Braking with one foot and accelerating with the other

With much attention focused on the UK’s rapidly rising public-sector debt, fiscal policy will have to be tightened once the economy is recovering. This will entail substantial cuts in government expenditure and possibly tax rises too, whoever wins the election next year. The danger, of course, is that if aggregate demand is cut, or its growth is severely curtailed, the economy could lurch back into recession. For this reason, it is likely that monetary policy will have to remain expansionary for some time to come. Interest rates will stay low and further quantitative easing could take place.

This was the conclusion of a report by the Centre for Economics and Business Research (see link below). The CEBR argued that Bank Rate will remain at 0.5% at least until 2011 and not reach 2% until 2014. “The forecasts show that the fiscal consolidation is likely to be matched with an unprecedented monetary relaxation. … Douglas McWilliams, one of the report’s authors and Chief Executive at CEBR, commented: ‘We are likely to see an exciting policy mix, with the fiscal policy lever pulled right back while the monetary lever is fast forward. Our analysis says that this ought to work. If it does so, we are likely to see a major rerating of equities and property which in turn should stimulate economic growth after a lag.’

The following articles look at the report and the implications of its predictions for economic growth and exchange rates.

Bank rate to ‘stay frozen’ for five years Times Online (11/10/09)
Mortgage rates to stay low until 2014 Telegraph (12/10/09)
Tax and spending squeeze to keep bank rate low David Smith’s EconomicsUK.com (11/10/09)
UK rates ‘to stay low for years’ BBC News (12/10/09)
Pound plunges as UK markets rally to year high Telegraph (11/10/09)
Tough times ahead as traders poised to offload their sterling Sunday Herald (11/10/09)

CEBR News Release (12/10/09)

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