MPC to start cutting rates soon

Roger Bootle, Economic Adviser to Deloitte, responds to September's MPC meeting

Lingering inflation concerns kept the Monetary Policy Committee's finger off the interest rate trigger again today. But it is only a matter of time before it is forced to respond to the rapidly deteriorating outlook for the economy by cutting rates very aggressively.

It is not hard to see why the MPC decided to stand pat for the fourth consecutive month at today's meeting. At 4.4% in July, inflation is more than double the Committee's 2% target and likely to head towards 5% as recently announced gas and electricity hikes hit the index.

That means that the Governor, Mervyn King, will have to write a series of further letters (one every three months) to the Chancellor explaining why inflation is so high. Against that background, the Committee may have feared that a rate cut today would have given the impression that it is targeting growth, not inflation.

But worries about the inflation outlook are likely to ease significantly over the coming months. After all, the recent fall in the oil price - if sustained - means that the upward influence of energy prices should soon start to fade rapidly.

Admittedly, there are concerns that core (excluding food and energy) inflation might yet pick up in response to the pass-through of previous sharp rises in producers' costs. Meanwhile, the Committee may worry that workers will yet seek to compensate themselves for higher prices in the forthcoming new year payround.

But it seems increasingly likely that these pressures will be more than offset by the disinflationary effects of the downturn in the economy. With the housing market in freefall - and not likely to be affected by Mr Darling's package of measures - GDP looks very likely to contract in the second half of this year. What's more, I now expect the economy to register negative GDP growth of about -0.2% next year, the first full-year recession since 1991.

Neither will the recent sharp fall in the pound do much to improve the near-term outlook. Although it has given the competitiveness of UK exporters a much-needed boost, exports are unlikely to pick up strongly while the global economy - and particularly the euro-zone - remains so weak. Meanwhile, it will do nothing to shore up the housing market and the domestic economy.

The upshot is that the MPC's inaction will soon come to an end. I think interest rates will be falling again by the end of the year - perhaps in November - and will drop to 3.5% or even less in 2009. But that will come too late to prevent the economy from entering a full-blown recession.

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