In last week’s Quarterly Inflation Report, the Bank of England acknowledged the strength of the recovery, but stressed that a rise in interest rates was still some way off.
Ben Brettell, Economics Editor, Hargreaves Lansdown commented: “Mark Carney continues to walk the tightrope between talking up the UK economy and dampening expectations that interest rates will rise.
The degree of slack in the labour market is key. The Bank noted that despite the continuing fall in unemployment, it remains historically high. Productivity growth is yet to emerge, and the number of people reporting they would like to work longer hours points to significant spare capacity. This means there is scope for the economy to grow further without pushing up inflation, which in turn means no rate rise is necessary.
All this suggests that unless inflation expectations really start to take off, the Bank will judge that there is enough slack in the economy to keep rates on hold for a while yet. They will need a clear and unequivocal reason to raise them, as the risks of tightening too early are substantial. Are households and companies capable of withstanding higher rates? The answer is we simply don’t know.
Expectations rates might rise as early as this year are probably unfounded – it looks likely the first rise won’t come until 2015, and quite possibly after May’s election. However, of much more interest to mortgage-holders, savers and investors is where rates might end up. On this subject the Bank of England has been fairly clear – it expects rates to stabilise at much lower levels than we saw pre-crisis. A peak of 2-3% looks more likely than 5-6%.”
Commenting on the effect on savers and investors, he concluded: “Overall today’s message is very much still ‘lower for longer. This is obviously bad news for savers, but good news for investors and borrowers. Stock markets don’t like rising interest rates – lower rates for longer will keep the markets happy and could sustain the current rally. They are also positive for bond investors. Much has been made of the risk that higher interest rates and inflation could cause a sell-off in bonds. Lower rates for longer could postpone this.”