Treasury forecasts could hit interest rates

The Treasury’s economic forecasts could be partly responsible for interest rates rising, the Lords’ economic affairs committee has said.

Looking at monetary policy over the last year – during which interest rates have risen twice – the committee expressed concern “over-optimistic” growth forecasts might affect interest rates.

In 1997 the Labour party handed over responsibility for setting interests rates and managing large parts of the economy to the Bank of England’s independent monetary policy committee (MPC).

But such is the extent of the government’s influence over the economy through taxes and the number of people employed by the state, the MPC carefully considers government plans and predictions when setting interest rates.

And this influence is worrying the Lords’ economics affairs committee.

“Our main concern here about these fiscal projections relates to their implications for monetary policy and, in particular, whether the fiscal stance -which is even looser than was first forecast by the Treasury – contributed to increases in interest rates,” the committee’s report The Current State of Monetary Policy states.

“As the public sector affects total demand and supply, it also affects interest rates.”

The report added: “It is correct for the MPC to consider total demand and supply and not particular components of demand, and we accept that, in principle, this could imply that from time to time monetary policy would have to respond to fiscal policy.

“Nonetheless, we are concerned that consistently over-optimistic GDP growth forecasts have led to over-estimates of tax revenues and hence to under-estimates of the budget deficit and borrowing requirements.

“This cannot be of help in setting monetary policy. This is something that we think the government should take careful note of.”

The Treasury rejected the suggestion its predictions had influenced interest rates – which have risen from 4.5 per cent to five per cent this year, adding to mortgage payments and the cost of loans in the UK.

“Fiscal and economic forecasting is complex, but the government’s record is good, with forecasts generally in line with consensus on both economic growth and the public finances,” a Treasury spokesman said.

“The government is committed to further improving public finance forecasting and has introduced new innovations to do so.”

Recent changes to economic predictions had been due to factors outside the Treasury’s control, such as the dollar-pound exchange rate and high energy prices.

The Treasury added that its forecasts have always changed in line with new economic data.

“What matters for the Bank of England is how well they target inflation, and in this area they have an excellent record of meeting the two per cent target,” the Treasury spokesman added.