Rates should be kept low

Andrew Smith, chief economist at KPMG in the UK, explains why the economy needs interest rates to remain low.

Cutting interest rates to 0.5 per cent helped stop the financial system going into meltdown and mitigated some of the worst effects of the recession. The latest GDP figures are a reminder that the recovery is still fragile. Output is well below previous levels and unemployment’s a lot higher than it was.

At the moment, ahead of the Bank of England Monetary Policy Committee on February 10, it looks sensible to keep interest rates as low as possible. My view for some time has been that they will probably stay at the current level all the way through 2011.

Recently there’s been a lot more pressure to raise interest rates because the job of the Monetary Policy Committee (MPC) is to keep inflation as measured by the consumer price index at 2 per cent. It’s been above that for most months during the past couple of years. I believe that this is due to special factors as opposed to serious underlying inflationary pressures in the economy.

The increase appears to be from the government itself raising indirect taxes. We have also seen a sharp decline in the value of the pound over the past few years. But if you exclude the effect of the tax rises, for example, the inflation rate you’re left with is within the target.

The Bank of England and the MPC have adhered to the view that these are one-off factors that you would expect to unwind.

Interest rates are abnormally low and at some point they’re going to return to more typical levels. For me, however, that can’t happen until the economy has returned to some sort of normality, and we’re still quite a long way from that.

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