Uncertainty remains over inflation and interest rates

For people keeping a keen eye out for indications of how long interest rates might stay unchanged, there has been plenty to digest over the last week.

The minutes from the Monetary Policy Committee’s (MPC) June meeting were published on Thursday and they revealed that, for first the first time since August 2008, one member, Andrew Sentence, voted for a rate rise of 0.25%.

In general, the committee felt that factors such as spare capacity in the economy, falling oil prices and continued uncertainty in economies around the world, meant that inflation was likely to fall back later in 2010. However, Mr Sentence felt that inflation had “proved resilient in the aftermath of the recession” and that a rate rise was needed to keep it in check.

On their own, these minutes would suggest that a rate rise in the near future is becoming more likely, but much has happened since their release. Last week, the US Federal Reserve kept its own benchmark rate on hold again and said that factors including “subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

There followed the G20 summit in Toronto at the weekend where the US warned another nations against making sudden moves to reduce deficits that could also jeapordise the return to economic growth – Treasury Secretary Geithner stressed the need to, “recognize that it’s only been a year since the world economy stopped collapsing.”

We’ve also had George Osborne’s budget in which the Chancellor announced substantial cuts to public spending and increases in both VAT and Capital Gains Tax.  The MPC said in its minutes that, “uncertainty over the nature and scope of the fiscal measures to be announced in the forthcoming Budget would be resolved by the time of the Committee’s next meeting.”

Taking all this in, it seems little has changed to alter the consensus view from economists that UK interest rates are likely to remain unchanged for the remainder of 2010 (thisismoney.co.uk has a good roundup of budget reactions from leading economists).

It will be interesting to see how the MPC members react to both the budget and other recent events when they meet again next month.

In the meantime, if you think you’re no closer to guessing what will happen with inflation and interest rates, then it appears you’re not alone.  The MPC said that the outlook for inflation in the medium term would depend upon households’ and firms’ expectations for inflation.  But it also said that those expectations would be influenced by what happens with inflation!  That’s economists for you.

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