9/18/07

Today's Guardian Newspaper had a particular article that caught my attention, not only because it seemed to be an interesting article, but also because it is very pertinent to the topics we have been discussing in class. It deals with inflation rates and their relation to interest rates and the overall UK economy. It was a very insightful article and gave me a more powerful understanding of how an economy functions and how one aspect can have a waterfall effect on the many other economic facets within a country.

Title of Article: Inflation drops further
Source: Guardian (9/18/07)

Although not done intentionally, the inflation rate fell by 0.1 percentage points in August from July's 1.9% reading. This news was announced after the Bank of England made another £4.4 billion available to money markets in attempts to bring down the Libor (London interbank offered rate) interest rates closer to that of the bank rate, which is around 5.75%. With this decrease, the inflation rate is at its lowest level in more than a year, is significantly less than the spring all-time high of 3.1%, and is also below the Bank's 2% target for the second consecutive month. It also carries the potential to allow banks to lower interest rates if the ongoing chaos in financial markets continues.

The article credits the decrease in inflation rates to mortgage lenders cutting their exit administration fees as well as many gas and electric companies lowering their prices. With this, it makes sense that housing, water, electricity, gas and other fuels inflation has gone down to 2.8% from 3.5% in July, which is the lowest its been since March 2004.

Until recently, officials expected the interest rates to rise to 6% or over, but with the decrease in inflation rates, many are now expecting a cut to occur before Christmas. Howard Archer from Global Insight says the decrease is very encouraging but expects the Bank of England to be very cautious about lowering interest rates just yet given the record oil price and possible increase in food prices, as these two factors may cause the inflation rate to rise once again in the coming months. To judge whether or not interest rates should be trimmed, the Bank plans to monitor how the current credit crunch and Northern Rock crisis is affecting the economy and the outlook for growth and inflation, and says that if growth is being significantly hit and continues to dilute underlying inflationary pressures, officials will then be more likely to lower interest rates.

While it would be a welcome change to the now high interest rates, I believe the Bank of England is being very smart to be weary of lowering them just yet. I don't know very much about economics as of now, but I at least know that the field is very dynamic, and just because inflation rates are low right now it does not mean that they will be low for long. If the Bank lowers interest rates now, inflation rates may spike tomorrow and then the Bank would be in serious trouble. Therefore, the Bank should continue to do what it is doing now and just keep track of the inflation rate decrease, and not make any decisions to lower interest rates until the inflation rate decrease remains constant.