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Drop in inflation suggests base rate will remain low for the short term

March 27th, 2014

An unexpected drop that has taken the rate of inflation to the lowest level inside four years to 1.7 per cent has opened the door for the Bank of England to further delay a raise to the bank base rate. While interest rates currently remain at historic low levels with the base rate sitting at 0.5 per cent for almost six years, a rapidly improving economy and financial outlook for the UK has sparked a belief for many market commentators that now would be the time for an increase to rates.

However, the BOE have consistently maintained that the time to raise rates will come, but no indication has been given as to when this will take place. With a reduction in the rate of inflation, the temptation could now be that rates should remain at their current level until early to mid-2015.

The reduction in inflation has altered many financial experts view of the timescales for potential interest rate rises, as prior to 2013 the expectation was a move would be required sooner rather than later to balance the ailing economy. Contrary to these opinions, a positive performance in the housing market over the past 15 months has changed the economic outlook.

As the rate of inflation now sits below the target expected by the Treasury at 2 per cent, rates could remain low for even longer than expected, as a lack of pressure to increase would allow the BOE breathing space to plot a steady course of rate rises over the coming years.

Contractors looking to invest will hold particular interest in this matter, although the senior economist at Aviva investors, Stewart Robertson, feels that the drop in inflation should not be an immediate cause for concern: ‘This obviously needs watching, but we don’t need to worry about inflation unless growth picks up sharply (and there isn’t as much spare capacity as thought), or sterling tumbles, or if wages pick up a lot.

‘None of these look to be an immediate threat. Our calculations have inflation between 1.7% and 2.0% for the rest of the year.’

While market experts will be aware that the housing market has had a positive impact on the economy, there continues to be a fear that rapidly increasing property values could destabilise the progress seen over the past year. While this point will help the monetary policy committee to shape the forward guidance ideology that Mark Carney, Governor of the Bank of England, has introduced, the chief aim has always been to meet the inflation target of 2 per cent to bring balance to the overall economic outlook.

An economist from the Centre of Economics and Business Research, Alasdair Cavallar, noted that: ‘This pattern of a fast-growing housing market and weak demand in other sectors makes the Bank of England’s task especially difficult, as the base rate is a blunt instrument.

‘The Bank is likely to stick to its course – although now keeping a “beady eye” on the property market, according to governor Charlie Bean, it does not consider that market to be overheating at present.’

Cavallar also said: ‘The Bank will therefore wait for continued strong business investment, a return to productivity growth and sustained growth in exports before considering raising the base rate. Now that Help to Buy has been extended to 2020, the supply side may have the confidence to invest in building new homes to meet this demand, which would vindicate the Bank’s view by preventing a housing bubble from forming and enabling it to wait for those three elements to arrive.’

Article By: Simon Butler, Senior Mortgage Consultant at Contractor Mortgages Made Easy

Media Contact: Raman Kaur, Public Relations Manager

Tel: 01489 555 080

Email: media@contractormortgagesuk.com

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