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Interest Rates Held at 0.5% once again

Friday, May 06, 2011
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The Monetary Policy Committee decided to keep interest rates unchanged at 0.5%, a rate which offers little comfort to savers and pensioners groups who have seen a significant fall in interest paid out on deposit accounts, i.e. falling incomes from savings. The Base Rate is at a historically low level, its lowest rate since the foundation of the Bank of England.

Data from Timetric.

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Bank of England Target 2.0 from Timetric

Decisions to allow sterling to depreciate two or more years ago, placed upward pressures on imports as contracts are renewed, but how far are external pressures on oil and commodity prices beyond the ability of the MPC to limit UK inflation rates? Hands up those of you who predicted the Arab Spring and its impact on oil prices.

Students could consider this clip from The BBC’s Politics Show can be used to weigh up the case for and against raising UK interest rates to consider developing their evaluation of UK monetary policy, can they weigh up the case for keeping base rates unchanged, against the case for increasing them.  If unemployment is approaching 2.48 million, it may suggest that there is downward pressure on wage.

But we are all aware of the rate of change in prices of wheat, rice, bread and other foodstuffs which might help to alter views on where inflation might go in the next 12 months? 

The commodity price rises could lead to changing expectations in the UK, pessimistic animal spirits. “If filling up the tank in your car used to cost £40 a week but now costs £50, does that £10 come off your grocery bill or do you have one less meal out at a restaurant?” It spells out the opportunity cost of running a car.

To what extent has the MPC’s policy failed to check inflation, as the CPI has once again breached the 2% target rate, students can also consider the success or otherwise of the UK against changes in inflation rates across the world.

CPI figures from The Economist magazine make uncomfortable reading for the MPC – The Euro zone +2.3%, USA + 2.5%, Japan +0.2%, China +5.0%, UK +3.9%. Germany 2.1%,  France 2.0%, Canada +2.4%, Russia 9.1%.

Yet taking a longer view, although the RPI has risen c 5.%, it is small beer compared to the inflation rates of the mid 1970s and early 1980s.

The MPC reduced Base Rate to 0.5% in March 2009, but there is little scope for additional rate reductions to stiumualte aggregate demand within the UK economy. Rate reductions may have lost their potency for the time being.

This gloom may be offset by the large falls in the price of crude oil, this evening US light, sweet crude dropped 8.8 % pushing the price of a barrel to $99.52, below the psychologically significant price of $100.

This may be a market reaction to the assassination of Osama Bin Laden, and increased risks of slower growth in the USA and Germany. But it could trigger off a change in sentiment, remove some negative feelings and raise optimism about the future.

However, if oil prices start to fall, it might instil a greater level of optimism amongst consumers. They will see changes, they might be able to afford a meal out, take a weekend break without worrying so much about their budget.

“Robert Gardner, Nationwide’s chief economist, says that while people’s ability to spend may not be as constrained as it was during the recession, there is no getting away from the fact that conditions are still difficult. “Employment is still tough and wages haven’t been rising fast enough to keep up with inflation. People can see the cost of food rising,” he says.To him, confidence is about people’s willingness to spend and it is wrong to dismiss it as unimportant - although he admits it is not the only indicator that needs to be looked at when assessing economic recovery.

The real key factor to confidence, he says, is what is going on in the labour market. “It’s such a fundamental to determining what is happening with household budgets. “If the labour market picks up, there will be more people in jobs, people will feel more confident.“That in turn increases demand and will be vital to boosting consumer spending, which makes up about 60% of all spending across the UK.

Do consumers act rationally or is there an element of irrationality within us all?  The MPC not only extrapolates statistical data, but has to take into account sudden changes in consumer and investor sentiment, which leads to an element of uncertainty over future growth rates, inflation and employment levels.

 




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