Forecast for interest rates in 2008

Over the past year and a half interest rates have been at the top of the financial agenda for many analysts and economists, following a series of five interest rate hikes that started in August 2006. The base rate in the UK went up from 4.5% in August 2006 to 5.75% by July of 2007 after a series of five 0.25% hikes, leaving many homeowners facing unmanageable mortgage repayments and making it increasingly difficult for non-homeowners to afford a mortgage.

In December 2007, as had been widely expected, interest rates came down by 0.25% taking the base rate to 5.5%. The Bank of England had to take into consideration the effects of the credit crunch in the UK and a slowdown in the economy.

It was thought that these factors would result in a further interest rate cut in January 2008, but following the January Monetary Policy Committee meeting the Bank of England announced that interest rates would remain unchanged. One of the reasons for this is likely to be concerns over rising inflation, which also had to be taken into account.

Analysts and economists continue to speculate over what will happen with interest rates in the UK over the course of this year, and the general consensus seems to be that there will be two or three interest rate cuts this year, with some industry professionals predicting that the base rate could actually fall as low as 4% by the end of the year.

Below are some of the views given by industry experts with regards to what will happen with interest rates this year.

Following the Bank of England’s announcement that interest rates were being cut by 0.25% in December an economist from Deloitte and Touche stated: ‘Today’s decision by the MPC to cut interest rates from 5.75% to 5.5% is the first step in a prolonged period of monetary easing that could see rates fall very sharply. I previously thought that rates would drop to 5%, but I now think that they could eventually be cut all the way to 4%. Inflation is likely to rise further in the coming months. However, the rise in interbank interest rates means that the risk of a very sharp and prolonged economic downturn is growing by the day.’

A Bear Stearns official stated: ‘The Bank of England has pulled the rip-cord to much lower rates. We could well be staring into the jaws of UK rates coming down to 4% in this cycle. The doves’ concerns about downside risks to growth have taken much higher priority over the hawks’ fears about upside inflation risks. The background worry right now is that the UK could dip into recession next year.’

An Investec economist said: ‘Evidently the MPC is taking much more note of recent signs of a slowdown in the economy and its fears over the possible effects of the credit squeeze have begun to crystallize. The question obviously now is whether rates come down again and if so how quickly. The outlook is very uncertain. We are pencilling two further 25 basis-point cuts over the first half of next year.’

According to Howard Archer from Global Insight: ‘The recent flurry of markedly softer data and survey evidence relating to the services sector, consumer confidence and the housing market has clearly raised fears within the MPC that there is an increased risk that growth could slow sharply over the coming months. The Bank of England’s statement also reveals that tighter conditions in credit markets also prompted the MPC into acting, despite concerns about ongoing inflationary pressures stemming from elevated energy, food and commodity prices, some signs of pay picking up, resilient inflation expectations and possible capacity constraints.’

He added: ‘We expect the Bank of England to enact two further 25 basis point cuts in interest rates during the first half of 2008, taking them down to 5% by mid-year. This reflects our belief that UK growth will slow markedly over the coming months and will average just 1.9% in 2008. Slowing growth should increasingly dilute underlying inflationary pressures.’

Although there was no interest rate cut in January of this year, which came as a disappointment to many industry officials as well as the homeowners that are struggling with mortgage repayments, expectations of a 0.25% cut have now shifted to February.

Many experts feel that the Bank of England will have to put concerns over inflation on the back burner in the light of low levels of consumer confidence, the slowdown in the economy, and the financial strains facing millions of homeowners. With many people due to come off cheap fixed rate deals over the coming months many feel that the Bank of England needs to act sooner rather than later when it comes to another cut in the base rate.