Rising base rate is still a distant prospect, warns Bank governor

Mervyn King

Mervyn King, governor of the Bank of England, has warned that interest rates are likely to stay low for the foreseeable future.

In a speech to the parliamentary Treasury Committee last week King said there will come a point when the Treasury needs to ease off the accelerator and return the base rate to more normal levels, but this will not happen any time soon.

King says: “I look forward to that time as it will probably be a signal that there’s a smoother ride ahead but I fear there is a considerable distance to travel before we can use the word ’normal’ again.”

He says in the months ahead it will be the job of the Monetary Policy Committee to judge whether the outlook for inflation warrants pressing down even harder or whether it should ease off somewhat.

King says: “The debate at the moment is about the appropriate degree of stimulus, not applying the brakes.”

There was a gradual improvement in credit conditions earlier in the year but King says this effect seems to have come to a halt recently, while financial markets generally have been volatile.

He says we should not read too much into the 1.1% estimated gross domestic product growth in Q2 2010.

King adds: “We continue to face the challenge of rebalancing our economy away from consumption and towards exports, while raising our savings rate. During this process there is a risk that spending will remain weak, with the economy operating below capacity.”

Last year Ernst & Young predicted that interest rates could be held at 0.5% until 2014.

It says high energy prices and VAT hikes will keep inflation above the 2% target for the next 18 months but it will fall as these effects wear off and spare capacity bears down on pricing decisions and wage bargaining.

To prevent inflation moving below 1%, Ernst & Young says it will be necessary to keep the base rate at 0.5% for longer than financial markets had previously anticipated.