When will official UK interest-rates or Base Rates actually rise?

Today sees the latest meeting of the Monetary Policy Committee of the Bank of England and it is likely that two of the members will vote again for an increase in UK Base Rates. However in spite of that fact I believe that we have moved further away from an interest-rate increase in the UK rather than nearer. That may seem odd with an economy growing at an annual rate of around 3% but then the credit crunch has been full of oddities has it not? I think that we have reached the stage that tearing chapters out of economic textbooks will no longer do as that completely new ones will have to be written.

I have form in this particular area as I wrote this back on the 27th of December last.

So should we see any slowing of the UK economy in 2014 and the exchange rate of the pound continues to be strong there are factors pointing towards a base rate cut. This would be reinforced if the pound strength actually pushed inflation to below its target. The MPC would be likely to ignore the years of inflation being above target and concentrate myopically on the immediate figures in such a situation. After all if eight people can wake up one day and discover that they all suddenly support Forward Guidance cutting base rates in such a situation might seem logical to them.

Actually I was being a bit unfair on Martin Weale who did at least express some doubts on Forward Guidance but not on the other seven. Since then we have seen a strong pound overall which has helped push the annual rate of Consumer Price Inflation to 1.5% comfortably below its 2% target. The actual exchange rate picture is complex especially after the US Federal Reserve Minutes talked down the US Dollar overnight but the effective or trade weighted index has risen from just below 85 when I wrote that piece to 88 now. So it remains a disinflationary influence although in a world where we can add the US Federal Reserve to the Bank of Japan and the European Central Bank wanting their respective currencies lower we face an unpredictable future.

What about future inflation?

This is of course the crucial issue as the Bank of England is supposed to be targeting inflation two years out. What we see right now is an oil price which has headed substantially lower and is now technically in a bear market with the price of a barrel of Brent Crude Oil below US $92 as I type this. Other commodities prices are weak too particularly the price of Iron Ore as it rattles around the US $80 per tonne level. Overall the Commodity Research Bureau (CRB) Index has fallen from a peak of 504.52 in early May to 472.8 now. So we are seeing disinflationary pressure from this area.

Adding to this has come this from the United Nations Food and Agriculture Office this morning.

The FAO Food Price Index averaged 191.5 points in September 2014, down 5.2 points (2.6 percent) from August and as much as 12.2 points (6.0 percent) from the corresponding period last year. The September slide, which represented the sixth consecutive monthly drop, brought the value of the index to its lowest level since August 2010. The decline in September marks the longest period of continuous falls in the value of the index since the late 1990s.

Actually the category which has reduced the fall has been the price of meat (up 11.6% on a year ago) but even it barely registered a rise in September.

Added to this is the apparent weakness of our trading partners in Europe. It was only on Tuesday that I analysed the apparent slow down in the German economy and this morning has seen exports in August fall by 5.8% compared to July (seasonally adjusted). August was a bad month for the German economy with a lot riding on the impact of the change in the timing of school holidays. We got a central banking viewpoint on this from the US Federal Reserve last night.

economic activity stagnated in the Euro area…..indicators of
economic activity in the euro area remained weak

 

Some participants expressed concern that the persistent shortfall of economic growth and inflation in the euro area could lead to a further appreciation of the dollar and have adverse effects on the U.S. external sector.

 

If this is a matter of concern to the United States then imagine what an issue it is to the UK! Whilst the US has large volumes of trade relatively it trades much less than the UK does and of course Europe is the major partner for us. The currency situation is slightly different as until last night the US Dollar had been pushing the pound lower but it is hard to avoid the thought that the Bank of England will be mulling this issue.

Wage inflation

This section is relatively simple at least according to the official numbers. So far it is the dog that has not barked and if anything it has gone into reverse. It seems so contradictory and wrong but then so much of the credit crunch era has felt like that. With average earnings being reported as rising at an annual rate of 0.6% there is little case for an interest-rate rise being made.

House prices

These continue to rise and as I reported yesterday the latest numbers from the Halifax are just below a double-digit annual increase. However there were some hints of slowing here and these have been repeated today by the Royal Institute of Chartered Surveyors (RICS).

Demand and supply are looking a little more balanced, which is removing some of the upward pressure in prices, particularly in London…….Next year, we expect the house price outlook to be far more subdued.

 

Some care is needed as the level remains far too high but a central banker wishing to avoid raising interest-rates is likely to focus on the apparent change in trend. After all if the surges we have seen were not a reason for a Base Rate rise why would a fading be?

