Will interest rates ever rise?

August 13, 2014

There is very little that has such an effect on businesses and individuals alike, as the bank rate. Unbelievably, it’s now five years since base rate has nestled at 0.5%, and despite many predictions of increases over that period it has failed to budge. So called experts were predicting it may increase sometime during Spring 2015, only in June revised to as early as Winter 2014, but the key indicators which determine a change of rate by the Bank of England, seem to change with the mood of the time.

One of the main tasks of the Bank of England’s Monetary Policy Committee (MPC) is to control inflation. It has actually failed to keep inflation within its own guidelines in recent years, and whilst historically low, has run higher than the USA and Germany, whilst the Eurozone lags behind lower still. Hitherto, the inclination may have been to increase interest rates to keep inflation in check; but not this time, an increase at this time would have affected growth and confidence in the recovery. It is worth noting that wage inflation was negligible over the period which may well be viewed as a better indicator of the potential for future inflation spiralling.

In a guide to the ‘markets’, Mark Carney announced last year that employment would be the key indicator which determined movements in rates, and a level of 7% was set as a target, which forecasters originally predicted may occur during 2016. However, a run of positive employment news over the ensuing months saw unemployment fall to 7.2% and the buzz was of an earlier than expected rate increase. Mr Carney was very quick to intervene and state the link would now be dropped and that it would be unlikely that interest rates would rise in the short term.

However, on the 12th June 2014 Carney indicated to the market that rates may rise sooner than anticipated, the financial markets moving significantly on this news, with homeowners bracing themselves for rate hikes. As we move further into June Carney is accused of being an ‘unreliable boyfriend’ by sending out even more mixed messages to the Treasury Select Committee, seemingly backtracking by saying bank rate could stay at 0.5% for even longer, this time citing the sluggish growth in wage inflation as a factor.

So, in reality, what effects a change in interest rates and, as a country, will we go it alone or is it more likely to change in line with other economies such as Eurozone or USA?

We are among many saddled with a huge amount of debt, which for those economies, is far more easily serviced at the bank rates we are seeing. It is therefore unlikely that there will be huge hikes whilst debt levels are so high. Moreover, whilst inflation is so low the effect of this debt dissipating quickly is also unlikely, so ‘inflating’ away a debt problem could take years. On that basis low interest rates ought to be around for a few years to come.

So perhaps the below are the current indicators which, with change may affect the mood to change interest rates:

We want to see GDP growth in the economy, so any real attempt to take money out of the economy through interest rate rises, may forestall that recovery, so there will be a longer period of continued low interest rates so that growth is maintained.

The Government want to see unemployment below the 7% level, and there is a desire for the private sector to achieve growth and create jobs and ease the burden of financing the public sector. As I write it stands at 6.4%.

There has been a prolonged period of stagnant wages growth. An eye on future statistics and any sudden pick-up in wage settlements will inevitably push up shop prices – which makes workers ask for more; so the inflationary spiral begins.

House prices are a factor – there is a desire to keep house price inflation under control, and prices are at an all-time high, albeit with a heavy weighting towards London, so keep an eye on the Halifax house price index.

Finally UK debt is a constant reminder of the challenges faced by the economy for years to come.

Of course, there are many other indicators which come into play; manufacturing output, retail sales, consumer confidence, balance of trade deficit, many of which find their way to the top of the political agenda from time to time.

Thankfully, the temperature of the economy is no longer managed politically, it is managed by the MPC, so highly damaging spikes in and use of interest rates for radical and political means, is less likely to happen in the future.

So hopefully, the above gives some food for thought; economists don’t usually get it right, and therefore I have no right to be right either; but as a guess, rates will increase at some time in the future, not the near future, but those interest rate increases will be incremental, and will be thought through considering many factors.

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