The beginning of July marked 10 years since the Bank of England last raised interest rates. With the Monetary Policy Committee keeping rates on hold again at the July meeting despite comments from the higher echelons of the bank suggesting monetary tightening could be on the cards, are we likely to see interest rates move above 0.25 per cent anytime soon?
Bank of England chief economist Andy Haldane has said he may back higher rates, while governor Mark Carney has also hinted that a rise is needed. Indeed, three MPC members voted for a rate rise in June, with outgoing member Kristin Forbes having been the only hawk prior to that.
Expectations have certainly shifted in some quarters, prompting a sell-off in bonds and bond proxies, while the financials, materials and energy sectors have benefitted.
Furthermore, fears are mounting that markets are getting carried away, giddy on loose monetary policy with capital being misallocated. Could a correction be on the horizon without a rate rise in sight? And how much bearing is inflation having on a potential rate rise?
Inflation surprised the market in May, reaching a four-year high of 2.9 per cent and notably overshooting the BofE’s target rate of 2 per cent, before dropping back down to 2.6 per cent in June. But is the inflation target likely to remain a priority for the BofE? Some industry commentators deem it to be out of date, while there has been a shift away from the focus on managing inflation by the US Federal Reserve, the European Central Bank and the Bank of Canada.
John Husselbee, head of multi-asset at Liontrust
While US policymakers look uniform in their decisions, minutes from the Monetary Policy Committee’s June meeting highlighted a deepening rift in the UK. While the decision in June was to leave rates on hold the BoE’s chief economist revealed he considered opposing Governor Mark Carney and voting for a rate rise.
Carney cited Brexit uncertainty as justification for leaving rates on hold at 0.25 per cent, but just hours later, economist Andy Haldane said it would be prudent to tighten policy before the end of the year. Haldane, previously one of the most dovish members of the committee, said the balance of risks had shifted so the dangers of moving too late outweighed those of raising interest rates too soon. Carney has since admitted that rate rises may be necessary if business investment increases.
Looking at how rate rises might affect investors, over recent months, bond markets have largely been in a deflationary mindset while equities – buoyed by Trump’s election – have been more geared towards reflation. When you have that kind of dichotomy, the bond market tends to win out, but this time the reflationary theme has been more pervasive and bond yields are lower than would be expected given where we are with QE. As policy continues to normalise however, we would expect the scales to tip in favour of the deflation/recession camp and bond yields are likely to continue rising from here.
We don’t think, at present, that we are about to enter into a global recession – and growth continues to pick up, albeit modestly. Are there any other measures the BoE may adopt? We have seen extraordinary policy over the last nine years – it would be foolish to rule anything out.
Tim Cockerill, investment director at Rowan Dartington
It has largely been forgotten that the interest rate at 0.5 per cent was deemed an emergency measure – a decade later and the emergency has become normality. The latest decision to keep them unchanged was not a surprise; after all we’ve had 10 years of slow economic recovery from the global financial crisis and now face the disruption of leaving the EU. While the BoE would love rates to rise at least so they have scope to cut again in the future, wage pressure doesn’t demand it; indeed real wage growth is currently negative. The UK hasn’t got a booming economy and although not in recession, for many it still feels like one.
Yet with consumer borrowing back at very high levels it might be tempting for the BoE to raise rates, but with interest charged on credit cards well into double figures a change in the base rate isn’t going to alter consumer behaviour, especially as many use credit to simply get by.
Monetary policy has become largely ineffective, and that’s why talk has turned to infrastructure spending. However, low interest rates are now baked into the mindset of consumers and businesses, so the scope to raise them is limited, too much and the housing market falls apart. What the economy doesn’t need though is more liquidity, it needs the opposite in fact, a slow withdrawal of QE; bond yields would rise and the asset price bubble that has grown over the decade would slowly unwind.
John Redwood, chief global strategist at Charles Stanley
There has been no hurry at the Bank of England to raise interest rates, despite the view of the chief economist that the cut last summer after the referendum vote could be reversed.
We are likely to hear more talk of rate rises as the factions on the Monetary Policy Committee discuss how to respond. An actual rise is less likely given the figures and outlook for the economy.
The Bank is tightening monetary policy anyway by seeking to rein in consumer credit. It has expressed concern about car loans just as the car market falls on the back of higher vehicle excise duties for expensive and CO2-generating cars. The Bank’s FPC does not wish to see too much build up of consumer debt in general, though some consumers want to bridge the squeeze on real incomes which many see as temporary.
The buy to let and dearer homes markets are still deflated by the large stamp duty rises in April 2016, and overall mortgage lending is under control. While a minority at the MPC table fret about the current inflation rate, the majority expects the inflation rate to spike and fall away assuming no further big gains in the oil price or a further fall in the currency.
The Bank is likely to be gripped by caution. To the extent that it takes a pessimistic view of the possible impact of Brexit on trade and financial services it will need to follow a looser policy. It needs also to be driven by the data which does not show any upwards momentum to wage rises despite the temporary increase in inflation. It is unlikely the Bank or the Government will want to tamper with the inflation target, as that could unsettle markets. The Bank has plenty of weaponry left should it need to stimulate the economy. It can resume bond buying, relax commercial bank balance sheet requirements, and announce a longer period of ultra low rates. None of this currently seems necessary. Forecasting more of the same might not be very exciting but it may prove to be the outcome.
Nick Greenwood, manager of the Miton Global Opportunities trust
While many central bankers have recently openly discussed the possibility of adopting a less accommodative monetary stance, they’re unlikely to vote for a meaningful rise in interest rates. Vast quantities of debt have been accumulated within the financial system since the global financial crisis. A modest interest rate rise would be sufficient to ramp up servicing costs and stop the economy dead. We will only see rates returning to historical norms if central banks lose control.
Longer term, there is much to fear. The UK national debt exceeds £1.5trn and given that the Tories seem to have lost their nerve over austerity, this figure will rise at a faster pace than in recent years. At some point, lenders will decide that the debt has risen to an unsustainable level and will want to be paid more for the risk they’re taking. It is then that rates rise and in an uncontrolled way. As an aside, it is frightening to think that many working in the City have never seen a rate rise.
In the closed-end world, many high yielding funds command premiums over the value of their underlying portfolios. These are vulnerable to any normalisation of interest rates. The damage will not be caused at portfolio level. Infrastructure funds, for example, use a discount rate well in excess of the current market. It will come from a change in the pattern of demand. Once investors can obtain a measurable yield from conventional sources, they will return to them. Some of the alternative income closed-ended funds now have market capitalisations in the billions. It’s questionable whether the market clearing system could cope if there were ever more sellers than buyers.