When Will Interest Rates Rise?

27.08.15

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The Bank of England’s August monetary policy meeting was a disappointing one for savers, signalling that the first interest rate move would not come until around May next year. The recent events in China also make it more likely that there will be no increase this year.

The Bank of England’s August monetary policy meeting was a disappointing one for savers, signalling that the first interest rate move would not come until around May next year. The recent events in China also make it more likely that there will be no increase this year.

The meeting on 6th August was the first time that the minutes were published alongside the interest rate announcement. The Bank of England’s (BoE) Inflation Report was also released that day.

The previous month, Governor Mark Carney had suggested that the situation would start to change at the turn of the year. Before the meeting, analysts and markets expected some dissent among the nine member Monetary Policy Committee (MPC), with up to three members expected to vote to increase the base rate. However, on the day only one member did.

The UK interest rate was therefore left at 0.5% for the 78th month. Quantitative easing was also maintained at £375 billion.

Factors taken into account by the MPC included lower oil prices, the strength of the pound and a weaker than expected job market.

The Bank’s assessment suggested that interest rates would follow market expectations, which are for a 0.25% rise in May, a second 0.25% later in 2016, followed by another two in 2017 to reach 1.7% by 2018.

On the positive side, the Inflation Report is more optimistic on growth than the previous one in May. Gross domestic product (GDP) for 2015 is now expected to be 2.8%, compared to the 2.5% forecast in May.

In May wages were expected to grow at 2.5%, a figure which has now been revised up to 3%. Likewise productivity is expected to grow by 1%, compared to the 0.25% that was expected in May.

At the Bank’s press conference, Mr Carney said that the likely timing of the first Bank rate increase “is drawing closer”, but the exact timing cannot be predicted since it will be the product of economic developments and prospects.

When deciding when to raise rates, the key components the bank will look at are wage growth, productivity, core inflation, import prices and risks to the international environment.

He advised:

“The path of rates is much more important than the precise timing of the first increase. Given the likely persistence of the headwinds facing the economy the MPC expects Bank Rate increases, when they come, to be gradual, and to be limited to a level below past averages.”

Since then there have been the developments in China, with fears about the slowing Chinese economy and what impact it could have internationally unsettling the markets.

On 25th August, China’s central bank cut its key lending rate again by 0.25% to 4.6% to calm stockmarkets. The interest rate cut was the fifth one by the People’s Bank of China. Lower interest rates will make it cheaper for banks to borrow money from the central bank and so easier for businesses and individuals to borrow money. The reserves banks are required to hold were also reduced, so there is more money available for lending.

The aim is to shore up long-term economic growth. The government hopes to convince investors that although the economy is slowing down, it will not have a hard landing.

Some analysts speculated this could delay the UK interest rate rise even further, even till 2017. It is however too early to know how the situation will progress, and the base rate could well remain on track for a 2016 rise.

A similar situation is going on in the US with analysts previously predicting a rate hike by the Federal Reserve Bank (Fed) this September. We would still need to see however how the Fed will really react and if the hike is postponed following the Chinese policy intervention that rattled global markets.

Earlier in August, Mr Carney had commented that there will always be some unpredicted global headwinds, “but that’s not a justification for permanent stasis”.

The situation in China does however make a rise this year more unlikely. Another key reason is UK consumer price inflation, which has fallen rapidly, something Mr Carney described as the “most striking event in the UK in the past year”.

Inflation is also low in Europe, and there is a risk that people could become too complacent about this threat to their wealth.

The key drivers of low inflation have been falling oil prices (a year ago they were double what they are now, and supermarket wars. Looking ahead, oil prices are unlikely to fall as much again, and how much lower can food prices go? Quantitative easing also expands the money supply. It has caused investment assets to increase in price, but so far has not really had an effect on the goods and services we spend our money on, so that may still be to come.

Over the last 65 years inflation rates of around 3% have been more common. This rate would halve the value of capital within 24 years. If your savings have only half the spending power in your later years of retirement, this could have significant implications for your standard of living or the wealth you wish to pass on to the next generations.

Do not wait until you feel the effects of inflation; that would be too late. You need to take action now to protect your savings for future years. Seek personalised advice on strategies to beat inflation, appropriate for your objectives and risk profile.

Click here for personalised advice 

  26th August 2015

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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