Today marks 10 years since the Bank of England last raised interest rates; the longest pause in rate rises since the second world war.
Mark Nash, head of global bonds at Old Mutual Global Investors, says the next milestone for the BofE may be the end of inflation targets, which now seem “out of date”.
“As major developed market central banks, including the US Federal Reserve, the European Central Bank and the Bank of Canada, stake some independence from inflation – the BoE is put under even more pressure to follow suit,” Nash says.
“The ethos of these central banks is shifting. Inflation targets look out of date in today’s globalised world, amid inflation-busting technological progress. Economic growth is strong – and that matters. Therefore, tighter policy is needed; this is what central banks are telling us.”
Nash warns that investors who have banked on continued loose monetary policy and “chased financial asset prices higher” are misguided, adding that: “change is on the way”, driven by the combined forces of high headline inflation and record low unemployment, as well as a weakened Government struggling to tackle anti-austerity sentiment.
“The much-published and very shallow ‘dip’ in growth in the first quarter of this year is, in our view, not enough to justify depression-level monetary settings,” Nash says.
“It has been 20 years since the BoE gained its independence and was set an inflation target; perhaps the potential end of the inflation-targeting era is the more relevant milestone for markets today. Cracks are showing in the MPC already, as the rug is slowly being pulled out from under its core arguments to keep rates low. If any asset is in need of a risk premium, it is the UK gilt market.”
Both Nash and Laith Khalaf, senior analyst at Hargreaves Lansdown, agree that borrowers view cheap money as the norm, with around 8 million Britons having never seen an interest rate rise from the Bank of England in their adult lives.
Markets are now pricing in a 55 per cent chance of a rate rise by the end of the year. However Khalaf says any interest rate rises will be gradual due to consumers’ “existing debt mountain” with the savings ratio now at a record low of 1.7 per cent, according to the ONS.
“The fragile debt dynamics of the UK economy put the Bank of England in a bind, because while a rate hike would help to curb consumer borrowing, it will also make the existing debt mountain less affordable. The central bank therefore faces a tightrope walk between keeping borrowing levels in check, without putting too big a dent in consumer activity, which would have a damaging effect on the UK economy,” Khalaf says.
“The Monetary Policy Committee has turned more hawkish recently, and expectations of a rate rise have built up considerably in recent weeks. However the large amount of consumer debt means that even when the Bank of England does finally decide to wean the UK off low interest rates, it will be a very slow and steady process.”
Sources: Hargreaves Lansdown, Bank of England, Thomson Reuters Lipper, Nationwide, ONS