Economists divided over interest rates

Businessmen divided

The team of economists that sets interest rates suffered a three-way split over whether rates should increase, decrease or remain at 5% in July, the minutes from its vote reveal.

Every month, the nine members of the Bank of England’s Monetary Policy Committee (MPC) meet to discuss the economic outlook and vote on interest rates. In recent months opinion among non-MPC economists has varied over whether rising inflation means interest rates should increase, or the economic downturn means rates should fall.

The debate is just as heated within the ranks of the MPC, it appears, with seven members of the committee voting for a rate freeze in July, one voting for a 0.25% increase and one voting for a 0.25% cut. This is the first time a member has voted for an increase in 12 months.

The minutes reveal that July’s decision was “a difficult one” for all members of the MPC. The majority took the view that, in order to bring inflation back down to its 2% target, interest rates should remain static until at least August. However, Professor Tim Besley argued that interest rates must be increased in order to calm inflation sufficiently, while David Blanchflower called for rates to be cut.

What this means for interest rates remains to be seen. The next quarterly inflation report is due out on 13 August, but the MPC will be allowed access to this prior to its next meeting on 7 August. The report's outlook for inflation is likely to have a big impact on where interest rates head next.

In the minutes of the MPC's July meeting, it is noted that an interest rate rise in that month would be unexpected and might spook the markets. However, experts tend to anticipate rate changes in months when the inflation report is due out – such as August.

Peter Newland, an economist at Lehman Brothers, says: "Given the MPC’s ongoing inflation concerns we cannot rule out an August rate hike... However, we judge that continued bad news on economic activity and signs of easing in inflation pressures (such as the recent decline in the oil price and cut in petrol prices) will be sufficient for the majority of members to keep rates on hold in August."

Ben Read, senior economist at the Centre for Economics and Business Research, says division within the MPC is likely to become more entrenched in the coming months as inflation rises and the economy slows. He adds that, with inflation inevitably worsening to as high as 4.5% within the next two months, more members will start voting for interest rate rises.

But Read says: “The medium-term prospects are that inflation will start to come back towards target early next year. We therefore expect rates to remain on hold for the rest of this year, although there will be increased pressure from both sides of the debate as inflation surges and the economy stagnates."


Meanwhile, there has been more bad news from banks, with another month of falling mortgage lending. The latest British Bankers’ Association (BBA) figures from the high street show that, in June, lending was 23% lower than in the same month last year.

The June figures show that remortgaging remained stronger than new purchase loans during the month, with the latter accounting for just 19% of all approved mortgages.

The fall-out of the mortgage market means more people are having to rent rather than buy. As a result, demand for rental accommodation has burgeoned, and is up 38% since last year, according to estate agent Your Move.

Managing director David Newnes says the credit crunch has buried any chances most first-time buyers might have had of getting on the property ladder.

“There has been a stellar rise in the number of people looking to rent since the credit crunch began to kick in,” he adds. “The criteria banks and building societies use for deciding how much you can borrow have got a lot tougher. People who would have fallen into the first time buyer bracket a year ago are now renting.”

A lot of attention has been paid to the impact of the credit crunch on first-time buyers and those with limited affordability. But specialist wealth management firm, The Route City wealth club, says that mortgage lenders are also turning their backs on high net worth – or triple A - borrowers.

Richard Roberts, property consultant at The Route City, explains: “High street lenders have historically fallen over themselves to attract this kind of borrower, but are now targeting the more competitive products at lower borrowing levels to spread risk.

“This spread of lending means that triple A rated clients are excluded simply due to the larger amounts they want to borrow.”