Bank of England policy itself is less expansionary

We have experienced a phase where the Bank of England actively pumped up the UK banking and housing markets via its Funding for Lending Scheme. That has now faded and is only supposed to be available to smaller and medium-sized businesses. So whilst this was an off-balance sheet activity its impact should now weaken going forwards.

Financial Markets

These have adjusted over recent weeks as these two twitter updates indicate.

10 year yield drops from 2.48% to 2.21% in one month

 

@JediEconomist 50 points of hikes out of Short Sterling there has been in 2 weeks. Always further and faster than ever we expect L goes.

 

For those who do not follow the futures markets the one for UK interest-rates is called Short Sterling and has the code L.

Comment

Back when I started this blog just under five years ago I established the viewpoint that central banks would delay raising interest-rates until they were absolutely certain that the recovery was in place and thriving. Does anybody actually believe that right now? I thought back then that this would lead to problems and it would appear that the IMF has caught up with me.

At the same time, a prolonged period of low-interest rates and other central bank policies has encouraged the buildup of excesses in financial risk-taking. This has resulted in elevated prices across a range of financial assets,

 

If we move to shorter-term tactical issues then a Base Rate rise by the Bank of England might lead to another surge in the value of the Pound on the foreign exchanges. This would be reinforced if the US Federal Reserve continues to insist that an interest-rate rise there is in the distance.. Also imagine what would happen if the UK raised Base Rates and the Euro area continued to weaken and pulled the UK with it.

Please do not misunderstand me I would prefer that UK Base Rates were higher and argued back in 2010/11 that we needed to nudge them higher to help deal with the inflationary episode we suffered. Right now it is the getting them there that I have problems with and it could remain some months away as we go forwards….

Advertisements

18 thoughts on “When will official UK interest-rates or Base Rates actually rise?

  1. My main worry about our ersatz recovery and the chronic UK emergency rates is that if/when we hit a proper recessionary bout we won’t have the same stimulus tools to deploy. If the US recovery is legit and the Fed is bold enough to lift rates next year, how could we QE again without demolishing the pound? You’d think the BOE would want to get rates back up to one percent, at least, during our alleged mini-boom, to give them something to cut in the next downturn! And why haven’t the markets thrown out all this will-they-won’t-they forward guidance claptrap? I wonder if the whole thing has just been a protracted bank rescue prior to allowing the crash to break on us as it would have done in 2008 without the interventions. Or do you see another way out?

    • ‘You’d think the BOE would want to get rates back up to one percent, at least, during our alleged mini-boom, to give them something to cut in the next downturn!’
      🙂
      ‘ I wonder if the whole thing has just been a protracted bank rescue prior to allowing the crash to break on us as it would have done in 2008 without the interventions.’
      It does appear that the last five years of making monetary policy redundant have allowed the banking classes time to clear their decks before we get consumed by the crash that takes asset markets back to or below long term averages

    • Hi Peter Walsh and welcome to my corner of the blogosphere.

      The problem with all the can kicking is the issue that we may as you imply arrive at the next recession weaker than we were in 2007/08. We will only have extraordinary monetary measures to deploy and they have plenty of side-effects. As to the markets I think that these days much of the smart money simply front runs the central banks and therefore a lot of their function has gone.

  2. it’s all bad decisions and wasted opportunities that lead us to where we are now. Is it the case that now a rise in rates might be perceived as an important positive step in returning to normality so that is why it is mentioned so frequently without actually being carried out? The next thing you know we’ll have a problem in China and a eurozone recession, and we will be back to square one.

    Don’t recessions come in 7 year cycles on average?

    • Hi Zummerzetman

      I think that it is normality that our establishment are afraid of as they do not want for example the banks to be treated normally or for government bonds to return to what until the credit crunch era was regarded as normal. They have intervened in so many markets it gets ever harder for them to admit their errors and retrace their steps.

      We look like we will be facing the next downturn in a weaker state than when the credit crunch hit us and yes it may be due.

      • Exactly. They give the impression that everything will be returning to normal soon, and are concerned people might cotton on to the fact it won’t and start asking why so the pretence must continue.

  3. Shaun, I have had similar thoughts myself and logically you would expect rates to be on hold for some time. Against that it the stoking up of a dangerous credit bubble based on low rates forever and the need to get rates up again so there is room to cut in future if necessary. To a certain extent it will make parking funds in Sterling more attractive which will stabilise the pound. A rate hike will have a temporary boost to the pound but I think there are enough doubts about our long term debts etc to prevent it rising too far. At least that’s what the bloggers on the forex forums say! I think rates will rise but only a small amount to ‘send a message’ to consumers credit markets. The justification will be strategic rather than economic.

