Latest interest rate predictions – July 2011

Update 29/07/11 - the newest interest rate prediction (August) can be found here

Where next for interest rates?

What’s happened since last month’s interest rate prediction?

• Rates remained at 0.5% – last month the Bank of England’s Monetary Policy Committee (MPC), who are the guys who decide the UK base rate, once again voted to keep the base rate at 0.5%, for the 27th month in a row.
• LESS support for a rate rise – in previous months members of the MPC voted 6-3 in favour of holding rates. But in June, Andrew Sentance, the former MPC member who had been leading the calls to raise rates, has left the committee and was replaced by Ben Broadbent. Broadbent voted to keep rates on hold meaning the committee was split 7-2 in favour of maintaining rates at 0.5%
• Price of oil and therefore petrol has gone through the roof - the uprisings in the oil rich Middle East, earlier in the year, saw the price of oil smash through the $120 a barrel mark, levels not seen since 2008. While oil prices have fallen they remain well above $100 a barrel. This continues to buoy inflation and prices in the short term (as delivery costs are passed on to consumers). A lot of analysts are claiming this is even more reason to put up interest rates BUT I don’t agree (see later).
• Inflation remains high – May's inflation measure (called CPI) remained unchanged at 4.5% but inflation is expected to hit 5% soon. High inflation could derail an economic recovery. To combat inflation interest rates are usually increased.
• The economy has stagnated – economic growth as measured by Gross Domestic Product (GDP) was negative (-0.5%) in the last quarter of 2010. This trend was reversed in the first 3 months of 2011, when GDP grew by 0.5%. So we’ve only regained the ground lost during the winter! At least we technically avoided another recession but this shows that the economic recovery is still very fragile. The upshot is that if the economy is in a bad way (rising unemployment etc) increasing rates could tip personal finances over the edge and spell disaster. Especially as nearly half of home owners are living in fear of a rate rise. So this could put off the MPC from raising rates.
• Unemployment fell – UK unemployment fell 88,000 in the three months to April this year to 2.43 million, the biggest drop since the summer of 2000 raising hopes that the country may escape a large rise in the jobless total in spite of the upcoming austerity measures. Personally I don’t buy that and such a huge unemployment figure is never a good thing.
• Any signs of green shoots? – Unfortunately GDP figures were disappointing. The Office of National Statistics (ONS) announced that consumer spending contracted by 0.6% for the second quarter in a row forcing closures on the high street. The UK economy has experienced the slowest  pick-up in consumer spending of any post-recession period since 1830. The government’s deficit reduction policy isn’t working and while there have been recent signs of a pick up in UK manufacturing it only accounts for 12% of UK output, so its impact is limited.  Or to sum it all up, the UK economy is in serious trouble. Raising rates would hammer consumers further and could derail any sniff of an economic recovery which would be bad news.
• Mervyn King is still not panicking and doesn't want to raise rates – Mervyn King, the guy who heads up the group of people who sets the bank base rate. Speaking at the European Parliament in Brussels in May, Mervyn King warned that a rise in long-term interest rates would have “severe” consequences. So it doesn’t sound like he’ll be changing his ‘steady as she goes’ tune any time soon. In fact he recently indicated that there would be no rise in interest rates until there was clearer evidence that the economy was growing and that unemployment and the interest rates actually paid by consumers were falling. None of these will be happening any time soon.
• UK Economic growth forecasts continue to be cut – by not only the Organisation for Economic Co-operation and Development (OECD) but also by the Government and the International Monetary Fund. Suggesting that the recovery is more fragile than first thought.

So when will interest rates rise?

The market’s views on when the first rate rise has continued to be pushed back, now centring around July 2012. But this could change at the drop of a hat.

The Money to the Masses Interest Rate Clock time is being wound back

As regular readers will know our interest rate clock sums up a lot of economic data, analysis and opinion, such as the above, and if a jump in interest rates is looking increasingly likely then the clock time will be moved closer to midnight. If it looks less likely then it will move away from midnight (with 23.45 being an expectation of an interest rate drop). So you can ignore all the waffle and just concentrate on the clock time.

But the recent lacklustre GDP figure coupled with falling consumer spending (as I predicted) mean that taking the economy off life support machine too soon could be disastrous.

As I’ve said previously, while inflation is still the key problem facing the MPC, and sky high petrol prices are exacerbating the issue, interest rate rises are not a direct consequence. Rising petrol prices are squeezing consumers wallets at a time when unemployment is still high. Consequently, consumers have less money in their wallets to spend on other things. So the most likely outcome, in the short term, is a drop in consumer spending rather than an increase in wage demands.

And it will be increasing wage demands which will start driving non-temporary inflation because the cost of rising wages will have to be factored into the cost the goods and services we buy. If prices go up we demand higher wages again and so on and so on. A spiral of inflation. But the government has the unions in their sights and are looking to change the laws to make striking more difficult, and therefore keep wage demands muted. Also a recent survey suggested that private sector pay at UK listed companies has risen at the slowest rate on record. If consumer spending is squeezed and wages are constrained then demand within the economy will continue to fall (or at least not grow) which provides a downward pressure on inflation.

In addition, raising rates usually dampens inflation by cooling spending (saving becomes more attractive and credit is more expensive). Less demand means lower prices hence lower inflation.  But the oil price is an external factor to the UK so raising rates won’t make any difference to this particular inflationary factor anyway.

For me, I think there are still a number of uncertainties in the economy for rates to rise just yet and realistically we might not see a rate rise until the final quarter of the year (over even into 2012). Bear in mind that the MPC tend to raise rates after a quarterly inflation report (the next two reports being scheduled for August and November). So keep an eye on these.

So to sum up I am moving the clock time back to 23:53 for now.

The historic clock time adjustments are listed below to give you an idea of how my expectation of an interest rate rise has changed over time:

• May 2010 – 23:55
• July 2010 – 23.54
• September 2010 – 23.53
• January 2011 – 23.54
• Feb 2011 – 23.56
• May 2011 – 23.55
• July 2011 -  23:53

Should you rush to fix your mortgage now?

Luckily I’ve answered this question in my article Reader’s Question: Should I fix my mortgage now?