View from City Road: Chancellor should bank another rate cut soon

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The Independent Online
The leaps and bounds in the equity market are attributable to one factor alone: the buyers believe not only that interest rates will come down further, but that the drop is likely to be sustained. Given the gradual build-up in the Budget tax increases and spending cuts, the judgement is unlikely to be wrong. The real question is how far and how fast interest rates now fall.

The markets themselves are discounting a further drop to 5 per cent in bank base rates in the early part of next year, a fall consistent with a decline in mortgage rates to just below 7 per cent. But that would not necessarily be the end. There is a case for interest rates at 4 per cent. The fiscal measures really are tough; the risk to the pound is limited by the likely decline in German interest rates; and real interest rates - after allowing for inflation - are just 0.5 per cent in the United States.

There is, though, an effective floor below Britain's interest rates imposed by the underlying inflation rate, which is likely to hover just below the top of the Government's 1-4 per cent target range early next year. That argues for a maximum of another half-point cut, with any further cuts depending on falling inflation.

But the Chancellor should move soon. If he waits until January, he will begin to miss those mortgage lenders who fix variable payments once a year. Since more than a third of borrowers are affected, he would be wise to bank another cut before Christmas.

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