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Stick or Twist? Where next for interest rates?

Posted Thursday, June 16th, 2011 by Neil Edwards

The Bank of England's Monetary Policy Committee recently announced that UK interest rates are being kept at the record low of 0.5%. This is the 27th straight month that the bank has left rates unchanged.

The decision came despite the annual rate of inflation rising to 4.5% in April, up from 4% in March - and well above the Bank of England's target of 2%

In a recent copy of the FT, former Chancellor of the Exchequer, Lord Lawson said: "The greatest immediate danger to the UK economy comes from a rise in inflationary expectations. Time is fast approaching for action to buttress words, in the shape of a rise in official short-term interest rates."

The Marketing Eye took the time to ask some of its clients and associates for their thoughts on whether now is the right time to consider an interest rate rise?

Mike Norrie from Castle Corporate Finance in Tonbridge, agrees with Lord Lawson and says that, reluctantly, it may be time for a small increase.

"Both businesses and consumers have spent three years reducing debt," he says. "The focus now is on building economic stability."

Neil Edwards from The Marketing Eye in Uckfield, says that rates may have to increase modestly soon, as a signal to the world that the Monetary Policy Committee is taking inflation seriously.

"The risks of posturing are, however, high," he says. "Prices are going up because the cost of imported goods is going up - not because demand is running away with itself on the back of borrowed money."

He says that an increase now could be catastrophic for the fragile recovery.

"The fear of it being the thin end of the wedge and the impact on confidence will outweigh the economic benefits of an increase," he continues. "Our export industry will be dealt a blow by any strengthening of the Pound, people with mortgages will curb spending and businesses will think twice about investment and new employment."

However, the OECD considers that the time is now right for a rise in UK interest rates, to stave off further increases in public inflation expectations.

Nick Green from Handelsbanken in Tunbridge Wells says. "There are two arguments against this 1) inflation increases seen have been mainly due to changes in commodity prices, VAT increases etc and a rise in interest rates is unlikely to have much effect and 2) such a rise could further dampen the UK economy and spending due to the impact on peoples disposable income."

Nick says that the counter measure to increasing rates and counter the above would be to ‘reign-back' the austerity measures to a certain extent to try and stimulate demand.

He adds: "The interest rate markets have seen a fall in recent weeks in three and five year money by nearly 0.5%, implying the markets don't yet see an imminent interest rate rise, but rise they will - exactly when and by how much remains the uncertainty."

Paul Fiest from Fiest Hedgethorne in Brighton says that if we had told him this time last year that the bank base rate would have remained at just 0.5% for another 12 months, he wouldn't have believed it.

"Currently, it appears that the likelihood of an increase has shrunk again with the announcement from manufacturers that new orders have fallen for the first time in two years," he says. "All the while, the economy is in such a weak state, it is difficult to see how the Bank of England will raise rates this year."

Bob Pitman from Priory Business Group in Paddock Wood, says he believes that the current tack on interest rates needs to be maintained - at least until the end of the year.

"It only seems a short time ago that our substantial cash deposits were producing a healthy income in their own right," he says. "Sadly, they are now earning so little interest that any opportunity that presents itself to gain commercial advantage from them is taken. This is, of course, exactly what the country needs - cash injected into the economy not stashed away."

Kieron Robertson from Valiant Financial Consultants, says that it depends whether you are a borrower or a saver.

 "Lower interest rates are great news for borrowers and you could be forgiven for thinking that the plan has always been to reduce debt levels through inflation but, whilst it may be good news for debt, it is not so good for those with savings left on deposit," he says. "Many factor in the ‘investment risk' side of things for their nest eggs but far fewer think about any ‘inflationary risk' they may expose themselves to and both, in my eyes, warrant careful consideration."

Brant McNaughton from Ecce Media in Orpington says: "Even with a 1% increase, interest rates are still inherently low and standard borrowing is incredibly cheap - for the lucky few that can access it."

He continues by saying that, on the flip side, for those that can't readily assess borrowing, the ascent of companies such as Wonga.com which are lending at rates of 4219% - a 1% interest rate increase won't even raise an eyebrow.

Finally, Martin Pollins from Bizezia in Haywards Heath, says that banks are using base rate as a weapon.

 "The Bank of England base rate has been 0.5% since March 2009. The gap between base rate (0.5%) and actual interest charged (average over 12%) is, however, now over 11.5% or 23 times base rate," he says.

Martin says that if you go back to August 2007 (the recognised start of the credit crunch), base rate was 5.75%, but actual rates being charged were 8.6% - a gap of only 2.85% or about half of base rate.

"Today lenders want a profit margin of 11.5%, whereas, before the credit crunch, they managed comfortably on a profit margin of 2.85%," he explains. "How banks can use base rate as a weapon to pay so little on deposits on one hand, while taking advantage of borrowers on the other, is beyond comprehension."

What are your views?  We'd be pleased to hear and share them?



Posted Thursday, June 16th, 2011 by Neil Edwards

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