A Daily Reckoning Special Report

By Brian Durrant

Picture this. A schoolmaster is taking a dozen school boys on an extended field trip to the coast. It's sunny. The sea is very inviting but the schoolmaster knows it is dangerous and alerts the students to the red flag and other warning signs. One student defies this advice, and shouts to the others "come on in, the water's lovely". One by one the others dive in and they have a great time. The schoolmaster shakes his head. When the students come out of the sea unharmed, the schoolmaster tells them how foolish they were and they will not be so lucky next time. The students dismiss him as a killjoy. In the following days the boys have more fun in the sea, while the schoolmaster's warnings are ignored repeatedly. Then one day a freak undertow drags the swimmers out to sea. Their lives are in danger. What does the schoolmaster do? Does he do nothing, muttering smugly "I told you so"? Or does he swallow his pride and mount a rescue operation, knowing that the students will then conclude if they defy him in future they will be rescued in any case...

UK Interest Rates Forecast 2008: more cuts to come

This dilemma is similar to that faced by the Bank of England in its current dealings with banks. In the early stages of the so called "credit crunch", the Bank of England took a detached view warning of the dangers of bailing out institutions that had taken reckless lending decisions for profit. The Bank argued that it was not its job to provide a safety net for imprudent behaviour.

But as the crunch dragged on, the Bank of England has realised that the crisis could potentially affect the economy’s "innocent bystanders". There has been a growing realisation that monetary policy can no longer be an academic posture to teach errant banks a lesson but needs to be a practical exercise to head off a recession. Faced with the fear of cutting interest rates too much or reducing them too little, the former course of action is easier to rectify if it is wrong. That is why on December 6th the Bank of England succumbed to an irresistible tide of opinion demanding interest rate cuts and the nine members of the Monetary Policy Committee (MPC) agreed unanimously to cut interest rates by a quarter of a percentage point, to 5.5%. It seems that the moral hazard argument has its place, but there is a point when policy makers, mindful of the 1930s depression, have to cast it aside. We have now reached that point. There will likely be more interest rate cuts to come this year.

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UK Interest Rates Forecast 2008: the housing market will fall

The outlook for the housing market looks bleak. Mortgage lenders are predicting no change in house prices in 2008, which is about as close as anyone with such a vested interest could ever come to predicting a drop. We believe that house prices will stagnate at best, but there will not be a precipitous crash. For a crash to happen, the UK economy must be the assassin of the housing market as it was in the late 1980s and early 1990s. At the moment the economy does not yet look sickly enough for anything more dramatic than a gentle fall.

At the same time, households will feel the squeeze of weak income growth and, soaring food, fuel and petrol prices. On top of this British exporters will find it very tough to compete with American firms with the dollar so weak. Furthermore cutting interest rates is the only tool available to stimulate the economy. The alternative option involving a fiscal stimulus has already been exhausted by Gordon Brown, when he was Chancellor. Since 2000, the government has been just as guilty of reckless borrowing as any household. His legacy to his successor is government finances which are deeply in the red and already at its overdraft limit.

UK Interest Rates Forecast 2008: rates to go below 5%

The bottom line is that there are more interest rate cuts in the pipeline. Official rates are currently at 5.5%. We are likely to see them below the 5% mark next year, implying at least three more rounds of cuts from the Bank of England. The message for mortgage holders is straightforward. Don't be tempted to lock yourself into fixed rate mortgage agreements just yet, while those of you who are already in fixed rate arrangements should consider the variable option if they are due to expire soon.

First published on Mon 07 Jan, 2008

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