After five years of consistently saying interest rates will stay low with the Bank of England Base Rate stuck at 0.5%, we are starting to change our view. We think the time may have finally come for some of our clients to fix their mortgage interest rate.
Some economists are saying the Bank of England (BoE) may need to raise the Base Rate next year. Dame DeAnne Julius, member of the rate-setting Monetary Policy Committee from 1997-2001, recently called on the Bank to raise rates shortly after unemployment falls below 7%, expected in the second half of 2014.
Two other former members, Ian Plenderleith and Marian Bell, echoed this view. BoE policy-maker Martin Weale also warned two weeks ago about the dangers of keeping rates at their record low for too long, with increasing inflation expectations forcing the BoE to move sooner than expected.
This contrasts with the official BoE line that interest rates are likely to remain at their record low level even after unemployment falls below 7%. Wrong-footed by the sudden, unexpected improvement in the British economy, the goalposts have shifted. The BoE is now saying that unemployment falling below 7% is merely a “way station”, not an automatic trigger for lower rates. In fact inflation expectations rather than falls in unemployment are still the most likely trigger of rate rises.
George Osborne, who gave Governor of the BoE Mark Carney the job because he thinks he’s thebest man to help him win the next election, is depending on low rates until at least 2015. This is the basis of the famous ‘forward guidance’ where the BoE promises us low rates for two or three years in the hope that we will all have confidence to spend our money. In his first speech as Governor in August Mr Carney went to great lengths to stress that rates would not rise till 2016.
Either way the hope is that when rates do finally rise, it will be with a gentle upward tilt so slight we hardly notice. Dame DeAnne hopes for “a very measured pace – a quarter point at a time”, with rates gradually nudging up. In this ideal world the economy will strengthen without the bankruptcies and mayhem which would follow a sudden hike to the ‘normal’ 5% we knew before the crisis. A recovering Europe and continued low inflation are the driving-forces behind this optimistic scenario.
This may be what happens. Maybe our economists and politicians have got it right and are delivering sustainable growth. But the recovery could also turn out to be much stronger than even the BoE expected and rates may rise sooner. Or it could be a fake recovery generated by George Osborne in the run-up to the election in 2015, where we once again all ‘get rich’ by buying and selling houses off one another. Maybe ongoing stagnation in Europe will eventually snuff out any real growth and rates will remain low anyway. There is a wide range of possibilities.
However one recent, very worrying statement from the BoE is that it is “highly unlikely” that “growth and inflation would evolve exactly in line” with their projections. Whilst this humility is welcome, it merely recognises what we have all learnt over the last few years – most economists have got it very wrong, most of the time.
An example of this was a monthly poll of economists by Reuters in June 2010 where the majority view was for the Base Rate to rise to 2% by the end of 2011. Late in 2010, with the rate still at 0.5%, the same economists predicted a rise by the end of 2012 and were proved wrong again. If economists were good at predictions we would not still be in the midst of the biggest recession since the 1930’s, which so few foresaw.
Another scenario is that low interest rates and money-printing (Quantitative Easing) are the new normal. Here Western economies are hooked on massive financial doping and it’s just impossible to get off it without causing severe damage to the economy. Japan cut its rates to 0.5% in 1995; two decades later there is no sign of them going back up. Another example from history is the 1930’s and 40’s where the BoE kept the Base Rate at the then record-low of 2% for two decades.
Indeed in the absence of inflation, currently falling in Western economies, there is no apparent need to raise rates. Wages are rising at a pathetic annual rate of 0.7%. Rising wages would push up shop prices, making workers ask for pay rises, creating the feared inflationary-spiral. We appear to be a long way off this scenario.
But appearances can deceive; low inflation can rapidly become high inflation. Fearing moderate deflation in 1967, the British Government pursued policies similar to today’s. By 1970 inflation had shot up to 8%. Will Mr Carney or his successor be forced into an embarrassing U-turn a few years from now?
The policies being pursued by Western governments are unusual and mistakes are therefore likely. This applies especially to the timing of the withdrawal of monetary stimulus (low interest rates and money-printing). If the BoE fails to detect an improvement in credit conditions and maintains loose monetary policies for too long, it will allow inflation to become entrenched.
The problem for Western governments is that any change in monetary policy only works a year or so later. So to stop inflation taking off, you must increase rates before inflation is an obvious problem. But if you act when there is no sign of inflation, people ask why you are stunting the economy’s growth. Politicians don’t like that and this explains why history shows that central bankers always keep rates too low for too long. The fact that the same bankers today blame premature monetary tightening for extending the 1930’s Depression in the USA doesn’t help.
So the most likely scenario for the BoE Base Rate is that Mr Carney will maintain the 0.5% Base Rate until 2015. Then rates may increase, but we don’t know by how much and it may be by a benign, small amount. However a few years down the line – and it is impossible to put a time-scale on this – there is then the danger of higher, out-of-control inflation. Current Western government policy is simply a step into the unknown.
If this isn’t enough to think about, there is another factor: mortgage lenders can put up their interest rates irrespective of what is happening with the BoE Base Rate. Last week the BoE’s Financial Policy Committee announced it will stop providing cheap finance for home loans through the Funding for Lending scheme. Launched in July 2012, it has helped lenders offer more competitive interest rates over the last few months, with rates falling in some cases by over 1%.
It therefore looks as though mortgage rates can only go up in the short-term and the Base Rate will go up after the election, although probably not before. It may not be a dramatic increase, but depending on your plans for the next few years, your current interest rate, whether you are tied-in and the size of your mortgage loan, now may be a good time to fix your mortgage rate.
All Financial Therapeutics clients should now be reviewing their mortgages. If you want to discuss the options – and we think you should – contact us by email. However if you are still enjoying a very low lifetime tracker below 2% (most clients who have mortgages with Scottish Widows Bank) or you are tied in to your current deal with a 3% exit penalty, it will probably be better to sit tight for the time being.
David Bowker
Financial Therapeutics is a trading style of Financial Therapeutics UK Ltd.
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