Bank is unlikely to scare the horses

How long can interest rates stay this low? It's a question that is starting to tax investors as the Government revises its growth figures upwards, borrowing continues apace and America's faltering recovery continues.

If activity in the futures markets is anything to go by, we could see rates rise sharply over the next year, with some commentators predicting that they could hit 5 per cent or even more by the end of next year. That may not sound much to those who remember the days of rates at 10 per cent, but it would be a jump of more than 40 per cent from current levels - enough to make a noticeable difference to monthly mortgage payments.

Many economists now believe that the cut in July, which put rates at a 48-year low, was not really needed. All the statistics since - including last week's consumer borrowing and house price statistics - indicate that the fall in consumer confidence that prompted it was a blip. That, they say, means it should be reversed. Indeed, Richard Jeffrey of Bridgewell Securities thinks there is a 50/50 chance rates will rise at this week's meeting of the Monetary Policy Committee.

Few others are that pessimistic - indeed, Steven Andrew, chief economist at Isis Asset Management, thinks the strength of the consumer spending figures means that rates will still be low well into next year.

There is no doubt that consumers are spending far more than they can afford - if retail sales were following their long-term trend, they would be rising at about 1 per cent a year, compared to the actual rise of 4 per cent.

But with borrowing so cheap, that is not as dangerous as it sounds. Andrew points out that retail sales have already slowed substantially: a year ago, growth rates were 6 per cent or more. He believes the Bank of England will be content simply to let the consumer spree slow down gradually, rather than spooking shoppers with an interest rate rise.

He adds that the revisions to growth figures made last week underline that conclusion. While growth in the first half was double that previously announced, the difference was accounted for not by the consumer but by areas like building and construction. While growth in personal consumption was strong in the first quarter, it slowed in the second. Consumer borrowing has also been growing less quickly.

Jim Leaviss, who manages M&G's bond fund, says the argument against a rise is even more compelling in the US, where the recovery is weak at best, unemployment is still at 6 per cent and unused capacity is equal to one in every four factories standing idle. 'Historically, the US has not started to raise interest rates until unemployment has been falling for a year,' he says.

Add in the presidential elections next year - which are likely to be fought at least partly on the health of the economy - and the fact that much of Europe remains mired in recession, and there is little for anyone to get excited about.

Indeed, Leaviss predicts that there could still be further cuts to come from the European Central Bank as the dollar weakens and the euro strengthens.

Regardless of whether the hawks or the doves have got it right, there is little doubt that both consumer spending and house-price inflation will have to fall substantially to get back to historic levels. The MPC's challenge is to ensure that process does not upset the economy by tipping us into recession.

The stock market has registered the uncertainty over interest rates by marking time for the past few weeks. Most predict that, following its sharp rise over the summer, it will continue to do that for much of the rest of the year until there is more evidence about what is happening to the economy.

ISIS's Andrew believes that, provided the economy continues to pick up, however gradually, shares should start to move slowly upwards again.

Interest-rate sensitive stocks such as housebuilders and general retailers - both of which have been very strong as interest rates have fallen over the last year - could lag behind if consumer spending continues to slow.