UK: Economic Update – Interest rates could soon start falling.
Roger Bootle’s response to May’s MPC meeting

• Today’s decision by the MPC to keep interest rates on hold at 4.75% for the ninth month in a row all but confirms that interest rates have peaked, in line with my longstanding forecast.

• If the MPC was going to raise interest rates once more, arguably this would have been the month to do it given that CPI inflation rose from 1.6% in February to a seven year high of 1.9% in March and given that this is an Inflation Report month. But the no change announcement suggests that the Committee is more concerned about the recent slowdown in activity than the oil-induced spike in inflation.

• GDP growth in Q1 of this year is provisionally estimated to have fallen from 0.7% in the fourth quarter of last year to 0.6%. And the more up-to-date figures suggest that the consumer slowdown is gathering pace.

• Indeed, retail sales fell by a monthly 0.1% in March which left the annual growth rate at just 2.7%, down from the rates of 7% plus seen last summer. Moreover, the fall in the reported sales balance of the CBI Distributive Trades survey from -9 in March to -14 in April, together with the downbeat earnings reports from high street retailers such as Kingfisher and HMV, suggests that sales are likely to have been weak in April too.

• This more cautious spending attitude is due to the housing market slowdown reducing wealth and dampening the feel-good factor. Although house prices have yet to fall on a sustained monthly basis, the annual growth rates on both the Halifax and Nationwide measures have dropped from around 20% last summer to just 7% odd in April.

• Accordingly, the Committee would have been concerned that a pre-emptive rate hike to counter the recent pick-up in inflation would prove to be the final nail in the consumer coffin and further undermine confidence in the housing market.

• With interest rate rises now largely off the agenda, attention will soon turn to when the Committee is likely to start cutting interest rates. Although this will depend on the data, my suspicions are that a continuation of the weakness of consumer spending and a further step down in house price inflation could prompt the Committee to lower interest rates in August. And even if it waits, it is very likely that rates will be falling by the end of this year and could drop all the way to 3.5% by the end of next year.

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