When Will Interest Rates Rise ??


Wednesday was set to be an important day for the UK economy, with the release of unemployment data at exactly the same time as the minutes of January’s Monetary Policy Committee (MPC) were published.

Back in August, in an attempt to suppress rising interest rate expectations, the new Bank of England Governor, Mark Carney, issued “forward guidance”, stating that the Bank of England base rate would remain at 0.5% until the unemployment rate reached 7%. At the time, the unemployment rate stood at 7.7% and the Bank thought the 7% level would not be reached until 2016.

Fast forward to this Wednesday and it was announced that the unemployment rate, having already fallen to 7.4% in the three months (the Bank’s preferred measure) to October, fell by more than expected to 7.1% in the three months to November. The market had been poised for a fall to 7.3%.

The 167,000 fall in unemployment over the three months to a four and a half year low of 2.32 million people, was the largest decline since 1997 and the second biggest since records began in 1971. Adding fuel to the good news fire, both long-term and youth unemployment fell. As a result, interest rate expectations and in turn, Sterling rose.

In an attempt to ease interest rate expectations, the minutes of January’s MPC meeting stated that there was no immediate need to raise the base rate, even if the 7% threshold was reached in the near term. The Bank pointed out that pay growth remains subdued, rising by just 0.9% year-on-year, in the three months to October, far below the rate of inflation, leaving consumers with less money in their pockets, something that has been prevalent for the last five years.

Despite these comments, the market is now expecting the first interest rate rise around the end of this year, from early 2015 immediately prior to the announcement and far earlier than the 2016 hike anticipated by the MPC just five months ago.

This leaves the Bank with a rather large dilemma. Inflation, as measured by CPI is now back to the Bank’s 2% target for the first time since 2009 and with Sterling’s appreciation (on the back of rising interest rate expectations) acting as a deflationary force on import prices, the near term inflation outlook looks benign.

However, despite inflation being contained, real wages are still falling, leaving consumers with less to spend on essential items, let alone discretionary spend. The last thing consumers (and indeed small businesses) need right now is further demands on their already strained budgets, in the form of higher debt servicing costs.

It is possible the MPC will reduce the 7% unemployment threshold next month, alongside the February inflation report, which although knocking the Bank’s credibility, should go some way to limit the upward march in interest rate expectations.

However, what this week serves to highlight, is that the end of easy money is drawing ever closer and investors should prepare for a return to the real world of normalised interest rates. What are normalised interest rates? Who knows? – but they are not ½% per annum, so Be Prepared!

Source: Michael Addis of Whitefoord

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Written by Sam Gulley | Financial Planning Consultant

Sam joined Mantle Financial Planning in 2009 having previously been with Alexander Forbes and HSBC bank. Read more >>

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