Bank of England Base Rate is on the rise, so what’s the logic behind it?
With Chartered Financial Planner, Andrew Gilmore.
In March 2009, the Bank of England reduced the base interest rate to 0.5%, the lowest rate in nearly 300 years. We saw a further cut in August 2016 to 0.25% before seeing the first rise since 2007 in November 2017.
As a reminder, these early slashes to rates were emergency credit crunch measures to encourage borrowing and spending, although you could argue that is what caused the crashes in the first place.
Although this feels like a lifetime ago, the serious nature does mean we have a generation of borrowers who see the current rates as ‘the norm’.
Aside from a reversed cut due to Brexit concerns, last week seems to mark the beginning of the lifting of this emergency stimulus as rates rose to 0.75%. In theory this means higher interest rates: slightly positive for savers and slightly negative for borrowers, but in reality this is likely to have little effect on either, as it is so small and most saver and borrower rates are fixed for many years.
So why are we seeing rates rise now you may wonder? Here are our theories, taken from our knowledge of the industry;
Firstly, the consensus is that we are no longer in the grips of the credit crunch and this ‘needed to happen’ as other major economies are currently raising their cost of borrowing. America is raising rates and Europe and Japan are reducing their emergency money printing so we won’t stand out as breaking ranks if we do it now.
Secondly, we have near full employment, the economy is ticking along, albeit slowly, and wage pressures are expected to build due to Brexit affecting the labour supply. This could all lead to inflation and costs going up which the Bank is duty bound to limit to 2%. Higher rates send a message that high wage growth will not be tolerated and “nips it in the bud”.
The Bank of England is also convinced that Brexit (in just 7 months’ time) is going to be an economic disaster and therefore we will need room to cut rates next year. The higher they are, the sharper (and more powerful) the cut can be to support the economy when required.
Finally, the sceptic in me says that Mark Carney has been warning of interest rates rising “soon” for about 7 years, and its all getting a bit embarrassing that he’s never raised rates yet!
The market is definitely convinced this is a temporary rise – the pound has fallen to 1.29 against the American dollar and 1.12 to the Euro, ie the market thinks the base rate will be lower after Brexit – in 7 months. Ironically this means higher inflation, yet nobody believes the Bank of England is serious!
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