The Bank of England's Monetary Policy Committee (MPC) announced at midday today that UK interest rates will once again be held 0.5%. The interest rate remains at the lowest level ever seen in the 316-year history of the Bank of England, at which it has now been parked for 18 successive months.
Today's announcement comes as no surprise, given recent statements from Bank of England Governor Mervyn King which suggest that he believes interest rates will remain low for an extended period.
The Ernst & Young Item Club believes that low interest rates are likely to be required for much of the duration of the current parliament, in response to the expected impact of the coalition Government's package of public spending cuts, and in order to help tackle the threat of sharply falling inflation.
According to Professor Peter Spencer of the Ernst & Young Item Club (speaking to the BBC):
The Item Club therefore concludes:
The Ernst & Young Item Club believes that low interest rates are likely to be required for much of the duration of the current parliament, in response to the expected impact of the coalition Government's package of public spending cuts, and in order to help tackle the threat of sharply falling inflation.
According to Professor Peter Spencer of the Ernst & Young Item Club (speaking to the BBC):
A base rate of 0.5% will begin to look like the new normal.Spencer argues that inflation will remain elevated over the next 18 months, pushed up by energy prices and the impact of rising VAT. But in the medium-term, deflationary risks will arise as "these effects wear off and spare capacity bears down on pricing decisions and wage bargaining".
The Item Club therefore concludes:
To prevent CPI inflation moving below 1% it will be necessary keep the Bank base rate low at 0.5% for much longer than the OBR and the markets have anticipated.
Chancellor George Osborne's testimony to the House of Commons Treasury Committee (PDF format, 301.2K) last month indicates that he too believes interest rates should remain low.
Update:
CBI head of economic analysis Lai Wah Co issued the following reaction to today's interest rate decision:
After the strong gain in economic activity between March and June, growth is expected to be slower in the second half of this year, but the recovery continues to be supported by the current, exceptionally loose monetary policy. A move towards a gradual withdrawal of the monetary stimulus may be warranted in the coming months.
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