Low rates forever? Or are the experts wrong – again?
Are we expecting low rates forever? Or are experts wrong? CREDIT: A RICHARD ALLEN
• Richard Evans, PERSONAL FINANCE EDITOR
17 July 2016 • 8:11am
“Experts” attracted a lot of criticism from the pro-Brexit side during the referendum campaign for their allegedly excessive doom-mongering and suspiciously precise predictions of disaster. But one group of experts who do have a poor record is those who attempt to predict when interest rates are going to rise.
Ever since the Bank of England announced an “emergency cut” in Bank Rate to 0.5pc all the way back in 2009, economists have been predicting that official interest rates would rise again within a year or two. Every time, events have proved them wrong: Bank Rate remains at the same 0.5pc to this day.
Indeed, the most likely change is seen as another cut, possibly as soon as next month, although the Bank surprised almost everyone by leaving the rate unchanged on Thursday.
Bank of England Governor Mark Carney had suggested a cut was coming as early as July. The MCP decided to hold it at 0.5pc. CREDIT: MATT DUNHAM
Few expect a cut to 0.25pc or even 0pc to have any great effect – borrowing is already incredibly cheap and savers have got used to paltry returns.
What they are really interested in is when rates will eventually start to rise again. Here we steer clear of experts’ predictions and instead summarise all the factors that could bring about, or delay, the first rise in Bank Rate since 2009.
Why Bank Rate may have to stay low
1. The risk that higher rates would pose to mortgage borrowers and the housing market A whole generation of home owners have now become accustomed to low mortgage repayments. Many are on fixed rates and some will have allowed for rate rises, but others would struggle to cope with higher mortgage rates.
If a rise in Bank Rate caused a rush of forced sales or repossessions, both the housing market and the banks could suffer, both with dire consequences for the economy.
David Hollingworth of London & Country, the mortgage broker, said about 90pc of his customers were choosing fixed-rate mortgages. “More are electing to lock in for longer,” he said. “Five-year fixed rates have been particularly popular and the rate cuts on 10-year deals are bound to enhance their appeal.”
He added: “It’s easy to forget that there will be a generation of mortgage borrowers who have never seen a rate move, up or down. Complacency about the record low Bank Rate being the norm could only be heightened given the talk of a need to cut rates.”
2. Inflation remains low The Bank of England’s formal target is to maintain the consumer prices index close to 2pc. As inflation has been stuck below that level for a long time, and as rate rises are normally used to choke off inflation rather than stimulate it, conventional economic theory suggests that the Bank should cut rates, not raise them.
However, some are beginning to challenge that orthodoxy – see below.
The Bank of England may still decide to cut rates CREDIT: NIKLAS HALLE/GETTY IMAGES
3. Economic growth is anaemic Again, the conventional view is that higher interest rates reduce growth and low rates stimulate it. Britain’s growth on an annualised basis is currently about 1.6pc, much lower than the historic trend (an average of 2.5pc since 1956).
4. The risk of raising rates too early and being forced into a retreat This has happened several times to the American central bank, the Fed – its rate rise late last year could end up in this category, some say. If the Bank were to raise rates prematurely, witness the economy suffer and then have to cut again, its credibility would be severely dented.
Why interest rates could have to rise
1. A run on the pound Sterling has fallen sharply in the aftermath of Brexit, but not to the extent that worries the Bank or the Government. Indeed, a weaker currency can be beneficial by making exports cheaper and encouraging businesses and consumers to “buy British” because imports become more expensive.
But an uncontrolled fall in the pound would have to be addressed, and the most likely course of action would be to raise interest rates.
2. A sustained rise in inflation As mentioned above, the Bank’s target is to maintain inflation close to 2pc. Sterling’s decline by 10pc or so following Brexit is very likely to cause the consumer prices index to rise above this figure.
If the increase is temporary the Bank may well choose to ignore it, but if inflation were to become embedded, perhaps because wages also rose significantly
3. Orthodox economic thinking is challenged To recap, conventional thinking is that low interest rates encourage inflation and economic growth. But some investors say the logic breaks down when rates are so close to zero and when they are left there for long periods.
Low rates, for example, increase the amount that savers have to set aside for retirement in order to achieve a desired level of income. This is because low official interest rates affect market rates on savings accounts and annuities, both currently at record lows.
If millions of people who are 10 or 20 years from retirement are now “over-saving”, this has the effect of reducing the amount they spend on goods and service – or so the theory goes. This means that low rates are restricting economic activity, the opposite of what is intended.
If the opposing view gains ground, the Bank may decide that higher rates are better for the economy.
Low rates increase the amount that savers have to set aside for retirement CREDIT: PA
4. Asset bubbles need controlling Low interest rates encourage savers to switch money out of cash and into shares and property. The Bank may use higher rates to cool things down.
5. Banks need bailing out Banks’ profits suffer when interest rates fall close to zero. Another banking crisis is the last thing Britain needs, so the Bank of England may decide to give them some low-key help by raising Bank Rate, or at least declining to cut it further. Final salary pensions schemes also suffer.
So what should savers and borrowers do?
Predicting the future path of rates through this web of conflicting influences is almost impossible. If borrowers could not cope with higher mortgage costs they should guard against the possibility by fixing their loan at today’s rock-bottom rates.
Savers may want to consider a mix of maturity dates for their fixed-term bonds, so they have some higher returns guaranteed but retain the flexibility to take advantage if better deals come along.
Robs comments, I like this article. It state some fundamental points with regards to the current and future mortgage rates. I just hope wages increase if and when mortgage interest rates go up.