News Column

Business analysis: Interest rates: The coming increase may not happen until next year, says Larry Elliott

August 21, 2014

Larry Elliot



An increase in interest rates is coming. So much, so obvious. Borrowing costs have been at the emergency level of 0.5% since the economy was deep in recession in early 2009. This is no longer an emergency and therefore it is only a matter of time before the Bank of England starts to edge rates back up.

That point now looks closer after two members of the Bank's monetary policy committee - Martin Weale and Ian McCafferty - argued that rates should be pushed up to 0.75%. Split votes on the MPC have been a rarity since the Great Recession of 2008-09: the stop-start recovery has meant it has been three years since a member was prepared to call for policy to be tightened.

The fact that two MPC members are now in a minority over interest rates should come as no surprise. At issue is how much spare capacity remains in the economy after the strong growth of the past 18 months. The latest Bank estimate is that this amounts to 1% of national output, but spare capacity is difficult to gauge and - let's face it - Threadneedle Street's recent forecasting record has been nothing to write home about.

It will take time for higher interest rates to have an impact, so rates will have to be raised before all the slack is used up. In those circumstances, it is entirely predictable that there should be more than one view on the MPC about when this should be.

The real question is whether other members of the MPC will join Weale and McCafferty over the coming months. The chances of a rate rise before the end of 2014, probably in November, have clearly increased as a result of the August vote, but there are still reasons for thinking that the MPC may wait until 2015 before moving.

There has been nothing in the recent data to make any of the seven MPC members voting to keep rates on hold change their minds. Indeed, since the August meeting official figures have shown inflation falling to 1.6% and earnings growth dipping to 0.6%. The international outlook has darkened, with activity in the eurozone coming to a halt in the second quarter and tension mounting in Ukraine.

What's more, the message that the Bank is moving closer to a rate rise may make it harder to raise borrowing costs. Consumers may start to spend less in anticipation of their mortgage costs rising, while a stronger pound will make imports cheaper and thus bear down on inflation.

The MPC is now operating month by month, with members truffling through each and every piece of new data for clues as to what is happening to the economy. Rates will rise only if the incoming data is strong enough to make three other members of the MPC join Weale and McCafferty. As things stand, it is hard to see that happening.


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Source: Guardian (UK)


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