    • Hi Pavlaki

      We keep repeating the policy of kicking that poor battered can into the future and the problem from that is that we are arriving at the time which was supposed to be when we could pick it up! Instead we keep going forwards with ever more baggage. Believe it or not the FT is running an article saying the ECB needs to act to help equity markets! Even a relatively small decline is apparently now too much,

      I think that raising interest-rates would not be the reverse for the domestic economy that many argue but in a world where more and more want lower currencies I fear an overshoot of the Pound. As to when a rise may happen we may yet run the electoral cycle which would be perhaps the ultimate irony for the “independent” Bank of England.

  4. I think it’s deliberate to keep mentioning a rise in interest rates but then to not do it so as to aid the banks’ recovery. They can then pay a pittance to savers and yet keep rates for borrowing (including mortgages) quite a bit higher so the net effect is that borrowers are given some leeway at the expense of savers. We have some way to go on this tack I should imagine.

    • Yep….the banks are clearing a nice margin between the cost of funds and what they lend at,quite often,thanks to taxpayers.

  5. Hello Shaun

    I’ve always posit that the BoE will raise rates when wage inflation take hold

    so for us mere mortals if we see our living standards improve via being better paid these wonks will stamp on the rate rise brake to put us back in our place

    Banks Rule !

    Forbin

    • Hi Forbin

      It is the major factor right now I think and the water is muddy as there are disputes between the official average earnings survey and some of the private-sector surveys. The other factor is productivity which has been raised higher by the GDP revisions and by allowing for falling North Sea Oil & Gas output but the underlying theme is not massively changed.

      Speaking of the price of oil it dipped below US $90 a barrel earlier which makes me wonder if a game is afoot there. Maybe it is being caused by the way that so many banks have pulled out of trading it or it is a punishment for Russia and Putin? Perhaps both are at play…

  6. It seems to me that we either raise rates and allow money to get to the working parts of the economy or we keep them low and bail out the banks, homeowners and CRE owners.At the moment all the support is for the indebted.

    Have they not thought that by raising rates they might actually stimulate growth as savers spend more freely?Doubt it.That’s not in their playbook and would certainly have a negative effect on credit demand and we can’t have that can we?

    • Agree! I have banged that particular drum for a while now. If,as they tell us, savers outnumber borrowers then a decent return on savings is likely to loosen the purse strings and stimulate the economy. As it is everyone draws their horns in and cuts discretionary spending.

  7. Shaun, Interest rates are not going up before the election, Are you mad? We’ve had that exciting back to back media circus at all the party conferences, there is no event of any consequence between now Christmas and the May election lets get that straight now.. Great Britain is an island and it matters not about China or Europe, we can carry on bidding up our decrepit property ( a little slower) and carry on buying those lurverly BMW’s that will queue on our clogged and pot-holed road network.

    Of course I am joking, and only a grey swan event will shake us back into reality. How about this, brown-outs cripple productivity further as the nuclear power stations fail simultaneously and the over-stretched rest of the UK infrastructure falls over like dominoes without consistent energy supply.

    Paul C.

  8. Given the implications of a rate rise, and the fact that, outside of actually building far,far more houses, there seems to be no intention of fixing the housing market, doesn’t the following make sense:

    A yearly tax on second (and third and fourth etc.) UK located properties of 4% of its/their market value, irrespective of whether they are holiday homes, or buy to let.

    Far better than a mansion tax, or empty bedroom tax.

    I suspect there’d suddenly be an increase of available houses on the market, and there’d be a hope for property values to at least, halt their rises, if not actually drop in value.

    No basic homeowner’s would lose out as far as I can tell, and whilst there’d be a gnashing and wailing from the BTL, haven’t they all had it too good for too long?

    • Sorry, meant to add the following to line 4:

      I suspect there’d suddenly be an increase of available houses on the market, and there’d be a ‘ shared/societal hope/need ‘ for property values to at least, halt their rises, if not actually drop in value. Significantly above CPI/RPI inflation, year on year asset value increases for multiple BTL owners would start to feel like a bad thing.

  9. The banks are still insolvent.
    Our politicians are still owned by the banks.
    The last thing the banks need is a huge raft of defaulted home loans.
    When ftbers take out home loans, they usually think, “We’ll be stretched for the first few years, but OK after that, as wages rise.”
    We need a period of sustained wage inflation before homeowners can pay higher mortgage rates.
    Interest rates are going nowhere. (At least not anywhere markedly different)

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s