The end of low interest rates?

By Tony Newham, director

Markets, economists and other experts haven’t had a great record of making the right calls in recent years. Indicators such as higher inflation, low unemployment and high levels of consumer debt are driving sentiment towards a slow but steady rise in the Bank of England’s base rate. At the June meeting of the Bank of England’s Monetary Policy Committee (MPC), three of the eight MPC members voted to increase rates immediately. While not a majority in favour, this sentiment within the MPC in favour of a rise has not been seen for many years.

However, here is the most amazing statistic: in mid-2007, inflation was lower than it is now, at circa 2.1%, and the unemployment rate was higher than now – at around 5.3%. This compared with current consumer price inflation of circa 2.5%, and the unemployment rate currently at around 4.5%. Yet in July 2007, the Bank of England base rate was 5.75% despite inflation being lower and unemployment being higher than now. So why are we not seeing immediate and rapid increases in interest rates? Perhaps one arrives at the conclusion that we are in a new world, a new paradigm where interest rates are unlikely to go much above 1% or 2% before being reduced again as the next unforeseen economic crisis manifests itself. Naturally, some potential economic hurdles are much more visible – the big one, of course, being Brexit.

It’s also interesting to note that another barometer of sentiment remains subdued on future rate rises. The UK interest rate swap market is the driver of fixed rates for all types of borrowing, and the message here seems clear – rates will stay low for some time to come. For example, yesterday’s five-year swap rate is still sub-1% – at 0.988%. This means that a lender can buy a five-year swap at 0.988%, and provide you with a five-year fixed rate at not too much more than this level (after adding on the lender’s profit margin).

Having watched economic surprises unfold over many years, I am of the opinion that we should not be fixated on any opinion and keep an open mind on possibilities. If you are sensitive to interest rate rises and your debt is on a floating rate, look at the fixed interest rate options now while rates are still low. But whether or not floating rates will rise by very much is still open to significant doubt.

*Note that this content is the opinion of the author only and should not be relied on to make investment, borrowing or other financial decisions.