Forecasts for rates have suddenly shifted. Azad Zangana, Senior Economist at Schroders, answers five pressing questions about the future of monetary policy.
Rate rises are important to many in the UK, particularly those whose wealth is tied to the value of their homes and the mortgage debt they pay on them. A rate rise could have a substantial impact on both, potentially driving down the value of the home while increasing mortgage costs.
It can also have an impact on markets and certain types of assets, which is explored here.
The next UK interest rate announcement will be made on 10 May 2018. The Bank of England (BoE) is trying to raise interest rates, but with the economy slowing and Brexit on the horizon the chances of rates rising sooner rather than later have fallen significantly.
The market is now pricing in a 17% chance of a rate rise in May, having been at 100% on 29 March 2018, after recent data pointed to a more buoyant economic outlook.
More recently, data from the Office for National Statistics has shown that the UK economy almost stalled in the first quarter of 2018 growing by just 0.1 per cent, the weakest quarterly growth since 2012. Furthermore, inflation fell to 2.5% in March, from 2.7% in February. It was the lowest rate in a year.
If growth had remained solid and inflation high then the decision to raise rates would not have been so complicated.
However, the data surprised many, including the Bank of England’s rate-setting monetary policy committee (MPC). It prompted the Bank’s governor, Mark Carney, to reiterate that he didn’t want to get too focused on the precise timing of a rate increase, more the general path.
The BoE raised interest rates for the first time in a decade in November 2017, taking the headline borrowing rate to 0.5% from 0.25%. Through this period of volatile forecasts, the Schroders Economics Team has maintained its view that November will mark the next rise in rates. It expects only one rise in 2018 and two in 2019, with rates reaching 1.25%.
Given the uncertainty Azad Zangana, Senior European Economist and Strategist, answers some of the most pressing questions.
Why wouldn’t the BoE raise rates in May?
Recent data suggests that the UK economy may not have been as strong as previously thought. Bad weather in February and March probably played a role, but the data suggested that there was something else behind the weakness. Rather than take a risk and hike anyway, the BoE is likely to wait to see whether the data improves in coming months.
What effect would not raising rates in May have?
Very little. A hike would have meant a rise in borrowing costs for mortgage holders, and potentially slightly higher interest rates for savers. However, without the hike, borrowers and savers are unlikely to see any change.
When will UK interest rates rise?
We think the next interest rate rise is likely to happen in November 2018, by 0.25% to 0.75%. By then, economic data should have recovered, and uncertainty over Brexit should be lower.
How quickly do you think rates will rise thereafter?
We think we could see two more (0.25%) rate rises in 2019. The economy is likely to gather momentum, and the UK will have departed from the European Union, albeit into a transition phase. While two more hikes is an acceleration compared to this year and last, it is still a very slow pace of hikes compared to history.
What would be the harm in leaving interest rates as they are?
At the moment, there is little harm. However, as the economy continues to recover, the risk of higher inflation grows. Raising interest rates to more normal levels would help slow the economy to a more stable pace of growth, which should reduce the risk that inflation overshoots the BoE’s target. High inflation not only hurts the purchasing power of households, but it also erodes the value of savings.
This article has first been published on schroders.com.