Group Economics
Interest and Exchange Rate Forecast
31st March 2008
Contacts:
Robert Gardner (UK)
Group Economics
+44 131 626 3697
robert.a.gardner@rbs.co.uk
Robert Blotevogel (UK/FX)
Group Economics
+44 131 626 3701
robert.blotevogel@rbs.co.uk
Julien Seetharamdoo (US)
Group Economics
+44 131 626 3925
julien.seetharamdoo@rbs.co.uk
Robbie Denoon (EZ)
Group Economics
+44 131 626 3874
robbie.denoon@rbs.co.uk
Interest Rates
The UK’s Monetary Policy Committee (MPC) left the Bank Rate at 5.25% at its March
meeting. Nevertheless, it looks increasingly likely that the MPC will have to lower rates
more aggressively to ensure the UK achieves a soft landing. Tensions have re-emerged in
money markets, and a lower Bank rate is needed to offset this tightening in financial
conditions. The interest rate that banks charge each other for three month loans (LIBOR)
has risen sharply again (from 5.6% in early February to 6% at the end of March), which
threatens to feed through to the cost of funds for households and businesses. Moreover, at
5.25% the Bank Rate is still acting as a drag on activity, even though the economy is
growing below its trend rate. Inflation risks have not completely dissipated. CPI is already
above the 2% target and is expected to rise towards 3% in the months ahead. However, this
is being driven by rising food/energy prices. Underlying inflation remains subdued and
inflation should fall back later in the year as the rises in food/energy fall out of the index. We
expect the Bank Rate to be lowered by 25bps in April and August taking it to 4.75% by the
end of 2008 and to 4.5% in early 2009.
The Federal Reserve cut interest rates by 75bps on 18th March, bringing the fed funds
rate to 2.25%. In the accompanying statement, the phrase “the Committee will act in a timely
manner as needed to promote sustainable economic growth and price stability” was
reinstated, having been absent from the Jan 22nd (emergency) and 30th (scheduled) rate
cut statements. In