There has been much noise over the past few weeks concerning the path of UK interest rates. The base rate, currently 0.5% has been at this historical low for over 5 years now and calls have been increasing of late for rates to rise.
Common sense would dictate that rates have to rise at some point but I have to question whether we are forgetting why rates were cut so drastically in the first place. Lowering interest rates puts money back in the pocket of both consumers and businesses – mainly by reducing the cost of their borrowings. Although many UK businesses have used this saving to reduce their borrowings and are in many instances sat on a big fat pile of cash, many individuals haven’t been so sensible.
Consumer spending has been on the rise for quite some time now and much of this has come from the money gained by the reduction in mortgage costs. This isn’t such a problem for small one-off purchases but the same can’t be said for new cars and other items bought on finance. In many cases, the mortgage saving has been ‘re-invested’ in a new finance arrangement with little regard for how that extra money will be found when interest rates regain their upward path.
Although it does seem that the UK recovery is gaining more and more traction and the Bank of England will naturally be expected to justify their existence, we have to remember that interest rates are mainly used as a means of controlling inflation. Increasing the base rate will usually have the side effect of gradually reducing inflation but we have to remember that there is little sign of inflation becoming a problem – in fact many commentators still feel that deflation (prices getting cheaper rather than more expensive) poses the greater threat.
Combined with the average UK consumer holding far too much debt, and the fact that there is the little matter of a general election less than a year away (it is well accepted that rising interest rates will not do anything for the coalition’s chances at the ballot boxes), we really cannot see interest rates making much of a move before the summer of 2015. Ok we accept a token rise of 0.25% may happen towards the end of the year but this would merely be the Bank of England flexing its muscles and showing they are in control. In any case, it could be argued that ‘forward guidance’, their method of indicating the future direction of rates, has pretty much the same effect.
One thing we can be fairly sure of is that whenever rates do start to rise, it will be a slow, steady process. It also looks like we can get used to interest rates remaining below 5% for the foreseeable future (the BoE has indicated that 2-3% is likely to be the new normal).
Then hopefully, just hopefully, you savers might just be able to get some interest on your savings!