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How long before interest rates rise? That is the question millions of households and businesses are asking after the Bank of England last week turned off its printing presses.
Having pumped £200 billion of freshly minted cash into the ailing economy, and cut rates to 0.5%, Threadneedle Street signalled that life-support may soon be coming to an end.
The Bank insists it is monitoring the situation and could inject yet more money into the economy if the recovery falters. Governor Mervyn King will say as much tomorrow at the eagerly-awaited inflation report in which the Bank will outline its latest forecasts for the economy.
The feeling in the City, however, is that unless disaster strikes, there will be no more quantitative easing and rates will have to rise. Economists are divided over when the first rate rise will be. Some think as early as this spring, others not until 2011.
When they do move, they could move very fast. A report by Barclays Wealth and Barclays Capital warns rates could hit 3.5% in 2012 and 6.5% in 2015.
It will, of course, depend on the outlook for inflation, and tomorrow's quarterly report by the Bank will provide more clues as to what it thinks.
The Bank is likely to trim back growth forecasts following the UK's woefully weak recovery — the 0.1% growth rate in the fourth quarter of 2009 marked the end of the recession but was hardly cause for celebration.
In the last inflation report in November, Bank boffins pencilled in growth of around 4% by the end of 2010, a far stronger recovery than now looks likely.
The monetary policy committee last week described economic growth as “sluggish” and warned of “a gradual recovery in the level of activity”.
The City reckons this paves the way for downgrades tomorrow. Philip Shaw of Investec says: “The MPC's previous projections were too optimistic.
The wording of the recent statement accompanying the interest rate announcement gave the impression that the committee is somewhat hesitant over recovery prospects.
We would not be surprised if the inflation report contains a set of downgraded GDP projections from what looked a set of optimistic forecasts in November.”
The Bank will also raise its forecast for inflation, which hit 2.9% in December and is certain to have rocketed over 3% in January to 3.5% or higher. In November, the Bank saw a peak of 3% this year, although it will again argue that this spike in inflation is temporary and will be reversed.
The MPC last week said “inflation will fall below the target” of 2% later this year.
Peter Dixon of Commerzbank says: “The Bank will have to raise its short-term inflation projections in the light of recent trends. However, Governor King will likely paint an upbeat view of growth prospects whilst arguing that the current spike in inflation is only temporary.”
The Bank often prefers to take the big decisions — and the first rate rise after the unprecedented action we have seen will certainly be big — to coincide with the inflation report.
If it follows this pattern then the meetings in May, August and November 2010 and February 2011 are the potential settings for a reversal in policy and a rise in rates.
Should inflation prove more persistent than expected by the Bank it could be a headache for whoever wins the general election.
An election on 6 May — the expected date — would see the MPC postpone its meeting planned for 5-6 May and instead start talks on Friday 7 May with the decision announced at noon on Monday 10 May.
A rate rise just days after the election would make the tax increases and spending cuts planned by both Labour and the Conservatives — but the Conservatives in particular — even more painful.
Any decision by the government to delay the fiscal squeeze to compensate for the rate rise would put the UK's AAA credit rating at risk and could trigger a sterling crisis.
The Bank may therefore hold off until later in the year, wary of the political ramifications of a move so close to polling day and that tough government action to cut the deficit would dampen demand in the economy and keep a lid on inflation.
The Tories promise an emergency budget within 50 days should they win power which would also give the Bank reason to delay. If it sticks to its quarterly timetable, 5 August and 4 November are the dates to look out for.
Reader views (1)
Add 1.5% over 3 months. Interest rates at the moment are a joke. In 1979 I could get 12.5% at National Savings on Instant Access. Now my 40 year savings of £10,000 at 3% give me £6 a week BEFORE TAX, I may as well spend it. However I wont because I know banks are short of cash, Building Societies like the Skipton who took over the Scarborough to stop the politically unacceptable scenario of a BS going bust are still struggling to make up the cash deficit they took over and the only way at the moment is to raise their morgage rates, but not to savers as they are in the same Bankers Boys Club and have to fall in line with the rules. But for how long. Something will give, and the banks will be the first.
- Trader Jim, Uphill Struggle, 10/02/2010 12:10
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