Can interest rates be interesting?

can interest rates be interesting title with graph in background

It’s 2020. But here we are again, still talking about ‘Brexit’ day on 31st January. Whilst we could complain about the uncertainty it has so far brought on and has yet to end, we wanted to spend some time talking about the interest rates.

Why do they matter?

The last time the Bank of England base rate started with anything other than a ‘zero’ was March 2009 when the equity markets hit rock bottom and swine flu was the big (non-economic) worry. Eleven years is a long time for most people, especially if you were a saver planning to live on the interest from your rainy day fund. Well bad news, I’m afraid it doesn't look likely to increase for the foreseeable future. There is a very good chance (c.70% as I write this) that there is going to be another rate cut on 30th January - the next meeting of the Monetary Policy Committee (MPC) of the Bank of England.

A drop in interest rates, back down to the prevailing rate of 0.5% from the last decade is likely, given the economic backdrop, but is of course far from guaranteed.

Why is it likely to drop? 

Well, UK growth continues to flirt with recession (think Brad Pitt and Jennifer Aniston during award season) and could, at best, be described as anaemic last year. A fall in interest rates would put some more cash in the pockets of those who have yet to fix their mortgage rates. It would perhaps also encourage firms to borrow more to invest and potentially grow. The inflation rate continues to lag the target rate of 2% and this spending might help boost inflation. It also might give everyone a bit more headroom for what could be a bumpy ride through the Brexit process.

Are the numbers still relevant?

But most of the data the Monetary Policy Committee MPC will be looking at was recorded before the General Election. Things have changed a bit since then – at the very least anecdotally and in some of the data too. The result of the election seems to have provided consumers and business with more confidence. Although it was too late to impact most of the Christmas trading scene, we are already seeing house prices reflect that stronger confidence (more on this topic next month). House price growth is reportedly higher at around 2.3%, although this may be because of the lower volumes of houses on the market (Christmas isn’t always a favoured time to sell/move house).

What are the wider impacts?

Unemployment continues to trend below what economists consider “full employment” at around 3.8%. This number has continually improved over the last decade and wage growth has finally overtaken inflation which should, in time, provide upwards inflationary pressure. 

The best way to explain this is to think about wages. When wages rise, people have more money, which also means they are likely to spend more. When shops and restaurants recognise this increase in ‘demand’ that consumers want to spend more, they will try to make the most of the opportunity by putting their prices up (because people can also afford it).

 

Why does all this tie in?

For most of the last decade, wages have been depressed and “real” wage growth has been negative (see the dark blue pay growth line). This means that we might think that we are earning more for the same work, but actually, we are essentially spending more too because the price of goods and services are, you guessed it, also going up. Almost feels like a mind trick...right?

When wages grow faster than inflation, workers have more money to pay off debt, spend or save. In a normal economic cycle, this in turn will cause inflation to rise because demand for goods and services rises. Companies must then put up prices to pay higher salaries. Once this starts happening, the central bank increases interest rates to help curb inflation and the cycle begins again. As you can see from the graph we have not had a normal business cycle with interest rates staying low (see the red line), mainly because inflation has continued to be below target for most of the last 10 years (i.e. the dotted light blue line named as 'CPI Rate').

Graph shows figures from January 2010 - Dec 2019 where there is falling unemployment, rising real pay growth and static interest rates (Figures from the Office of National Statistics)
Graph shows data of falling unemployment, rising real pay growth and static interest rates.
(Figures from the Office of National Statistics)

What's next then?

So, as always, there are factors on either side of the divide weighing on what to do with rates. What tends to happen in these circumstances is that the MPC sits on its hands and waits to see which way the wind is blowing before making a decision. This rate meeting potentially has a little more political pressure than normal because – despite the Bank of England being entirely separate from the government –“Brexit day” is January 31st. Mr. Johnston may also be looking for more impetus and potentially more headroom to employ his plans for investment in the UK – whatever they may be.

 

Could it be said that interest rates are interesting? Okay they might not be super exciting. It does, however focus the mind if like the UK Government, you borrow £1.8 trillion. 

 

What are your thoughts on the upcoming big day and how this might impact you? We would love to hear your thoughts at team@murphywealth.co.uk.

Contact Us

Pension Transfer Gold Standard

Other News