With the economy seemingly set for a downturn, hopes are high that interest rates will be eased to reduce the risk of a full-scale recession. A recent poll of 49 economists showed that 44 of those believe that the Bank of England will cut its base rate by a further quarter of a per cent before the end of March 2008 and the US Federal Reserve's recent slashing of the US Prime rate makes this more likely. However,  the situation is not as straightforward as it may seem.

Sterling is currently trading at its lowest level ever against the Euro and inflationary pressures are mounting, so further cuts in interest rates later in the year may be slower to materialise than some think. When the control of monetary policy was given over to the Bank of England, its remit was simple –to control inflation to ensure it remains within the Government’s target range. As of January 2008, inflation was running at 2.1 per cent against a target of 2.0 per cent. Much of the inflation index depends on the cost of imports, which is outside the control of the Bank of England – the exchange rate policies of the USA and China being particularly influential.

However, with weak retail sales reported for the all-important Christmas trading period, some slackening of monetary policy may be needed to give a fillip to consumer spending – the driving force behind UK economic growth for the last decade. Most economists are predicting that the Bank of England’s base rate will be 4.75 per cent or 5 per cent by the end of the year. 

The credit crunch means, in practical terms, that it is harder for consumers to get credit and it is more expensive relative to base rate than has been the norm in the last few years. It is thought likely that the worst effects of the credit crunch will be past by the late summer and it may well be that the Bank adopts a ‘wait and see’ approach to making further cuts.