Interest Rates – the Key to the Economy

I recently had an opportunity to hear a talk by one of the City’s top economists. Usually these talks are full of doom and gloom but not this time. Key indicators show that the markets are good value, the US economy is looking strong and interest rates look likely to stay low - at least until late this year but possibly until November 2012 or beyond. Talk of a double-dip recession seemed a distant memory.

Then we had the UK GDP (Gross Domestic Product) figures for quarter four of 2010. The forecast was for the economy to grow by 0.5% in quarter four. Instead we saw a 0.5 contraction which meant that the projected growth figures were disastrously wrong.

Can this be explained purely by bad weather or have the Government and the Bank of England got it wrong? And is “double-dip” back on the agenda? Even if we take the bad weather factor out of the equation, we would only have had zero growth.

While I don’t for one minute feel that a double-dip recession is likely to happen, there is no doubt that many of us are in a period of belt tightening, and job losses may not be good for the economy generally.

However, for companies that export, a combination of the ability to restructure personnel, lower wage increases and a cheap pound has led to almost boom times. Manufacturing hasn’t had it so good in quite a while. But what these companies need to ensure is that they take care of long-term growth by gradually absorbing those out of work. This will lead to sustainable growth.

For the first time since 2008, two members of the Bank of England monetary committee that sets interest rates voted for a 0.25% rise in rates. However, that was before the Quarter four figures were announced. There is no doubt in my mind that raising interest rates at this time would be a disaster for the economy. The resulting rise in house repossessions and a stronger pound would only be detrimental to recovery.

In any case, there must be severe doubts as to whether raising interest rates would have any effect on inflation. The inflationary pressures at present are higher oil and commodity prices, and record food prices. As these are led predominantly by world economic issues why would raising interest rates work here?

The Governor of the Bank of England, Mervyn King, has indicated that a rise in interest rates is not on the agenda. He needs to stand strong against media pressure which is starting to talk it up.

So far there is every indication that he will do so, even if it does involve writing a letter to the Chancellor each month to explain why inflation is not on target.

I’m with Mr King. But he needs more than a few lone voices. Businesses have to put their collective voice to a strategy that makes sound economic sense, and that can only be keeping interest rates where they are for some time to come.