Interest Rates Rise: Not a “One and Done” Decision

Interest Rates Rise UK Company Debt

For the first time in more than ten years, the Bank of England (BoE) has raised interest rates. The move from 0.25 percentage points to 0.5% comes on the back of an inflation rate rise to 3% in September and signals the start of a steady increase in borrowing costs over the next three years. “The symbolism of this hike is more significant than its economic impacts,” said Chief Economist at Aberdeen Standard Investments Lucy O’Carroll.

According to BoE Governor Mark Carney, the bank rate is likely to rise twice more over the next three years to get that return of inflation to target. He said: “With unemployment at a 42-year low, inflation running above target (at 3%) and growth just above its now, lower speed limit, the time has come to ease our foot off the accelerator.”

He added: “Future increases in the bank rate would be at a gradual pace and to a limited extent.

In August 2016, the BoE cut interest rates for the first time in over seven years to enable the banks to pass on cheaper borrowing to customers to avoid a recession following the outcome of the EU Referendum. The interest rate rise on 2 November from 0.25% to 0.5% sees this stimulus withdrawn…

The Monetary Policy Committee

The decision of the Monetary Policy Committee (MPC) attempts to set an interest rate that will return inflation to its 2% target. The panel is made up of nine members, including the Governor, three Deputy Governors for Monetary Policy as well as several members appointed by the Chancellor. On 2 November, seven out of nine members voted in favour of higher rates.

The panel said the rate increase was justified as a result of record-low employment, rising inflation and stronger economic growth. The BoE is currently trying to determine the right pace to increase interest rates; not too fast to damage the economy, but quickly enough to prevent inflation from rising further. At this time, the BoE has the same objectives as the US Federal Reserve. However, the Fed has pushed ahead with interest rates from 1% to 1.25%, with another increase on the cards in December.

Mortgages

Across the UK, almost four million households will now face higher mortgage payments, according to the BBC. Of these four million borrowers, the main losers will be homeowners with a variable rate mortgage as banks are expected to follow the BoE’s lead by raising interest rates on home loans. Borrowers on standard variable rates and with tracker mortgages will be affected in the short term, with rates likely to rise in December. However, the modest rise is unlikely to push many households beyond the limits of affordability.

Mortgage brokers are expecting a surge in borrowers signing up to fixed-rate mortgage deals after the BoE stated that further rises in base rates were to be expected over the next three years. Some lenders have already seen fixed-rate mortgages increasing since Carney hinted at a rate rise in September.

Savers

The rate rise is good news for the country’s 45 million savers who are likely to see a slight increase in their returns. For some time, savers have experienced non-existent returns on their savings, but experts claim, that it’s unlikely that the high-street lenders will pass on the benefits of the rate rise to their customers.

Finance expert at moneyfacts.co.uk Charlotte Nelson said: “Given it’s been a long time since the market has seen a base rate rise, it is very difficult to tell whether providers will increase their rates straight away or decide to wait and see what the rest of the market does before making a move.”

It’s also anticipated that there will be better deals for anyone considering buying an annuity for their pension as annuity rates are linked to interest rates, and the rate rise is likely to translate into higher income for pensions.

Price Pressures

Until now, the BoE has been reluctant to raise interest rates, claiming that inflation had jumped as a result of the fall in the value of Sterling since the EU referendum in June 2016. The weaker pound is driving up the costs of imported food, fuel and other goods. The BoE claims this effect is more than likely at its peak right now.

The other issue has been that real pay or wage growth is falling and failing to keep up with inflation, currently at a five-year high. This prolonged drop in real wages to 2.1% reflects the rising pressure on household budgets as prices are rising at a faster rate than pay. Chief Economist at PwC John Hawksworth said this was a striking point of the modern economy that wage growth was so weak despite low unemployment.

However, the BoE forecasts wage growth steadily increasing next year and says there are already signs that this is happening.

Outlook

Carney told the BBC that the BoE expected the economy to grow at around 1.7% a year for the next few years without generating inflation.This is well below the average of 2.5% seen since the Second World War. For the economy to grow at this figure, Carney said it would require about two more bank rate increases over the next three years. Financial experts are predicting that two more interest rate increases over the next three years would take the base rate to 1%

He added: “Brexit-related constraints” on investment and workers are holding back the UK’s economic growth. The MPC has also stated that the decision to leave the European Union is having a “noticeable impact” on the country’s economic outlook.

“The biggest determinate of our outlook is going to be those negotiations ongoing on Brexit both a transition deal to a new arrangement and what is the length of the arrangement with the European Union,” said the BoE Governor.

Jacob Rees-Mogg, the Conservative MP for North-East Somerset, remains unconvinced and has described Carney as an “enemy of Brexit” who has opposed Brexit right from the start and that his statements have consistently been hostile to Brexit.

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