The UK base rate remains at a historic low but analysts are already looking to the future, with some expecting interest rates to rise sooner rather than later.
After more than seven years at 0.5%, the Bank of England’s (BoE’s) Monetary Policy Committee (MPC) slashed the base rate to 0.25% in August 2016. The move was intended to calm the nerves of investors as the value of Sterling dropped following the Brexit vote.
Today, £1 is worth around $1.20 to $1.25 compared to between $1.40 and $1.45 in the months before the EU referendum.
However, some now suggest it is the central bank’s decision to cut the base rate, rather than the Leave vote itself, which has caused the pound’s continued struggle. “Sterling has weakened significantly since the Brexit vote and while fear of ‘hard’ Brexit is one explanation, Bank of England policy is another,” says Gareth Lewis, chief investment officer at financial planning and investment manager Tilney.
“Cutting rates and reintroducing quantitative easing can be expected to weaken a currency significantly.”
Rising inflation is one major issue that the BoE must contend with. At 1.6%, December 2016’s inflation rate was the highest for more than two years. The Bank now anticipates inflation will rise rapidly and reach 2.7% this year. It does not expect it will return to its 2% target until 2020 at the earliest.
Wait and see approach
The answer to rising inflation is typically to increase interest rates and encourage consumers to save rather than spend.
However, Kathleen Brooks, research director at City Index, says: “The overnight index swaps market, essentially an interest rate used by banks when they borrow from each other on a short-term basis, is still not pricing in for a rate hike until the end of 2018. It has even scaled back its expectations of a rate hike since mid-December when expectations were nearly 39.4% for interest rates to be 0.5% at the end of 2018; this is now 36.9%. This is probably down to growing fears of a hard Brexit with negative economic consequences for the UK.”
The BoE appears to be adopting a wait and see approach, with MPC member Andy Haldane saying the base rate is just as likely to go down as up.
An August 2016 poll of Moneywise readers found that four in ten expected the base rate to remain at 0.25% for the foreseeable future.
What do industry experts say?
Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management, says: “Post-referendum, the UK economy has been helped by a buoyant labour market and low inflation. However, economic surveys suggest fi rms are cautious about hiring plans and downbeat about business investment intentions. Much will hinge on how the negotiations with the EU take shape, and whether transitional arrangements can avoid a ‘cliff effect’.
“Despite the coming rise in infl ation overshooting the 2% target, we don’t think the Bank of England (BoE) will feel comfortable raising interest rates. The Bank will also want to keep its powder dry, so we don’t expect any interest rate cuts in 2017.”
Danny Cox, a chartered financial planner at investment firm Hargreaves Lansdown, says the value of Sterling may remain low until the markets can see a positive outlook for the British economy.
“The currency is perhaps the best bellwether of the market’s view of the state of an economy and where it is expected to go in future,” he says. “An expectation that there will be a slowdown in the economy would ultimately mean lower interest rates in the UK for longer.”
Stockbroker The Share Centre says that if economic data continues to be strong, the BoE may feel the need to signal the change in direction of the interest rate cycle and nudge rates up 0.25% later this year.
Gareth Lewis, chief investment officer at Tilney, sees signs that the Bank is changing its outlook. “There has been a pick-up in UK bank lending suggesting the UK has a growing infl ation problem requiring Bank of England action. Language has already changed to reflect the new reality,” he says.
“Therefore we could expect quantitative easing to end and possibly a reversal of the August rate cut.” He believes the bank will wait until at least the second quarter of the year before changing the base rate.
However, Moneywise columnist Jeff Prestridge believes savers could be in for a better year in 2017.