Do UK Interest Rates Lead or Lag Inflation?

By: Nadeem_Walayat

This analysis forms part of a series that aims resolve in an accurate UK interest rate forecast for 2010 which follows in depth analysis and forecasts for UK inflation and economy.

Do UK Interest Rates Lead or Lag Inflation?

One of the Bank of England's primary objectives is to keep UK inflation targeted between CPI 1% and 3% over a 2 year time frame through the use of monetary policy with the primary tool being interest rates. The consensus view is that when inflation is expected to rise then the Bank of England raises interest rates, and where the Bank of England expects inflation to fall towards its lower band then it lowers interest rates so as to boost economic activity and hence inflation. Therefore the purpose of this analysis is to confirm the role inflation plays in determining the Bank of England's primary objective of managing inflation and what it suggests for interest rates during 2010.

The below graph includes the Inflation forecast for 2010 as of December 2009 which projects towards a sustained trend to above 3% which on face value would imply the Bank of England should start raising interest rates.

The above graph implies that the Bank of England tends to react late to changing inflation and then continues the interest rate trend too far in the opposite direction which implies ever increasing volatility in the series. Given the already completed inflation forecast this implies that the Bank of England will respond much later than expected to rising inflation, though when it does respond it will continue raising interest rates even after inflation turns lower, which is suggestive of interest rates rising from mid 2010 and continuing into mid 2011,with smaller initial steps of 0.25%, mid steps of 0.5% and again 0.25% steps later in the cycle.

UK interest rate Forecast 2009

The UK interest rate forecast of early December 2008 for 2009 forecast that UK interest rates should decline to 1% (from 3%) by early 2009 and remain there into the second half of 2009. However following the cut to 0.5% in March 2009, the Bank of England has continued to pursue an artificial banking system by keeping interest rates at an extreme historic low of just 0.5% into the end of 2009 so as to flood the bankrupt banks with liquidity to enable them to rebuild their balance sheets by overcharging customers against the base interest rate and manipulated interbank market rate of 0.66% against rising real market interest rates which have been in a steady climb since March 2009 which increasingly means that the base interest rate has become irrelevant to the retail market place as explained in the article - Bailed Out Banks Not Lending, Sitting on Tax Payers Cash.

Forecasts for UK Inflation and Economy 2010 and Beyond

The below are the concluding forecast graphs from in depth analysis for UK inflation and economy that build towards the UK interest rate forecast for 2010 as well as the inflation mega-trends ebook. To receive the final analysis and forecast in your email in box, ensure you are subscribed to my always free newsletter.

UK inflation Forecast for 2010

UK Economy GDP Forecast for 2010 and 2011

Source: http://www.marketoracle.co.uk/Article16350.html

By Nadeem Walayat
http://www.marketoracle.co.uk

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Nadeem Walayat has over 20 years experience of trading derivatives, portfolio management and analysing the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem's forward looking analysis specialises on UK inflation, economy, interest rates and the housing market . Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 500 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

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