Bank of England tempers rate hike scaremongering

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A vocal lobby has for a while argued that ultra low rates in the UK (and worldwide) have penalised conscientious savers, forced them into riskier investments and fuelled property prices. Now a Bank of England (BoE) report has got some of the press, and politicians across the political spectrum, hot and bothered about the impact of BoE rate hikes on households’ spending and debt-servicing ability.

It strikes me as scaremongering by the press and politicians. For a start, most analysts have downgraded already conservative forecasts for the timing of the first hike from the current record-low rate of 0.25%. Specifically, in a recent Reuters poll, the majority of analysts expected the first hike only in Q3 2005, with the second hike (to 1%) in Q4 2015. The market is even more conservative, only pricing about 22bps of hikes between now and end-2015 (i.e. the market forecasts only a one in five probability of 100bp of hikes in that timeframe). Second, the BoE expects rate hikes beyond 2015 to be gradual and I would concur. To put things in context, policy rates hovered between 3.5% and 6% between January 2000 and October 2008, averaging 4.8% (see Figure 1). Furthermore, rate hikes are only likely to occur if the economy is forecast to be strong enough to generate a marked rise inflation.

olivier desbarres bank of england policy rate

Figure 1: Bank of England policy rate likely to stay at or near record low for a while yet

Indeed the BoE report (and the Financial Times to its credit) is far more nuanced. BoE governor Carney concludes that “Overall, the evidence does not suggest gradual increases in interest rates from their current historically low levels would have unusually large effects on household spending”. Specifically, the BoE forecasts that a 100bps rise in rates would reduce aggregate spending by 0.5% . These are modest changes in the greater scheme of things and certainly by historical standards.

Of course even marginal rate hikes can have a disproportionally large (and negative) impact on households with high (variable rate) debt-to-income ratios and stagnating incomes. So the BoE is prudent in preparing households, corporates and the government for the eventual rise in interest rates and allowing them some time to adjust their spending and investment. History tells us that preparedness beats complacency. But UK rates are likely to remain at or near record-low rates for a while yet and a more indebted UK economy has survived far higher interest rates in the past. Conversely, savers are unlikely to have much to cheer about any time soon.

 

Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He is a former G10 and emerging markets economist, rates and currency strategist with over 15 years’ experience with two of the world’s largest investment banks.


[1] Based on an average UK mortgage, unsecured loan and income (for those with a mortgage) of £83,000, £8,000 and £43,000, respectively, I estimate that a 100bp increase in rates would mean an extra £910 a year (£18 a week) in mortgage and loan payments, equivalent to around 2.1% of total income or about 2.8% of post-tax income assuming unchanged income

Sources

Figure 1 – Bank of England 

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