Despite further signs of recovery in several key economic indicators, the Monetary Policy
Committee (MPC) decided to leave interest rates unchanged at 0.5% and surprised financial markets by
injecting a further £50bn of new money into the economy via its quantitative easing programme. The MPC
appears to believe that even if the economy does return to growth in the second half of 2009, it will take a
long time before the spare capacity left behind by the recession is used up again. As a result, consumer prices
may be under significant downward pressure over the next 1-2 years, necessitating an accommodative
monetary policy to keep inflation in line with the 2% target. The projections contained in the August Inflation
Report signalled that this very loose monetary policy will remain in place for some time to come, with the base
rate unlikely to increase until well into next year.
Low interest rates help to explain jump in prices …
“The exceptionally low level of interest rates offers some explanation for why house prices have not repeated
the very sharp falls of 2008. There are two main channels through which the low level of interest rates has
impacted the housing market. First, mortgage payments for existing homeowners – especially those with
tracker or standard variable rate loans – have been reduced substantially. Before the MPC began cutting
rates, the average interest and principal payment per mortgage holder represented about 38% of the average
post-tax labour income. Following the steep cuts in base rate, this has fallen to just 28% of post-tax income,
despite historically high levels of outstanding mortgage debt. The fall in debt servicing costs has meant that
fewer homeowners are under immediate financial pressure to sell than might have been expected in a
recessionary economic background with rising unemployment. Partly as a result, fewer second-hand
properties have come onto the market than is normally the case in recessions, which has contributed to
moving the balance of supply and demand more in favour of sellers over the course of 2009
