Could UK interest rates rise this year? There has been speculation about the possibility since unemployment figures fell faster than expected. However the Bank of England responded by saying that rates will remain “well below historic norms” in the medium term.
The Bank of England (BoE) base rate has been held at 0.5% for 58 months now, benefiting borrowers but harming savers.
The new BoE governor, Mark Carney, broke with tradition in August by issuing forward guidance to reassure businesses and homeowners. He announced a policy where the Bank would not consider raising interest rates until the headline rate of unemployment fell to 7%. It was 7.8% at the time and the Bank projected it would not reach 7% until 2016.
However, unemployment has since fallen faster than expected, hitting 7.4% in October and then 7.1% at the end of the November. This latest figure was released by the Office for National Statistics on 22nd January.
With this being just a whisker above the 7% target, the media and some economists have speculated that we could see a rate rise in the near future. The markets also anticipated an early rise, and Sterling strengthened.
However, many other economists dismissed talk of an imminent rise, saying the rate was unlikely to change this year as it would be too harmful to the economic recovery.
The Bank itself had reiterated since August that the 7% target would not automatically trigger a rate rise, but rather a discussion on the possibility of an increase.
Following the release of the unemployment data, Mr Carney quickly stepped in to reassure businesses there would be no immediate rise.
Speaking to British business leaders at the World Economic Forum in Davos on 24th January, he said there is still some way to go to recover from the financial crisis. This means rates are likely to remain “well below historic norms” in the medium term, even as the economy recovers.
Even though unemployment is falling, the economic recovery has not yet reached “escape velocity”. The governor observed that many of the headwinds holding the economy back, like the high debt burden, slowing productivity growth and subdued consumer confidence, will remain for some time.
“These persistent headwinds mean that, even in the medium term, the level of interest rates necessary to sustain low unemployment and price stability will be somewhat lower than before the crisis”.
The Governor promised business leaders that the degree of stimulus would remain “exceptional for some time”, and that the path of interest rates would be consistent with a sustained recovery.
Inflation fell below the Bank’s target of 2% in December for the first time since November 2009, allowing interest rates to remain low even though the economy is growing.
Mr Carney also implied that the Bank will drop the simple link between interest rates and unemployment, and focus on a broader range of economic indicators.
It was time to “evolve” the guidance, he said, and the Monetary Policy Committee (MPC) will consider a range of options to update its guidance.
Other MPC members have issued similar statements. Paul Fisher, the Bank’s executive director for markets, said that there was a risk of choking off the economic recovery if rates were raised too soon, and the 2% inflation rate gave the Bank room to wait.
All this backs up the minutes of the MPC’s latest meeting, released on 22nd January, which clearly stated that:
“Members therefore saw no immediate need to raise Bank Rate even if the 7% unemployment threshold were to be reached in the near future… When the time did come to raise Bank Rate, it would be appropriate to do so only gradually.”
Although savers will be the ones to suffer again, the Bank will put the needs of the general economy first. It has to consider the impact rate rises will have on borrowers, both businesses and households.
With the economic recovery still fragile, it is risky to raise borrowing costs, including mortgage interest payments. Resolution Foundation, a UK thinktank, warned that a million households would face dangerously high mortgage and borrowing payments if the base rate increased to 3%.
On the other hand, a rate rise would come not a moment too soon for savers who have lost billions since the rate was cut to its historic low, as a result of inflation being higher than interest rates.
It is essential, particularly for retirees, to understand the impact inflation has on your savings over the longer-term. It is important to ensure your capital is working hard for you and in line with your personal circumstances. You need to speak to a professional wealth manager to discuss your personal objectives and risk tolerance, to determine the most effective strategy for holding your savings to achieve your aims.
Written by Gavin Scott, Senior Partner, Blevins Franks