Markets misjudge the interest rate outlook (Jan 10)

Markets continue to expect official interest rates in the UK to be raised from around the middle of 2010. No doubt the recent pick-up in inflation – as well as speculation that the Bank’s programme of quantitative easing will not be extended in February – has fuelled these concerns. Some commentators have also recently suggested that it might be desirable for the Monetary Policy Committee (MPC) to raise Bank Rate from its “emergency” level for “tactical reasons”. But the economic fundamentals are unlikely to justify any significant tightening of monetary policy this year. The MPC has already highlighted the deflationary risk that the large amount of spare capacity in the economy will pose after the near-term rise in inflation has passed. And, as Governor King has stated, money growth remains “undesirably low.” The imminent fiscal tightening is also likely to dampen the recovery severely, requiring monetary policy to remain very supportive for the foreseeable future.