The widely expected rise in the Bank of England base rate by 0.25% p.a. to 0.75% p.a. was announced yesterday. A surprise however was the unanimous 9-0 vote in favour by the members of the Bank’s Monetary Policy Committee. Was the rise justified and what will the consequences be? To set the context, a rate of 0.75% p.a. is hardly worth shouting about, historically it is well below its long term average – apparently this is 5% since the Bank of England was created in 1694. I recall paying 15% p.a. interest on my mortgage around 1990. For the large numbers of people on fixed rate mortgages the cost of borrowing will not increase, at least until their current deal comes to an end.
Mark Carney, the Bank’s Chairman argued the rate rise was justified as CPI* inflation at 2.4% is above its target of 2%. In addition unemployment is at a record low and there are signs of real wage growth. I am not convinced by the “full” employment argument. I suspect a lot of the new jobs are poor quality – low paid, part-time or zero hours’ contracts. A neighbour of mine is a care assistant on £7.83 per hour working her socks off, five or six nights a week just to pay the bills and save for a trip back to Albania. Night shifts in the health care profession can be as long as 12 hours. She is pretty exhausted.
Personally I am not sure that wage growth and consumer spending are causing inflation. This is evidenced by a slowing UK economy – we have gone from the fastest growing G7** economy to the slowest. Inflation would appear to be imported due to a weaker pound and from rising oil prices and weather related factors. I don’t see consumers with lots of money to burn going out on a spending spree and fuelling inflation. Moreover Brexit uncertainty is a headwind for the UK economy. This makes the decision to raise interest rates somewhat strange for me. It has been suggested that a reason for doing so was that it gives the Bank of England more leeway to lower rates again if the economy deteriorates but surely rate changes should be driven by current conditions not future potential issues.
The final point to note is that CPI inflation has been above 2% p.a. since February 2017. This has not triggered a series of rate rises to curb rising prices, there was just one in November 2017. All in all I am not convinced it is the right action at the right time. It appears to be a solution to a problem that does not exist! Then again what do I know? I am not an economist.
What then are the consequences of the interest rate rise? Tracker mortgages will rise by 0.25% p.a. as I suspect variable rate mortgages will do so too. In theory the rate rise will be good for savers who have been paid thin gruel for many years for keeping money in cash. It is generally accepted that banks benefit from higher interest rates and I presume the reason for this is that they can create bigger margins between what they earn, interest from loans and what they pay out to savers. I would be surprised if banks and building societies pass on the full interest rate rise to savers. There is evidence they have not done so in the past. Despite the Bank of England’s base rate being 0.5% p.a. from November 2017 to July 2018 savers in the worst accounts were getting 0.1% p.a. or less. The lesson here is to check the interest rate you are getting on your cash and shop around for a better deal. Three sites worth checking are Savings Champion, Moneyfacts and Moneysupermarket.com.
There is a salutary lesson here for savers investing solely in cash (none of my clients), hoping in vain in the last nine years that interest rates would go up. They have lost money in real terms. £10,000 in 2009 is still £10,000 today but its purchasing power has fallen with inflation which has carried a bigger punch than interest earned on cash. The point here is there is no such thing as a risk free investment. Being overly cautious has cost them money. This is not to suggest they should have gone gung-ho into pure equities but they would have been better served investing some of their cash into multi-asset and other cautious risk funds where above inflation returns have been achieved.
Finally in theory rising interest rates should boost Sterling as it attracts foreign investors. However the pound fell yesterday due to Carney’s caution on the economy and unknown Brexit outcomes. He even said if the negotiations with the EU go badly, interest rates could be cut. Foreign investors will have picked up a mixed message on the direction of Sterling. They were clearly unimpressed.
*CPI is the Consumer Prices Index
**The G7 are a group of leading democratic economies. The members are the US, Japan, UK, France, Germany, Canada and Italy.
The content of this blog is my own understanding of interest rates and the UK economy. My comments are intended as general commentary only. Nothing in this article should be construed as personal investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.