Interest rates will rise sooner than the market expects
When will UK interest rates rise? Not before the general election but they could well be increased before the end of the year. And if there is a run on the pound, the pressure will be for higher rates sooner rather than later.
It would be politically embarrassing if Britain’s official bank rate rose before the election, taking mortgage rates with it. It would destroy the government’s claim that rates are at a record low. But the decision is the Bank of England’s anyway, and the Bank would not dare making such a politically sensitive mood.
Nor would an incoming Conservative government want its first weeks to be blighted by a hike in rates, but necessity may demand otherwise – and it could use the old excuse of blaming the economic conditions left by its predecessor.
The market, as well as most economists, think there will be no increase in interest rates until well into 2011. Don’t bank on it.
But bank rate is an increasingly irrelevant number. The Bank has set its rate at just 0.5 per cent, but the clearing banks lend at a high multiple of that and small business can be paying double-figures. Many credit cards still charge more than 20 per cent, so this is hardly a sensitive tool for influencing credit.
Bank rate – under its various names of base rate or minimum lending rate – used to be a mid-market benchmark with commercial banks paying less to attract savings from their customers and charging more to relend the money to borrowers. That formula has broken down however, with both savings and lending rates above the official bank rate.
Building societies now pay around 3 per cent to attract savings and lend the funds at, say, 6 per cent. That is the real price of money in the commercial market.
It is also a measure of the real price of funds that the yield on UK government bonds is almost a full percentage point higher than the German government pays.
The Bank cut its official rate so low it could not go lower and introduced quantitative easing to do the same job of making credit available. It is equally questionable whether QE has worked, but now the Bank has halted the QE programme at £200bn and is looking for ways to unwind it. It will be wondering what to raise bank rate too.
Perhaps if a political party bit the bullet and campaigned on a manifesto promising higher rates for savers it might increase its electoral chances as well as warning of the reality that will come quicker than most economists think.
