Outlook: Rates on the up?

BRITAIN'S Monetary Policy Committee attempted to take some of the steam out of the exchange rate yesterday in its announcement of unchanged interest rates by planting the hope of further cuts to come. To the extent that the currency markets keep bidding the pound higher, the more likely it is that the committee will indeed be able to cut rates again. But in other respects, how realistic are these hopes?

Not very, seems to be the answer. The chances are that interest rates in the UK have reached their low point for the time being, despite the strong pound. The irrepressible rise of the currency is a symptom of the underlying strength of the economy. Investors want to buy British because UK growth prospects are good against lacklustre Europe.

In a modest version of the phenomenal success of the US in combining continuing growth with low inflation, the British economy is bounding out of the shadow of a mild slowdown with little immediate risk to the inflation target on the horizon.

But as Alan Greenspan, chairman of the US Federal Reserve, pointed out with respect to the US in a speech yesterday, continuing expansion does pose a threat of eventual inflation. He signalled that the Fed will, sooner or later, have to raise US interest rates. The MPC too will have to start looking out for warning signs of higher inflation. Much as it annoys those manufacturers struggling to hang on to export markets to hear it, the rest of the economy is expanding again. Their loss of business is being outweighed in the aggregate by the gains in financial services and IT.

And this is before the recent run of interest-rate reductions has had its full impact on the economy. Research published last week by the Bank of England showed that a rate cut takes a year to have its maximum impact on output. On this model, the full benefits of the rate reductions that started last year won't come through until this autumn, when recovery will already be well under way.

If the MPC matches on the way up its activism in bringing rates down, it will be in for a rough ride from the manufacturing lobby. But the rest of the economy should be thankful for a soft landing, even if this is as low as interest rates are going to get.