Interest rate rise not expected until end of 2011
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.
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%.
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
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Posh-sounding word for the FOReign EXchange market – the global market for trading currencies. The primary purpose of Forex is to assist international trade and investment by allowing businesses to convert one currency to another. The Forex market is one of the biggest markets in the world, and includes banks, central banks, institutional investors, currency speculators, corporations, governments, other financial institutions, and retail investors.
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.