UPDATED 07/07/2011 – The latest interst rate prediction (July) can be found here.
Where next for interest rates?
What’s happened since last month’s interest rate prediction?
The short answer is a lot:
- 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 23rd month in a row.
- Increasing support for a rate rise – for the first time 3 members of the MPC voted for a rate rise. This caused the markets and commentators to speculate that interest rates would definitely be rising by May, especially as:
- Inflation is getting worse – January's inflation measure (called CPI) was 4% which was widely predicted. High inflation could derail an economic recovery. To combat inflation interest rates are usually increased.
- Price of oil and therefore petrol has gone through the roof - the uprisings in the oil rich Middle East have seen the price of oil smash through the $100 a barrel mark, levels not seen since 2008. Unsurprisingly the price of petrol at the pumps has breached 130p a litre. This is pushing up 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)
- The economy is shrinking more than we thought – economic growth as measured by Gross Domestic Product (GDP) was negative in the last quarter of last year. Original estimates put the change in GDP at -0.5%. but this was later revised down to -0.6%. This was completely unexpected and means that the economic recovery is even more fragile than first feared. 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. So this could put off the MPC from raising rates.
- Unemployment is still on the rise – now at 2.5million. Never a good thing.
- The green shoots have gone – previous positive news on the state of the service sector (which is the most influential sector in the UK economy) was undone by poor figures released last week as well as evidence that consumers are spending less. This led to British Chambers of Commerce calling for the MPC to hold off raising rates.
- Mervyn King is still not panicking – Mervyn King, the guy who heads up the group of people who sets the bank base rate is sticking to his guns on the path of inflation and the economic recovery. Old Mervyn has been an advocate of keeping rates at 0.5% as he pretty much thinks everything will sort itself out in the end. His quarterly inflation report pretty much backed up this view.
- More people are calling for a rate increase – more and more noises are being made about the need for a rate rise including by the shadow MPC. But then they would disagree with what the real MPC are doing as that’s what they are there for.
So when will interest rates rise?
This month has been very interesting when it comes to where interest rates are going. The market’s views on when the first rate rise will be has been see-sawing again but largely centring around May (where it is now). The markets are even pricing in a 10% chance of a rate rise tomorrow.
Interestingly Reuter's survey of 63 economists don't expect a rate rise until the third quarter of the year.
The Money to the Masses Interest Rate Clock time remains the same
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.
Now this month’s clock has been tough to call. Swathes of good and bad economic data have got markets in a jitter. But just last month I wound the clock forward (indicating an increasing chance of a rate rise) before everyone else started talking of imminent rate rises. So I must know what I’m talking about.
But inflation is the key problem and everyone is citing the rising petrol price as the final nail in the coffin for not raising rates. But I don't necessarily agree. Rising petrol prices are squeezing consumers wallets at a time when unemployment is still on the rise. Consequently it means that 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 is the later which starts driving 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.
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.
For me, I think that the next month is crucial in seeing where the land lies (we have the Budget coming up soon). So for this reason I am leaving the clock time at 23:56 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
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?