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At the start of August, before the onset of turmoil in the financial markets, the RBS economics team was forecasting one more quarter-point hike in interest rates in the UK and two more in the euro area.

Now, to reflect changed conditions in the markets and the first evidence of an adverse impact on the real economy, we are forecasting that the next move both in the UK and Europe will be down.

Here in the UK we expect a quarter-point cut before the end of the year and another early in 2008. In the euro area we forecast two cuts next year.

In both cases the argument is the same: what was the appropriate official rate of interest six weeks ago is the wrong rate today.

This is because the one enduring legacy of the last six weeks of financial turbulence, one that will remain once the liquidity problems have disappeared, is a re-pricing of risk.

As a result, credit spreads will be decompressed and the margin between the official bank rate and the rates charged by commercial lenders will widen. This is already happening; without any change in base rate, several mortgage lenders have announced higher rates.

The result is a tightening of monetary and credit conditions over and above what the Bank of England thought was necessary a month ago.

The effect on borrowing and spending will also be greater than the Bank's experts on the monetary policy committee (MPC) thought would be needed to slow the economy in 2008 and to keep inflation at the two per cent target.

It follows that the MPC will need to lower the base rate to offset this unforeseen monetary tightening and to get rates charged to borrowers back where it wants them to be.

It may reach this conclusion at its meeting on October 4 or - possibly more likely - it will wait for its next inflation forecast in November.

Either way we should get a rate cut in time for Christmas. For hard-pressed mortgage borrowers, it cannot come too soon.

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