Debate on rates moves from inflation worries to concern over consumer spending
UK interest rates are expected to remain on hold for 2005 but could drop to 4% by the end of 2006, according to John Butler, UK economist at HSBC Bank.
He said: "The interest rate debate has shifted away from worrying about inflation, as wage growth has remained subdued, to worrying about consumption. While fundamentals remain sufficiently supportive, it is too early to expect interest rates to be cut but they now seem unlikely to go up anymore.
"We predict interest rates to remain unchanged at 4.75% for the rest of the year and expect cuts to 4% by the end of 2006."
Butler feels the recent slowdown in consumer spending has been in response to a cooling in the housing market and reduction in mortgage equity withdrawal. The sharp slowdown in property transactions has led to a slowdown in the amount of equity extracted from the housing market. Less mortgage equity withdrawal means less finance available to households. So even a slowing housing market is enough to cause a turnaround in consumer spending.
This has been most evident in spending on durables and other big ticket items where the slowdown has been most pronounced.
According to the British Retail Consortium, sales generally are 4.7% lower than a year ago. Retail sales contracted in Q1 and have slowed from an annual rate of growth of 7% a year ago to around 2.5% with reportedly further weakness ahead.
Butler feels the key supports for consumer spending are likely to fade and suggest that the recent weakness is a dummy run for the real thing.
He said: "Employment is likely to fall at the end 2005, taxes will probably rise next year and over the next few years the debt-servicing burden will trend higher, even if rates remain unchanged. Our long-held view is that consumption growth will weaken - we expect it to grow just 1.7% in 2005 and 1.2% in 2006."
One risk for the household sector, according to Butler, is that so far only half of the rise in base rates has been passed onto households. The large number of fixed rate mortgages taken out in 2003 will mature this year. This will almost certainly imply a jump up in mortgage payments for some.
However, Butler feels it would probably reduce household disposable income as a whole by between 0.2%-0.25%. Overall this represents a pretty small impact and, given the direction of mortgage rates at present, the potential impact is becoming even smaller.
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