Interest rate unlikely to rise anytime soon
The official rate of interest is unlikely to increase from its current level of 0.5% in the near future, the head of the Bank of England has hinted.
Speaking in front of the Treasury Select Committee, Bank of England governor, Mervyn King, said he was "more uncertain than ever" about the UK economy - with the green shoots providing a very mixed picture.
He said: "I feel more uncertain now than ever, because it's not a pattern of a recession coming into recovery that we've seen since the 1930s. There are genuine concerns about how quickly the recovery will pick up - looking at the clear evidence, [firms] are finding it hard to access credit from the banking system."
King also indicated that the base rate is unlikely to be raised in the near future.
He told MPs that he did not believe that "the big picture" had changed since the Bank of England's May inflation report. This puts headline inflation at just below the 2% medium term target if the base rate remains at 0.5% over the next two years and quantitative easing (the creation of new money) totals £125 billion as currently planned.
"If you withdraw stimulus too quickly, you run the risk that the downturn will resume," he explained. "Equally of course, we need to be very careful not to allow the stimulus to reach the point at which inflation takes off."
Howard Archer, chief UK and European economist at IHS Global Insight, says: "The comments by Mervin King broadly reinforce the view that the base rate is highly likely to stay at 0.5% through the rest of 2009 and may well continue at that level well into 2010.
"In addition, the Monetary Policy Committee (MPC) appears to be keeping an open mind on whether the Bank of England will need to further increase the amount that it is spending on quantitative easing."
King also set himself on a collision course with Gordon Brown after criticising the government's fiscal policy.
"We are confronted with a situation where the scale of deficits is truly extraordinary," he told MPs. "This reflects the scale of the global downturn, but it also reflects the fact that we came into this crisis with fiscal policy on a path that wasn't sustainable and a correction was needed."
He called for the chancellor Alistair Darling to cut the budget deficit under the course of a single parliament.
In April's Budget, Darling said the government's current account deficit would come down to 5.5% by 2013-2014.
"There will certainly need to be a plan for the lifetime of the next parliament, contingent on the state of the economy, to show how those deficits will be brought down, if the economy recovers, to reach levels of deficits below those which were shown in the budget figures," King said.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).