Interest rates: This is not your common-or-garden rise


I do. I remember heading along to the Bank of England in Threadneedle Street as the financial crisis and recession raged, and witnessing the most dramatic change in interest rates in modern history as the Monetary Policy Committee slashed them to 0.5%.

I remember just how tense the mood was inside the Bank. There was a sense that they had had to throw out the textbooks and begin again from first principles, as they tried to work out how the economy would function with near-zero rates.

And as I remember it, no one there even dreamt that the cost of borrowing would have remained at or below those pre-crisis levels for as long as they did.

But now, at last, the period of crisis-era rates is coming to an end. The Bank has raised borrowing costs to 0.75%. It is not a big increase by any means. And it still leaves Bank rate well below “normal” levels (which these days are closer to 2.5% than 5%, according to the Bank).

All the same, as the Bank took its decision today, the mood could hardly have been more different from those crisis days.

There was a slightly surreal absence of drama in the air.

Why? Mainly because this decision – highly symbolic as it might be – was actually unusually uncontroversial. Every one of the nine MPC members voted for it – the first time there has been unanimity for a rate increase in more than a decade.

The move was widely anticipated in financial markets. And the Bank said that while it would take a tiny bit off economic growth, it was unlikely to leave a major dent in the economy.

Bank of England Governor Mark Carney speaks during the central bank's quarterly inflation report press conference in the City of London.
Image: BoE Governor Mark Carney has spent the past few years preparing for a rates rise

Many people within the economy fraternity have spent the past decade or so fretting about what higher interest rates would do to households. Now it has happened why is everyone so relaxed about it?

In part, it is because that is precisely what the Bank and its governor, Mark Carney, had planned for. So much of their effort over the past few years, from forward guidance to speeches on this matter, has been aimed at trying to ready the country for the fact that borrowing costs would have to eventually return to normal.

The message seems to have been received.

On the surface, the statistics suggest that the country should be able to absorb the extra costs.

For households which are net savers, the consequent increase in savings rates, after nearly a decade of near-zero returns, should come as an immense relief.

There are more mortgage borrowers than ever before on fixed-rate products, which means they will not be immediately affected by the rate rise – though it will likely push up their mortgage costs when they come to renew.

In short, no one seems to be panicking that this rate increase will cause profound damage.

But there are some reasons for caution. First off, even though the majority of households are well placed to deal with these extra costs, there are small pockets of over-extended families for whom even a small increase in interest rates will mean the difference between being able to afford their mortgage and not.

There will be some borrowers who have become so accustomed to rock-bottom interest rates that any increase will cause an unexpected financial jolt.

More broadly, this is not your common-or-garden rate hike.

Normally when the Bank increases the cost of borrowing it is because the economy is doing very well – growth is tearing away, threatening to take inflation with it. In this case, the economy is expected to grow by only 1.5% this year.

And while unemployment is at record lows (indeed for the first time on record the Bank thinks the jobless rate will drop below 4% this year), wage growth is still well below its pre-crisis levels.

The real reason the Bank is raising interest rates is that with unemployment low and productivity also very weak, the economy simply cannot grow much faster without generating a bit more inflation.

Finally, for all the serenity at the Bank, there is a tacit acknowledgement that all its plans could be disrupted by Brexit.

If there is no deal on Brexit and the economy faces a crunch next year, the Bank may be forced again to cut rates. If it does so, this increase may start to look at best like an insurance policy; at worst like a mistake.

But these risks remain close to imponderable.

More from Business

In the meantime it is worth reflecting on an important moment in UK economic policy.

For the first time since the crisis, the UK is starting to drag itself slowly towards monetary policy normality.

From – SkyNews


Comments are closed.