When giving mortgage advice one question keeps cropping up and that is the one about views on future interest rates. Of course the absolute answer is "I don't know" and if you look at a chart of the Bank of England base rate over the decade you could easily have been sucked into the view that rates could never be lower many times, only to see them stay welded at [then] historically low levels or move even lower.
However as a financial professional it is reasonable to have an intelligent conversation about the drivers.
The consensus expectation is that there will be no change in interest rates and Bank of England policy in the very near term. However, that does not mean there won’t be some heated debates over four key questions:-
1. How fast is the UK economy growing? Britain is bouncing back as restrictions are eased and we start to return to normal. People are getting back to work. Shops and hospitality venues have opened their doors. There is the lifting of travel restrictions - notably to France, the biggest destination for the UK’s holidaymakers.
What no-one knows, however, is how sustainable the recovery will be. Will we simply go back to our pre-pandemic ways or has Covid permanently changed how we lead our lives? Will that be good or bad for economic growth? The Bank’s forecasts for growth are a key input to its interest rate decisions.
2. Is rising inflation temporary or here to stay? This is the key question for the Bank because its remit is to keep inflation close to its 2% target. For most of the past dozen or so years it has tried to achieve that goal by stimulating the economy - slashing interest rates close to zero and buying billions of pounds worth of bonds in order to keep yields and, therefore, the cost of borrowing low.
America is facing the same dilemma and, there too, the central bank is sticking to the line that inflation is ‘transitory’, to use the Federal Reserve’s description. History shows that maintaining easy policy for too long can lead to prices spiralling higher and a painful hangover as policy is tightened to bring inflation back under control.
3. What is the employment picture? One of the key metrics in determining the health of the economy is the employment rate which is linked to point 1. However employment is also a big driver of inflation through increased wage demands and at the moment we are at a point where the jury is still out if the continued growth [and pace of growth] in the economy will not only see improvement in the employment rate but provide inflationary pressures through pay increases.
4. When should policy start to tighten - and how best to do it? Every member of the monetary policy committee knows that money policy cannot stay easy for ever. Where the eight-strong group of rate-setters disagree is on the timing of that move. Move too soon and the still fragile recovery could be choked off. Move too late and the measures needed further down the track could be painful.
There are two parts to the Bank’s stimulus - low interest rates and so-called quantitative easing (buying the bonds). It is currently conducting a review of whether it is best to cut rates and then stop buying bonds, or the other way around. These days central banks like to avoid surprising the financial markets so we should expect some hints and guidance on the future policy approach and when interest rates will rise, this week.