The MPC is unlikely to raise rates as much as the market expects says Legal & General Investment Management.
09 March 2011
At today’s Fundamentals briefing, Legal & General Investment Management (LGIM) Economist, Tim Drayson, explained that while financial markets anticipate a series of interest rate increases throughout this year and into next year taking the cash rate beyond 2%, LGIM believe this is higher than the MPC will go.
Tim acknowledged that the Bank of England may see its creditability under threat with inflation trending above 4%. This is double its target of 2% and therefore a couple of interest rate rises are possible over the next two quarters.
The MPC has a difficult choice to make between helping promote economic growth, or acting to curb inflation. “The full effect of government cut-backs are only starting to feed through to a struggling UK economy, so it’s likely any increase in rates will cause growth to slow more than the government expects and could cause unemployment to rise beyond 10%. This would surely convince the MPC to halt any further rate rises until the economic recovery is more robust.” Tim argued.
Tim explained the differences between temporary inflation arising from rising food prices, the VAT increase this year and the spike in oil prices and the structural pressures facing the UK in the years ahead. “The rise in living standards within emerging economies may mean higher import prices become a more persistent feature of UK inflation in the future. With the extent to which UK retailers have outsourced production to these emerging markets, there is very little room for local businesses to reduce the prices of their goods as input costs move higher.” Tim explained.
Despite the increase in structural inflationary pressures, however, Tim maintained that the expectations surrounding how far interest rates will rise during 2012 appear excessive. “Despite inflation remaining significantly above target, we don’t believe the MPC needs to inflict this much pain on the economy. While we acknowledge the possibility of official rates moving to 1% by the summer, we believe they will then remain on hold throughout 2012”.
Notes to editors
See full PDF of the Fundamentals briefing in the attachments.
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