Gathering interest

It’s been more than a decade since there was an increase in interest rates in the UK.  Back in July 2007 the Bank of England base rate increased from 5.5% to 5.75% – a number that is hard to take in now we have had rates at 0.5% or below for eight and a half years. But there is increasing chatter about a rate rise on the horizon.

The reason is that inflation is increasing rapidly.  It reached 2.9% in August, just another 0.1% and the Governor will have to write a letter to the Chancellor to explain why. In more normal times inflation at this rate would lead to a rate rise without question. Yet despite it being way off the 2% target, the decision for the Monetary Policy Committee (MPC) isn’t so clear cut today. Why? Because there are few signs that inflation today is caused by the economy gathering pace, rather it’s because the fall in Sterling makes imported goods dearer. And there are few signs of pay rises fuelling price growth either. Wage growth is lower than inflation, creating an effective pay cut, squeezing household budgets, reducing consumers’ demand and dampening inflation.

But change is on the horizon.  The markets have fully priced in a rate rise by February but the consensus is moving to a rate rise in November, possibly to move earlier and avoid having to raise rates more in the future. The beginning of a return to more ‘normal’ conditions could help to lift confidence.

Even if rates do begin to rise, they won’t do so quickly. A decade on from the financial crash, the economy is still relatively fragile, worsened by the uncertainty of Brexit. So while higher rates might not be welcome for people with debt, a small rise will make little difference but will, more importantly, signal that the UK economy is back on track towards normality.