It’s now nearly five years since the Bank of England reduced rates to the record low of 0.5%. Many of us will be used to average rates of between 5% and 7%, and some of us will remember rates at 15%, so this will have been a historic period of in terms of monetary policy, and be quoted in the economic text books of the future.
In addition, Mark Carney, Governor of the Bank of England, has issued in his ‘Forward Guidance‘ programme and has indicated his intention to keep rates at this level until unemployment falls below seven percent. And, the Bank has said they do not expect this to happen until the middle of 2016.
However, the recovery (house price-led, in my opinion) is moving forward at such a rate now that there are increasingly loud whispers that interest rates will have to rise earlier than 2016.
Moreover, workers are being hired at the fastest rate since the late 1990s, and unemployment benefit claimants are falling at the fastest rate since 1997.
What effect might this have on the UK turnaround strategy?
If rates went up to just 2.5%, still very low against the long term average, this would be disastrous for many businesses and households.
For the many businesses that have been carrying forward large debt burdens from pre-2007, and maybe just been servicing the interest, this would mean the cost of their business finance would rise five-fold. This would likely be the last straw for these businesses, and be enough to finally push them over the edge into liquidation.
For those house owners who had taken out large mortgages on the back of the last property boom, from 2002 to 2007, this could also spell disaster. Particularly for those borrowers with interest only mortgages (who have just been able to keep up the payments with rates at 0.5%) – they would also see a five-fold increase in their monthly outgoings. With wage increases still not keeping up with inflation, this could mean people tragically losing their homes.
Former member of the Bank of England Monetary Policy Committee, Dame DeAnne Julius said at Fathom Consulting’s recent Monetary Policy Forum, that she expected unemployment to fall below the seven million figure by the middle of or towards the end of next year. If Mr Carney is true to his word rates will go up then!
Dame DeAnne believes the Bank of England would stop providing Forward Guidance at this time and concentrate on reducing inflation, which Fathom believe will be 3% by then due to the spare capacity in the economy.
Interestingly, the National Institute of Economic and Social Research (NIESR) says there is a 20% chance that unemployment could drop below 7% before the end of the first quarter of 2014.
The policies set by the Bank of England in these matters are crucial. If they raise interest rates now it will do an enormous amount of damage, as described above, and would likely put a massive spoke in the wheel of the UK economy’s startling turnaround and recovery in 2013.
On the other hand if they leave it too long, inflation – already a nagging concern for the policy makers – will get out of hand and be very difficult to control.
As we have seen recently in Europe, it is a very delicate call when trying to get these things right. The ECB (European Central Bank) has been forced to cut interest rates to just 0.25%, in an effort to stoke inflation as it is running around just 0.5%; and this could lead to major problems for the Euro region akin to Japan in their so-called ‘lost decade’.
Getting it right is vitally important to us all…
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