal in the short term.

"An ideal compromise would be a long-term deal, perhaps a lifetime tracker, with no early repayment charges, but few lenders still offer such deals. As an alternative a three year deal should be long enough to see conditions in the mortgage market better than those of today, even if they have not returned to normal by then."

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