Latest interest rate predictions – May 2011

5 min Read Published: 03 May 2011

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?

  • 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 25th month in a row.
  • Unchanged support for a rate rise – for the third time 3 members of the MPC voted for a rate rise. This position was unchanged from the previous month. So while there is support for a rate rise among MPC members it is not increasing at the moment. Plus, Andrew Sentance, the MPC member leading the calls to raise rates, is leaving the committee after May's meeting.
  • Price of oil and therefore petrol has gone through the roof - the uprisings in the oil rich Middle East, earlier in the year, have seen the price of oil smash through the $120 a barrel mark, levels not seen for 2 and a half years 2008. Unsurprisingly the price of petrol at the pumps breached 135p a litre – despite George Osborne cutting 1p a litre from fuel duty in March's Budget. 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).
  • Inflation is not as bad as feared – March’s inflation measure (called CPI) unexpectedly slowed to 4% catching the markets off guard. High inflation could derail an economic recovery. To combat inflation interest rates are usually increased but with an improving inflation picture that seems less likely.
  • The economy has stagnated – economic growth as measured by Gross Domestic Product (GDP) was negative (-5%) in the last quarter of 2010. This trend was reversed in the first 3 months of 2011, when GDP grew by 0.5% (all though this figure could be revised in the coming months). 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 – unexpectedly by 17,000 to 2.48m in the three months to February, raising hopes that the country may escape a large rise in the jobless total in the coming months in spite of austerity measures. Personally I don't buy that and such a huge unemployment figure is never a good thing.
  • The green shoots are back? – February’s negative news on the state of the service sector (which is the most influential sector in the UK economy) was replaced by positive figures in March as well as numbers showing that the service sector contributed positively towards the latest GDP figure. But similar figures from the manufacturing sector showed a drop in production between January and February. So we are certainly not out of the woods yet. Also concerns still remain over the level of UK consumer spending after March saw the worst monthly fall in retail sales in 16 years! Raising rates would hammer consumers further which would be bad news for the retail sector.
  • 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. But in fairness after the recent slowing in inflation maybe he's right?
  • UK Economic growth forecasts were cut – by not only the Organisation for Economic Co-operation and Development (OECD) but also by George Osborne during his Budget speech. Suggesting that the recovery is more fragile than first thought.
  • 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 occur had been see-sawing in the last few months, centring around May. But this view has now shot out towards the end of the year (October in particular).

The Money to the Masses Interest Rate Clock time is moving 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.

Swathes of good and bad economic data over the past few months have got markets in a jitter. But the recent lacklustre GDP figure coupled with a (temporary?) slowing in inflation and the worst monthly fall in consumer spending seen in 16 years mean that taking the economy off life support machine too soon could be disastrous.

As I said last month, 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. This was actually borne out in March's record fall in consumer spending, as stated above (so I must know what i'm talking about).

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 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. Bear in mind that the MPC tend to raise rates after a quarterly inflation report (the next two reports being scheduled for May and August). So keep an eye on August.

So to sum up I am moving the clock time back to 23:55  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

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?

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