Market Insight - August 2015
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The Budget, the Economy and the Path of Interest Rates
There are bumps ahead but the economy is doing well. Interest rates are on the up – but not for a while yet.

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Just like any company, the Budget is a time to look ahead and put the director’s plan for the next five years into numbers. Clearly the projections will be wrong – no one can ever account for unforeseen events – but it does give a direction of travel and in terms of the economy, how much more austerity has to be faced.

So what’s in store for the UK? The independent forecasts from the Office for Budget Responsibility based on the latest Budget suggest that the economy will continue to grow, but that it will still be a bumpy ride with lots of risks. The troubles in the Eurozone and China add a great deal more uncertainty to the pace of future growth, but in the meantime the rise in sterling will make it harder for UK businesses to export.

The other side of the currency equation is that imports will be cheaper and that will push inflation down in the UK. It doesn’t mean that interest rates won’t rise though. Just as the Monetary Policy Committee looks through spikes in inflation it thinks are temporary, it can look through troughs too. And that is what it is likely to do.

Yet there is a clear signal that interest rates will begin to rise ‘soon’, although it will be a slow and controlled process. How soon is soon will depend on many factors. The Governor himself has indicated that rates may begin to rise around the turn of the year, but with no guarantees. And where will they settle after that? The shape of the economy now suggests it probably won’t be as high as the long term average of around five per cent. That is good news for mortgage rates and will continue to help the affordability of credit needed to buy homes.

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