Skipton Financial Services
Thursday, August 2, 2018 - 15:50

Interest rates go up. But why now?

Only recently, savers were left feeling thwarted by the Bank of England’s decision to freeze base rate in May. But ever since the Monetary Policy Committee’s (MPC’s) meeting in June – which saw an unexpectedly close vote – a hike in August has been on the cards.

And today, such predictions have been confirmed. Base rate has finally risen from 0.5% to 0.75% - the highest level it’s been since February 2009.

Just a few weeks ago, a rate increase in November looked more likely to take place than in August. So you may be wondering just why rates are rising now; especially in view of the current economic climate and political uncertainty that is dominating the headlines.

To find out more, we spoke to our very own Mitch Hargreaves – Money Market Dealer at Skipton

Mitch Hargreaves

Mitch explained, “Whilst today’s news may be welcomed by savers, the timing of the hike is curious for two reasons.

“Firstly, the MPC has long insisted that policy decisions would be data-dependent. They were as good as their word in May, when a widely-expected rate hike never materialised following a week of disappointing economic figures. Since the June meeting, however, the picture has been similarly discouraging. Manufacturing and industrial output, earnings, inflation and retail sales all undershot expectations to varying degrees.”

With the currents twists and turns of Brexit, what influence is the Government’s negotiations with the European Union having on the MPC? “Bank of England Governor Mark Carney had advised that a disorderly Brexit would have implications for the interest rate glide path,” Mitch continued. “Since the last time the MPC convened, the Secretaries of State for both Brexit and Foreign Affairs have resigned, whilst the Prime Minister is yet to present a solution to the question of the Northern Irish border that is palatable to her EU counterparts. 

“Nevertheless, the market had maintained its confidence in an August hike in the weeks leading up to the meeting; the likelihood implied by market prices remained at greater than 80%, even as the weak data continued to roll off the press, and that probability only climbed as the meeting drew nearer. Today’s announcement clearly vindicates that confidence.”

Nevertheless, the decision to increase rates now would appear to go against the Bank of England’s own approach. Mitch stated, “On the face of it, increasing rates now may seem counter-intuitive in light of the MPC’s previous forward guidance. However, on hiking rates, Mark Carney painted a brighter picture of the economy.  The Governor argued that the blip in the first quarter performance had been just that, and highlighted the very limited amount of slack capacity remaining in the economy. 

“According to the Bank’s new ‘R-star’ measure, the long-term equilibrium interest rate would be around 2-3%, albeit lower in the nearer term. The implication is that in the MPC’s eyes, even the relatively sluggish pace of growth the UK is currently experiencing will be too much to avoid generating excessive inflation if interest rates do not rise accordingly.  That being said, the Bank forecasts that inflation will return to its 2% target by 2020, and at the time of writing, markets are not currently expecting a further hike until late next year.”

Looking ahead

For just over a decade, savers have had to endure historically low savings rates – making it very difficult to grow money in real terms over the long run. Although today’s hike creates some positivity for people, rates remain a far cry from where they used to be.

In fact, only three weeks ago, Bank of England deputy governor, financial stability, Sir Jon Cunliffe, disclosed it is unlikely interest rates will climb above 2% for decades to come. “The current yield curve sees bank rate rising slowly over three years and levelling off at under 2% for the next 30 years,” he stated.

Prior to the financial crisis, base rate had remained consistently above 5%. But it looks set to be a long time, if ever, before savers see such rates of interest again.

“Bank of England policymakers have been consistent in their guidance that the process of monetary tightening will be a gradual one.” Mitch concluded.  “The road ahead is long and clouded in uncertainty, and it will be some time until we see interest rates reach their peak.”

Here to help

With so much economic uncertainty and very little to keep savers optimistic at the moment, saving towards the future has never been harder.

If you feel you’re not achieving the returns you need on your long-term savings, we may be able to help you.

Providing you’re willing to accept some level of risk to your capital, we can discuss your personal situation, explore other options that could help your money work harder – and present you with personalised recommendations to consider.

Please remember that stock market-based investments are not like bank and building society savings accounts as your capital is at risk and you may get back less than you invested. The value of your investments and any income from them may fall as well as rise​.

The opinions and analysis provided are for information only and do not constitute financial advice.

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