News Column

Interest rate rise closer by the day

August 2, 2014

By Hugo Duncan, Daily Mail, London



Aug. 02--All eyes will be on the Bank of England next week for what is likely to be the liveliest meeting of the committee that sets interest rates for some time.

Rates have been frozen at 0.5pc since March 2009 – in what has been a terrible period for Britain's army of savers –but with the economy now producing more than it ever has and setting the pace in the G7 we are edging ever closer to an increase.

The monetary policy committee could take a step towards pulling the trigger on Thursday – with many observers expecting one or more of the nine-strong panel to vote for a rate hike.

There will, of course, be no rise in official borrowing costs until a majority sanction such a move, but even a single vote would mark the first real voice of dissent on the committee for some time and put businesses and households on warning.

The Bank has said rates cannot stay at rock bottom forever – a vote by any MPC member for higher rates would show that it means it.

It would also underline the scale of the turnaround in the British economy since this time last year when new governor Mark Carney was doing all he could to persuade people rate hikes were some way off.

His flagship policy of forward guidance – which was launched in August last year and said a rate rise would not be considered until unemployment fell to 7pc – suggested there would be no move until 2016, such was the bleak outlook for the economy.

But with unemployment falling faster than anyone expected – from nearly 8pc then to 6.5pc today – the policy was quickly ditched. That is not to say it was a disaster. Anyone who was worried about an early rate rise this time last year could rest easy – the Bank had no such plans and said so.

But the recovery meant the message had to change and it did.

Carney and co are at pains to say that when rates do rise – and no date has been set – the increases will be 'gradual and limited' with rates staying well below the 5pc average seen before the financial crisis.

The Bank seems happy with the idea that rates will only rise to around 2.5pc or 3pc in the next three years.

There is nervousness in parts of the Bank, and indeed the Government, about what impact rate hikes will have.

There hasn't been a rise since July 2007 when they moved up from 5.5pc to 5.75pc and the period of ultra-low rates since the crash has encouraged many people to borrow – sometimes not wisely.

The big worry is the housing market and the level of household debt. As the IMF said this week: 'Surges in house prices can easily be interpreted as signals that even higher prices are yet to come, reinforcing individuals' perceptions that they must do whatever it takes to get on the housing ladder.'

The Bank is alert to this. Only last week Carney warned that highly indebted households are 'likely to be particularly sensitive to interest rates'.

Household debt has fallen from around 170pc of household income to 140pc but is still high – with Carney warning that many families are 'vulnerable'.

The problem for the economy is that should the UK suffer another shock, overstretched households will pull in their horns with potentially damaging consequences.

As Carney said: 'History shows that the British people do everything they can to pay their mortgages. That means cutting back deeply on expenditures when the unexpected happens. If a lot of people are highly indebted, that could tip the economy into recession.'

So, with risks abound including from the still fragile eurozone and turmoil in Russia and the Middle East, the Bank wants to keep rates as low as possible for as long as possible.

But can it really guarantee hikes will be 'gradual and limited'? Of course not. The IMF's recent record is not great when it comes to the UK – only last year it warned the Chancellor was 'playing with fire' by pressing ahead with austerity only to see the economy take off.

But its warnings over interest rates last week are noteworthy.

It said that if the new tools the Bank has to cool the housing market do not work – and they include tough new lending and affordability tests – 'interest rate increases may also need to be considered'.

The Fund also said that although record low interest rates are 'appropriate for now' given low inflation, rates may need to be 'adjusted quickly if inflation takes off'.

Such an outcome may seem unlikely – but so did the last crisis. The 'normalisation' of interest rates may not turn out to be as smooth as the Bank hopes.

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Hugo Duncan is Economics Correspondent at the Daily Mail

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(c)2014 Daily Mail (London, )

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Source: Daily Mail (London, England)


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