Where now for interest rates?

After much delay and no little speculation, Gordon Brown, the Chancellor of the Exchequer, has finally announced the appointment of two new members for the Bank of England’s rate-setting monetary policy committee (MPC). Why is this important? Because the two-new appointments could change the balance of power on the committee at a time when there is speculation that the cost of borrowing is about to rise. (Last week the pound shot up half a cent against the dollar on rumours that Morgan Stanley UK economist David Miles, a renowned interest rate hawk, would get one of the MPC jobs.). In the end it was not Mr Miles but Timothy Besley, a professor at the London School of Economics, and Dr Andrew Sentence, British Airway’s chief economist who landed the prestigious positions.

The MPC has kept the cost of borrowing unchanged at 4.5 per cent since August last year. In the latter stages of 2005 and the early part of this year, many economists were predicating that the next move in rates would be downwards but the bank stuck firmly to its “wait and see” policy. More recently, mounting fears over inflation, renewed strength in the housing market and economy generally and higher rates globally mean the balance of opinion has swung to predicting that the next move in borrowing costs will be upwards. Within the City, the main point of debate has not been “if” but “when” rates will increase.

So where do these appointments leave expectations? The conclusion has to be that the hawks who want rates to shoot higher will be disappointed – at least for the time being. In early July, the MPC voted to keep rates on hold. Although we do not yet to have access to the minutes of the meeting, it was most probably a unanimous decision. The minutes of the previous month’s meeting had already revealed a more dovish tone among committee members after the recent market turmoil. The committee voted 7-1 to keep rates on hold and since then, David Walton, the only member to vote for a hike, has tragically died of a heart attack.

Although the current interest rate views of Professor Besly, who has worked as a consultant for the Treasury and the World Bank, are not known, Dr Sentence, who has been sitting on the Times shadow MPC for seven months, said last week that the economy was still vulnerable. “Consumer spending is still subdued, though it is beginning to recover,” he said. “This shows that growth prospects are still vulnerable to a weaker global economy which would hit exports and investment - so the Bank should be cautious about raising rates at this stage,” he added.

Adding to his reputation as an interest rate dove, Dr Sentence voted on the shadow MPC in favour of a rate cut in March and April this year.

The conclusion is that unless there is marked change in the inflation outlook over the coming months, there is little chance of higher borrowing costs before the end of this year. Beyond that, the picture gets murkier. Even the dovish Dr Sentence has said that interest rates may need to rise at some point.