Nevertheless, the Bank still noted caution over future inflation saying:

“The committee needs to balance the risk that a sharp slowing in activity pulls inflation below the target in the medium term against the risk that elevated inflation expectations keep inflation above target,”

With the prospect of mortgage interest rates falling further, many are suggesting that fixed rate mortgages are not offering particular good value. Instead the best mortgage products are tracker mortgages which are fixed to the Bank’s base rates.

Mortgage interest rates and Inflation at Bank of England

1. Predictions for the Bank of England’s base Rate
2. Predictions for Lenders standard variable rates.

Due to the global credit crunch, mortgage lenders are struggling to gain sufficient finance for mortgage lending. This shortage of funds is pushing up the cost of borrowing. Therefore, lenders are putting up their standard variable rates, independently of the Bank of England’s Base Rate. This is increasing the margin between the base rate and the average mortgage interest rate. You may ask why mortgage lenders need to borrow – surely they can raise funds from savings? This used to be the traditional business model for mortgages. But increasingly, lenders such as Northern Rock took the opportunity to issues more mortgages by borrowing from other institutions.

Forecasts for Bank of England’s Base Rate

In the medium term UK economic growth is likely to slow down, due to:

• falling house prices,
• global slowdown
• Tighter fiscal conditions (government public sector pay restraint and possible need for higher taxes)
• Falling consumer confidence related to stock market and house price falls.

These factors which have a downward impact on growth will reduce inflationary pressures enabling the MPC to cut interest rates. There are some upward cost push inflationary factors, (energy and food prices in particular) but, generally speaking these do not pose a long term threat to inflation.

Despite the scope for cut in interest rates, the MPC is likely to be more conservative than the US federal Reserve. I would predict only small and gradual cuts. A lot depends on how the economy responds to small rate cuts and whether the UK growth slows down more than the government forecast.

 Forecast for UK interest rates 2008

As a general rule, UK interest rates often follow closely US interest rates. There is not a perfect correlation but often the trade cycle of the US and UK converge.

This week the Fed cut interest rates by 0.75% in response to concerns over a falling stock market and a weak housing market. It is likely that the MPC will soon follow suit, although the MPC will be more cautious about cutting interest rates by a large amount. In recent years they have always sort to change rates by 0.25% at a time.

In the medium term, after many years of growth, the UK economy may slow down. The main reason for this is that the Housing Market is likely to slow down. Falling house prices would have a significant negative impact on the UK economy; it would reduce consumer confidence and reduce spending. Lower spending would reduce inflationary pressures, enabling the MPC to cut mortgage interest rates, without CPI inflation going over the governments inflation target.

Another factor that may contribute to lower interest rates in 2008 and 2009 is the global credit crunch. This is making it more difficult to borrow money, therefore lending, such as mortgage lending, may well contract causing lower growth.

It was interesting to note that the last 0.25% cut by the MPC did not translate into lower mortgage payments for many homeowners.

See also:

• Economic Forecasts 

Before the sub prime crisis affected the UK, many thought interest rates in the UK, would increase to 6% and possibly higher.

However, with the slow down in house prices and a growing credit crunch it now looks like interest rates may have peaked already at 5.75%.

The future of interest rates in the UK, depends on whether inflation remains close to its target of 2% +/- 1. At the moment it is difficult to predict because of conflicting inflation data. CPI inflation is 1.8%, but RPI (the old measure is over 4%). CPI inflation is on target, but, RPI is not.

Consumer spending in the UK is remarkably resilient, however, it will be interesting to see how the UK economy is affected by the global credit crunch.

If less mortgages are offered, then demand for housing may fall and therefore, house prices could start to fall in the UK.

If house prices did start to fall it would definitely leave scope for future interest rate cuts.

My feeling is that although it is unlikely house prices will fall significantly, we will see a slowdown in the housing market. With lower global growth, it is likely that interest rates can fall next year.

Future Fixed Rate Interest Rate Predictions

A 2 year fixed rate deal at the Brittania building society offers an introductory 2 year rate of 6.05%.

However, I would argue that now is not the best time to get a fixed rate. I think that in the new year, fixed rate deals will become more attractive. It is unlikely that interest rates will rise

• Remortgaging Advice and Quotes

Central Banks are concerned about rising inflation for the following reasons:

1. Uncertainty / Confusion

Higher inflation creates uncertainty about the future revenue and costs of firms. Therefore, firms become less willing to commit to investment decisions. This can dampen economic growth in the long run. Uncertainty can also extend to consumption and discourage consumer spending.

2. Domestic Goods Become less Competitive.

Higher inflation in the US, would make US exports less competitive. This would result in a fall in exports and a deteriorating balance of payments on the current account. If exports are less competitive it will put further downward pressure on the dollar, causing imports to be more expensive.

3.Inflationary growth is unsustainable.

High inflation is an indication that the economy is overheating. This means that the economy is growing above its long run trend rate and therefore is unsustainable. If growth is too fast it is likely to result in a recession – Boom and bust economic cycle. Generally the Fed wishes to avoid volatile economic growth. It is better to keep inflation low and growth sustainable.

4. Menu costs

When inflation is high firms will need to frequently change prices. This is time consuming and incurs an economic cost. However, this cost is less important given advances in technology.

5. Income redistribution

When inflation is high savers become worse off (unless their savings attract a higher interest than inflation). People on fixed incomes will also become worse off. Borrowers may benefit, because it becomes easier to pay back their debts.

6. Wage Price Spiral

This means when there is inflation, workers demand higher wage increases. This causes further inflation, therefore, in the future, workers demand higher wages. This is an example of how moderate inflation can easily get out of control.

If inflation rises above 2% there are several economic costs. The higher the inflation rate, the more serious the problems become.