Log inInterest rate hike – what hike?
Last week the Bank of England raised interest rates by 0.25% to 0.50%. To put this in context, on the back of the Brexit “Leave” vote last year, the Bank of England’s reaction had been to reduce rates from 0.50% to 0.25%. Last week’s decision effectively reversed this decision. This was reported by the media headlines as an interest rate hike.
To my mind a hike is something far bigger than a quarter per cent rise back to the previous all-time low level we experienced pre-Brexit. All indications are that further rises are by no means certain or imminent, despite what the headlines may imply.
So why did the Bank raise rates at this time? On the one hand, there had been increasing noises coming out of their monthly Monetary Policy Committee (MPC) meetings suggesting a rate rise was nearing. The Bank of England have been widely criticised in recent times for making such noises, markets reacting and then not actually carrying through on their inferences. Perhaps, they recognised the need to regain some credibility and felt the need to carry through on their recent warnings and actually increase the rate this time.
Perhaps it was a tacit acknowledgement that the post-Brexit reduction was a hasty decision and one which is widely viewed as an unnecessary reaction. Reverting rates back to 0.5% retains the previous status quo, which the economy had grown familiar with.
The Bank of England has increasingly linked interest rises to inflation. CPI (the Consumer Prices Index), the most widely used inflation measure in the UK, is now at 3%, far in excess of the UK target inflation rate of 2%. Higher interest rates are a way of controlling inflation and to have not taken any action, would have challenged the Bank’s credence on inflation targets. One knock on example of the effect of CPI rising is the cost to the Treasury of state pensions for example, which are linked to CPI and which will cost the Treasury more the higher CPI grows.
Are more “hikes” on the way? As ever, there are two schools of thought. One which says the Bank is simply reversing the decision from 2016 and no further rate rises will take place until Brexit negotiations are complete and the other, which says our economy should be following the US trend and continuing to nudge interest rates higher, albeit levelling out at a much lower level overall, around 2% – 2.5%, when compared to historic interest rates of 6% plus. Markets reacted positively to last week’s rate rise, perhaps proving the theory that this rise was “priced in”, a slightly overused phrase in investment terms. There aren’t many signs that further rate rises are similarly priced in and so any further rises may be less well received by the markets.
Brexit negotiations may be a handy fallback rationale, but are something of a red herring. The UK economy isn’t growing as fast as it once was, banks are passing on rate rises to consumers on mortgages but not savings and inflation is rising. Whilst once raising interest rates seemed inevitable and logical, the arguments for continuing to do so in the UK in the short term are less strong. If interest rates stagnate again then Brexit will likely be the reason cited, but the Bank of England need to think carefully about the signals they put out in future to ensure that the decisions they take are the right ones at the right time, rather than the ones they feel compelled to take.
Our view is that interest rates should be nudging upwards as they should have done some time ago, but the reality is they will do so at a snail’s pace.