UK rates now likely to have peaked

HOPES grew yesterday that UK interest rates may have peaked after the rate of inflation remained below the Bank of England's 2% target for the second month running, and US interest rates were cut by a higher than expected 0.5%.

HOPES grew yesterday that UK interest rates may have peaked after the rate of inflation remained below the Bank of England's 2% target for the second month running, and US interest rates were cut by a higher than expected 0.5%.

Cut-price clothing and cheaper energy bills saw the cost of living in the UK rise at its slowest rate for more than a year in August, with the Consumer Prices Index dropping to 1.8% from 1.9% in July, according to the Office for National Statistics (ONS).

And although the Retail Prices Index (RPI), often seen as the more representative measure of “real” inflation faced by householders, rose to 4.1% last month from 3.8% in July, the ONS said the increase reflect the cost of mortgage lenders passing on the July quarter-point increase in interest rates to borrowers.

With the RPI figure indicating a squeeze on disposable incomes and the CPI - on which the 2% inflation target is based - last having been as low as 1.8% in March last year, the data reinforced the view of many economists that the Bank of England rate may now have peaked at 5.75%.

Bank of England governor Mervyn King signalled in a speech last week that interest rates would be held until the current turmoil in financial markets passed.

The further drop in inflation, which comes after July's bigger than expected fall to 1.9%, even fuelled hopes that the next interest rate move by the bank could be a cut as the global credit crunch threatens the wider economy.

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David Kern, economic adviser to the British Chambers of Commerce, said: “The global financial crisis and the acute uncertainties in the UK financial system have transformed the economic situation for the worse.

“The immediate policy focus is on restoring savers' confidence. But the more serious danger, beyond the immediate crisis, concerns the adverse effects on the wider economy, particularly the higher cost and reduced availability of finance to businesses, mainly to small firms.”

He added: “The higher RPI highlights the squeeze on disposable incomes resulting from previous interest rate increases.

“Given the worsening dangers facing the economy, we strongly urge the MPC to consider further urgent steps to ease monetary conditions. Unless inter-bank rates fall markedly, a quarter point cut in the bank rate would still leave monetary conditions tighter than they were before the current crisis started.”

The CBI, in its latest economic forecast, also published yesterday, cut its economic growth forecast for 2008 by 0.2% to 2.2%, due in part to the turbulence in credit markets but also to predicted falls in UK consumer spending and overseas demand.

“The outlook for interest rates has become more uncertain, with the Bank of England having to be mindful of both its inflation mandate and the need for stability in the banking system,” it said.

“But based purely on the expected outlook for the real economy, the CBI has brought its expectation for a quarter point cut in interest rates forward to the second quarter of 2008.”

Ian McCafferty, CBI chief economic adviser, said: “The current turmoil has eliminated any expectations of higher interest rates this autumn, and we continue to believe the next move will be down.”

However, he added: “The bank needs to be alive to the need for short-term flexibility, but purely on the basis of our outlook for the real economy in 2008, there would seem to be little need for a cut in rates before next spring.”

Later in the day, however, the Federal Reserve cut US interests by half a percentage point from 5.25% to 4.75%, further boosting hopes of a cut in rates on this side of the Atlantic.

The Fed - the US central bank - had widely been expected to cut its rate by 0.25% in a move to prevent the slump in the US housing market and the ensuing turmoil in financial markets leading to a full-scale recession.

The 0.5% cut will further restrain the Bank of England's Monetary Policy Committee from imposing a further increase in UK rates to 6% - which was on the cards until the recent turbulence hit the markets - and could bring forward a cut in UK rates.