Interest rate rise not expected until end of 2011

Last updated: Jul 1st, 2011
News by Ruth Emery of Money Observer
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Earlier this year the money was on interest rates rising this summer. But now predictions are being revised as inflation remains stubbornly high and poor economic data continues to be released.

The money is now on rates increasing at the tail end of 2011 or at the start of 2012, with a fresh round of quantitative easing on standby in case fiscal tightening dampens economic growth too much.

Sir Mervyn King, the governor of the Bank of England, said earlier this week that there would be no rise in rates until unemployment fell, and that a further round of quantitative easing was an option.

Record lows

Interest rates have been at a record low of 0.5% for more than two years. According to Bank of England statistics, the average rate of interest with an instant access account is 0.3%. For cash ISAs it is slightly better, at 0.55%. Three years ago it was 4.56%.

Check out our round up of the best cash ISA rates

At the Monetary Policy Committee's meeting in June policymakers voted seven to two in favour of keeping rates on hold. Martin Weale was one of the members calling for a rate hike, and he recently said in a speech: "What an early rate rise would do is reduce the speculation that the bank has departed from its inflation mandate. This itself will reduce the subsequent risks and may, indeed, mean that, averaged over the next three years, monetary policy does not need to be as tight as the current yield curve suggests."

However, experts believe the duo will remain the minority within the MPC for some time yet. Alan Higgins, head of investment strategy, UK, at Coutts, says he originally thought interest rates would go up in August but now he reckons it will be November.

His colleague Carl Astorri, global head of economics and asset strategy, says: "With households struggling to make ends meet as their real take home pay is squeezed by a triple whammy of low wage growth, rising commodity prices and rising taxes, the bank will be in no hurry to raise rates. Doing so would just heap further misery on beleaguered households."

Astori adds that if the fiscal tightening "cuts too deeply into growth the next move by the MPC will actually be a further round of QE" rather than raise rates.

Ariel Bezalel, manager of the Jupiter Strategic Bond Fund, agrees that QE is a possibility. He comments: "Interest rates will remain low for a very long time. 90% of households with a mortgage are on a variable rate so any rate rise will hit them hard. If we saw more than a 0.25% rise later this year we could see headlines of a double dip back on the front of newspapers. The probability of more QE is increasing instead."

Rob Burgeman, investment expert at Brewin Dolphin, says although the drought in parts of the UK may cause food price inflation to climb, the MPC will sit tight. "Unless [we see] higher wage settlements (and there seems little sign of this), the Bank of England is likely to keep interest rates where they are. This should prove supportive to equity markets in what is likely to be a sluggish growth environment."

Max Johnson, a forex broker at Currency Solutions, goes a step further, saying that unless inflation starts to rise again by around an extra percentage point, "we can disregard any notion of a rise in bank rate during 2011". He adds: "Martin Weale may argue that a rate rise now, however nominal, will give us a head start on inflation and obviate sharper potential rises in the future, but we don't have the luxury of preparing for the future."

Consumer Prices Index inflation is currently running at 4.5%. This means the CPI rate has overshot the Bank of England's 2% target for 34 of the past 40 months.

The Retails Prices Index measure of inflation, which includes mortgage interest payments, is sitting at 5.2%.

This article was written for Money Observer

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