It all really depends on the economy

Ultimately the BoE interest rate (and hence mortgage rates) depends on the UK economy which of course is also influenced by the world economy. The key economic factors affecting interest rates are factors such as inflation, Gross Domestic Product (GDP) growth, and government borrowing requirements. We are also influenced by the Global economy - our ability to import and export to other countries, and our ability to ship goods around the world.

The Government

Over the last few years the current Government has consistently overestimated GDP growth . Every 0.5% error means the Chancellor has to find billions of pounds to plug the holes in his budget. The rate cut in the summer of 2005 indicated that the economy was flagging a little, as did the almost continuous high street retailer 'Sales' which don't seem to have stopped. However it seems that the UK economy over all is still moving positively albeit at a slower growth rate.

Economic growth in 2006 was somewhat short of the 3.5% the ex-Chancellor predicted (i.e. needed to make his books balance). The ex-Chancellor reduced growth expectations for 2007, and the new Chancellor has also tended to be a bit more cautious, but still predicting growth of around 2%, even with the potential of recession looming. Most economic commentators see the UK economy slowing to less than 2% in 2008, so as usual the Chancellor is optimistic in his forecast.

So the books will still need balancing. This means that either spending plans must be cut on the NHS, Education, Transport and so on, or taxes must rise again, neither of which is good for keeping voters happy which is probably why the much vaunted 2007 pre Christmas election was 'cancelled'. The other alternative is for the Government to borrow large amounts of  money, to add to the growing mountain of government debt.

With general elections being out of the picture for another couple of years, the Government may risk voter unhappiness to try balance their budget. We are already beginning to see Government employees such as NHS staff beginning to lose jobs, and of course we had another budget in March, which gave the Chancellor plenty of opportunity to strengthen the UK's claim to being the most heavily taxed citizens in Europe.

So we may be looking at higher taxes either directly or more likely as stealth taxes which the ex-Chancellor was rather fond of. In 2005 the ex-Chancellor was accused of 'fiddling the books' in order to make his budget stay closer to the targets he set. This was probably not a good approach especially in the light of the reduced expectation of economic growth. If economic growth stays around the same low level for the next year or two, the current Chancellor will still not be able to balance his budget even after the ex-Chancellor redefined the economic cycle period to suit his requirements.

One of the ways in which the Government could make their debt (and as a result all borrowers debt) shrink a little faster is to relax inflation targets. Higher inflation would help reduce that excess Government debt more quickly in real terms. Are we now likely to see a more relaxed view of inflation targets? This is what the US has been doing recently; allowing their currency to weaken, so effectively making imports more expensive and hence raising US inflation on foreign imports but making it easier for US companies to compete in the US market. Over the last couple of years the UK currency has been strong, but we may now see a weakening of the Pound in order to improve international exports.

One other factor in favour of relaxing the inflation target is that deflation is generally regarded as worse for the economy than inflation. This is because during a long term deflationary environment, such as in Japan over the last decade and a half, companies don't wants to invest because it will be cheaper to do so 'next week/month/year', and savers don't want to save (at least with traditional savings accounts or investments) because the central bank reduces interest rates which reduces savings rates. Savings rates in Japan in April 2003 were a mere 0.07% (the decimal point is in the right place!) and is still very low, even now. In this kind of environment both the consumer and business just stops spending or investing in 'paper' assets because prices might be lower 'next week/month/year', and so the economy just grinds to a halt and is hard to kick start again.

UK consumers have over £1trillion  of debt which is now just beginning to unwind with bankruptcies and repossessions on the increase. A large proportion of this UK debt is mortgage debt which is still largely offset by the overall equity held in property, but a reasonable chunk of the debt is unsecured debt such as credit card and unsecured loans. The UK consumer is now starting to tighten their belts as the energy prices, and other living cost such as inflationary council tax rises begin to bite, so finally we see the effects of last years rate rises beginning to change consumer behaviour.

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