Bank of England in tug-of-war between rates and inflation

10 April 2008 / by Rachael Stiles
The Bank of England's Monetary Policy Committee (MPC) is under growing pressure to reduce the base rate today, despite inflationary pressures.

Economists are urging the MPC to cut rates by at least a quarter point to five per cent, but the Bank of England faces a tug of war between cutting the base rate to ease up the availability of credit and restore optimism amongst lenders and borrowers, whilst also stemming inflation which threatens to break through the Government-imposed target.

Regardless of inflationary pressures, experts believe that cutting the base rate should be the Bank's first priority, as it will give some relief to the seized-up credit markets, which continue to slow with the soaring Libor – the rate at which banks lend to each other.

This month, Britain's banks have approached the Bank of England for an additional £3.57 billion to ease the cost of inter-bank borrowing.

Consequentially, a growing number of mortgage lenders are hiking the rates they offer customers or withdrawing mortgages from their product range, specifically 100 per cent deals, making it increasingly difficult for homeowners to refinance their loans, and first time buyer mortgage deals are becoming increasingly hard to come by.

Those wanting to get a foot on the property ladder now have to take out a deal that ties them for five years unless they have a deposit of 10 per cent or more.

Geoffrey Dicks, an economist on The Times Monetary Policy Committee which voted unanimously for a rate cut yesterday, said that the case for a 25 basis-point cut this month is "overwhelming", and that another one will probably be needed next month.

Another member of the committee, Bronwyn Curtis, said that "more decisive action is needed to tackle liquidity in the wholesale markets." While the Chancellor Alistair Darling has admitted that there will be a slowdown in the housing market, critics have accused him of downplaying the potential serious threat of the credit crisis to the UK economy.

Speculating on today's MPC interest rate decision, Henk Potts, Equity Strategist at Barclays Stockbrokers said: "Pressure has been building and building on the Bank of England to reduce interest rates as the economic picture deteriorates and property prices fall. Recent evidence also suggests that the credit crunch is starting to contaminate the wider economy.

"While inflation is likely to remain high for most of 2008, it should begin to moderate into 2009 as slower growth reduces capacity pressures, while commodity price inflation wanes, thus giving the Bank the room for manoeuvre that it requires."

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