12 Feb 2013

How Long Will Interest Rates Stay at 0.5%?

It’s been a long while since our savings have fetched anything more than a paltry 0.5%, or perhaps the slightly more palatable, but still appalling 2.5% for that capital in our ISA’s or 1 year bonus yielding accounts. The question on so many investor’s lips is when will the Bank of England raise its rates and ‘do what is fair’ for savers?’

The first thing to understand is that, rather surprisingly to some, it is not the primary purpose of interest rates to provide a nice little earner for savers- though granted, it seemed like that was a given for so long during the late nineties and earlier 2000’s boom. Rather, interest rates are probably the most certain tool that we have at our disposal for controlling inflation: that is how fast prices are rising- the CPI figure we hear so much about on the news.
The general rule is that the higher interest rates go, the lower inflation will drop, and inflation was today announced to be running at 2.7%; for all intents and purposes, a reasonably respectable and steady figure. Why then would the Bank of England raise rates now when they didn’t even do anything a year or two ago when inflation was running at close to 5%? The answer to that question is: they probably won’t. It seems that British monetary policy (the setting of interest rates) has become rather intertwined with our current fiscal situation (the health of the economy and government coffers). An interest rate of 0.5% means cheap money for borrowers and investors, who are going to spend it in the economy and (hopefully) raise our GDP; this is obviously the main reason why Sir Mervyn King and his committee has been so reluctant to do anything with the rates.
So to give you the answer I promised, we will only start to see rate rises in certain conditions:
a) The United Kingdom (and ideally world) suddenly see an upsurge in economic growth and the BoE decides it can safely raise rates

b) Inflation starts getting so out of hand (and I mean around the 7%-8% mark) that the BoE decides it cannot leave things as they are (unlikely, to be honest)

c) The new Canadian BoE governor is a risk taking shark, who wants to show the world that he is confident in a British recovery by raising rates and hopefully stimulating something that way, since nothing textbook has actually been working for the last 5 years.

On the whole, I see none of these possibilities really on the horizon. Rates have been at 0.5% for so long now that there would most likely be no hesitation at keeping them that way until at least 2015. If I was going to make quite an outlandish statement I’d say that rates will stay low (if not 0.5% then 1%-1.5% or so) until 2018, 2019, maybe even 2020. Looking that far into the future is hard, but nothing can really dramatically change in the near term with public and private debt at the current levels. The monetary policy committee, who can stroll in knowing what the result will be, have a cup of tea and then head on home, have never had it so good.


Post a Comment