News Column

Is Mark Carney right that the "new normal" for interest rates will be around 2.5 per cent?

June 30, 2014

YES Samuel Tombs Although Mark Carney's forecasting record has been patchy at best, I suspect he is right to assert that the "new normal" for interest rates will be much lower than in the past. The household debt-to-income ratio is still very high, meaning that interest rate rises will have bigger effects on spending than in the past. In addition, spreads on new loans over Bank Rate - for good reason - are likely to remain wider than they were before the recession. Meanwhile, the fiscal squeeze will subdue the economy for many more years. The Monetary Policy Committee has said it will consider unwinding QE once interest rates have risen materially. Asset sales may therefore act as a cap on Bank Rate for a period. All this is not to say that interest rates may never need to exceed 2.5 per cent when unforeseen shocks arise. But the likelihood is that the economy simply won't be able to cope with pre-recession levels of interest rates on a sustained basis. Samuel Tombs is UK economist at Capital Economics.

NO Patrick Minford Mark Carney has said interest rates will settle at around 2.5 per cent a few years hence. But there are two main uncertainties. The first is whether inflation will remain under control in spite of all the money printing the Bank has undertaken. The second is how tight the margin of spare capacity will be. Growth is now powering ahead. And because some industries, like North Sea oil and banking, are unlikely to recover to their past levels, we know that the economy already has only a limited margin of spare capacity. Before the crisis, the normal interest rate was around 5 per cent, reflecting inflation of 2 per cent and a real return on savings of 3 per cent. We must hope that we get a return to that sort of normality again; investment will be strong and savers will be content. Normal rates of 2.5 per cent, with 2 per cent inflation, means a weak economy and poor saving returns. This is not something to wish for, and I believe it is unlikely - the economy is far better than that.

Patrick Minford is professor of applied economics at Cardiff Business School.

For more stories on investments and markets, please see HispanicBusiness' Finance Channel

Source: City A.M. (UK)

Story Tools Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters