Rate Cut Dilemma

In normal circumstances, cuts in interest rates would be a near certainty. The looming prospect of negative economic growth, together with the continuing fall in property prices, would normally be enough for the Bank of England to drop the price of borrowing.

Inflation, as measured by the Consumer Prices Index (CPI), has risen to 4.7%. The main culprits are escalating food, oil and utility bills. And therein lays the dilemma.

Global factors

Global factors driving the current surge in inflation include a sharp increase in world food prices by 40% in the year to August, and wholesale gas prices up by 90%. The Bank of England expects inflation to peak soon at about 5%, and then fall as the impact of energy and food price rises diminishes.

Fear of escalating inflation

Unfortunately escalating inflation is likely to drive elevated wage demands and settlements, further fuelling inflation. The risks of a wage and prices spiral developing are now greater than they were.

The Bank of England concludes that a period of muted economic growth is necessary to dampen pressures on prices and wages, and return inflation to the target level. In other words, although there may be two quarters of negative growth (technically a recession), there is unlikely to be any cuts in interest rates until the Bank is satisfied that the inflationary threat has passed.

More housing market pain to come

So the take home message appears to be – don’t expect any cuts in interest rates in the immediate future, no matter how painful that may be for the housing market.