Interest rates: Time to rise?

By Jo Gilbey
Find me on: LinkedIn 08-Jul-2014 16:45:00

Interest rates

It’s long been said that Bank of England governors have a history of going 'zig' when everyone else is going 'zag'. This is certainly a trait that media pundits have highlighted as being present in current governor Mark Carney, and you only have to look at his early policies to see why. As nations around the world were slowly recovering from the global financial crash, many highlighted policies to amend their interest rates accordingly. Whether this was to keep them low indefinitely to encourage spending or elevate them slowly and surely in a bid to maintain stability, each had their own take on what to do for the best.

Carney, on the other hand, cemented his maverick status almost immediately by reprising a policy first rolled out back in his native Canada - that of tying interest rates to the unemployment figures.

Whilst these two disparate markets may seem to have little in common, there is more to it than meets the eye. For example, businesses were told that interest rates would not rise until unemployment figures had fallen below seven per cent. With this not anticipated for months or even years, companies could take on new starters without fear of a bumper outlay just a few weeks down the line.

Then, this extra employment not only gave strength to Britain's small businesses but also served to reduce the benefit bill and get more people paying income tax.

Carney was hailed a hero for the scheme by analysts across the political spectrum and entered firmly into the canon of maverick BoE governors. Now, some months on, ONS figures have declared that unemployment has dropped below the famed seven per cent point, but Carney has said he's in no rush to raise the interest rates as expected.

This turnaround took some by surprise and begged the question: is now the right time?

The historic low

When unemployment dipped below seven per cent, Carney explained the recovery was still precarious and that Britain would continue to benefit from the 0.5 per cent interest rate - a historic low. With the economy suffering no great harm from rates staying low, it was decided that they should remain unchanged.

More recently, Carney took aim at pay packets, suggesting that now more people are in work, attention should instead be paid to their salaries. He argued that, despite the economy growing in both strength and confidence, this hadn't yet filtered down into wage packets. As such, workers were not getting the kinds of pay increases that the BoE would expect - even after prolonged periods of wage freezes and cost of living increases.

The root of his argument is that there's spare capacity within Britain's labour market that may not have been so apparent in the days when unemployment was greater than seven per cent. Now, with this a consideration, interest rates can remain low until the spare capacity starts to fill.

Only once capacity issues are resolved, he argued, can measures be put in place to achieve interest rate rises that will result in "durable" expansion.

Perhaps unsurprisingly, Carney is staying resolutely tight-lipped on the exact time for interest rate rises. In terms of a time when rates return back to their more typical average of five per cent, he said it might not be on the cards for another three years or more.

What Carney was a little more open about was the interest rate levels he referred to as ‘the new normal’. Though not denying that rates may eventually return to the five per cent average Britain has seen for many years, he admitted that a more accurate figure (at least for the foreseeable future) would be 2.5 per cent. This was the likeliest medium term scenario, with the added caveat that increases would be gradual enough to not destabilise Britain’s growing economy.

In regard to questions on his "mixed messages" (where he said rates could rise after unemployment levels dropped but decided against it), Carney maintained that the seven per cent mark wasn't a 'trigger' but a 'threshold'.

Time to rise?

Despite all of Carney's promises and reassurances, there are some organisations which believe a rise should be forthcoming sooner rather than later. Among these is the Institute of Directors (IoD) which argued that interest rates should, by now, be reaching a level where monetary policy can once again become an "effective economic lever".

In addition, MPs have joined the growing chorus of people saying that Carney has been giving out conflicting messages. One even went so far as to liken him to an unreliable boyfriend, one who runs hot and cold to leave people unsure where they stand.

One argument is that low interest rates are contributing to Britain's ever-growing housing market - something that Carney himself said he would be considering very carefully. Although low interest rates are good for homeowners (in keeping mortgage payments down), it's not quite so beneficial for first-time buyers trying to buy their first property.

Such an unrestricted market has sent demand soaring and brought about a notable rise in property prices. This way, even those who had been priced out during the recession (as they didn't have the sizeable deposits being requested by banks), are still finding a purchase beyond their reach. The longer this goes on, the more prices are set to rise and the harder it will be to get on the property ladder.

Simultaneously, any large-scale property price increases are set to undermine recent economy growth and put the market back on precarious footing - despite Carney's claims of doing it for stability's sake.

So what's the verdict?

Whether or not interest rates should be increased is a hot topic, but the problem is that many opinions proffered are wholly biased. Homeowners, for example, will be hoping that rates stay low because it means more money in their account every month once their mortgage comes out. Similarly, business owners considering expansion will also hope that lower rates stick around in the longer term.

Conversely, first-time buyers may not be salivating at the prospect of high monthly mortgage payments, but it's still better than rates so low that property prices continue to rise, making even getting on the property ladder in the first place little more than a pipe dream.

Carney has a duty to everyone and must tackle it without bias. As such, one group is sure to feel the pinch, if it means a better outcome for the economy. For as long as the recovery is stable, interest rates can remain at their historic low. When the rates start pushing into more precarious territory, however, few would begrudge base rate increases.

All this may sound good on paper, but it also brings us back to the issue of when exactly the economy enters into choppy water. This, too, is a topic on which people have strong and varied opinions, which only brings us back to square one.

But let's not forget, Carney's being hailed as a maverick. Even if his methods appear to be somewhat out of the ordinary, it's worth remembering that he's just the latest in a long line of such individuals who have steered the Bank of England through some similarly turbulent times. Regardless of opinion, the buck (or even the penny) stops with him.


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Interest rates