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It’s what the Bank of England didn’t say that matters

The Bank of England bumped interest rates to 0.5% this week – a highly anticipated move designed to curb the momentum behind inflation. But it wasn’t what the Monetary Policy Committee said that caught my attention – it’s what it didn’t.    

Headed up by Mark Carney, the Bank of England voted 7-2 to increase rates for the first time in a decade, lifting the bank rate off 0.25% – the lowest in its 323-year history.

Hints that a rise was on the cards came thick and fast in the run up to the November meeting, and better-than-expected economic growth in the third quarter seemed to seal its fate. A hike had almost been fully priced into the financial markets before the meeting.

Although it’s the first interest rate rise in a decade, Mark Carney has really only undone the cut he made following the 2016 Brexit referendum. Still, is it a sign that monetary policy is changing for good?

Dovish Carney

The Bank of England control monetary policy, especially interest rates, to keep inflation in line with the government’s 2% target.

If Central Banks want to stimulate the economy – like after the global financial crisis, for example – they will loosen monetary policy by lowering interest rates and launching quantitative easing (QE) campaigns.

If an economy looks like it’s overheating, Central Banks will tighten policy by increasing interest rates or unwinding QE programmes.

Monetary policy has been loose since the global financial crisis, and Central Banks have been looking for an opportunity to return to a more normal environment.

As economies have to be strong enough to withstand the shock of a rate rise, the first rate rise in a decade was assumed to put some strength  behind sterling – which has been stuck in the doldrums since the UK voted to leave the EU. It didn’t.

What’s interesting is that the hawkish action of raising interest rates has been complemented with dovish rhetoric over future rate rises.

Deleted sentences speak louder than words

Today, short-term fluctuations are influenced just as much by what people don’t say over what they do. The MPC minutes were dovish, sure, but there were key hawkish sentiments missing from the September release.

Gone were the warnings that monetary policy will be tightened by more than experts have forecast if the economy carries on the same path. In its place were warnings that any future increases in the bank rate will be “gradual” and “limited”.

Essentially, the Bank of England just isn’t convinced the economy is strong enough to stomach a big shift towards normal monetary policy just yet.

Brexit weighing on Carney’s mind

If Carney could paint the perfect backdrop for the first rise in interest rates in a decade – I’m sure this wouldn’t be it.

Even if unemployment is at record lows, economic growth trudges behind many other developed nations, wage growth is stagnant and productivity is low. Personal debt levels are high and inflation has accelerated, reaching 3% in September, with retail sales growth only just starting to slow as households adjust their budgets to account for the squeeze.  

With Brexit on the horizon, but very little progress in negotiations, it makes sense that the Bank of England is nervous. If we get a good deal from Brexit, it could be a different story.

Remember though, just because the Bank of England is independent, doesn’t mean it’s omniscient. Mark Carney has gotten it wrong before, and they could have it wrong now.

But with the base rate back at 0.5%, how will this impact household budgets that are already feeling the pressure?

An end to cheap money?

The era of cheap money hasn’t completely come to an end, but debt will become more expensive to borrowers.  

Consumers have become increasingly reliant on debt, as monetary policy has encouraged. If the cost of borrowing spikes, many could be forced to cut spending to repay their loans or even default.

I’ve been nagging my friends to look at their mortgages, because those with variable rates will be exposed to the kickback from the rise. Some banks will be passing on this rise as soon as December.

Who will benefit from higher interest rates?

A rise in interest rates is good news for savers and those looking to buy an annuity with their pension. But it’s still only a 0.25% increase.

Whilst the returns on cash savings account should improve, don’t forget that any money earning less than inflation will be losing purchasing power when sat in your savings account.

Make your money works harder for you on the financial markets and protect your returns in your £20,000 annual tax-free ISA wrapper.  

Once you get to 55, you can swap your pension pot for a reliable income throughout retirement. The income you get is expressed as a percentage of the amount you transfer, and is heavily influenced by the bank rate.

Over the last three decades, the returns offered by annuity providers have slumped from nearly 16% in 1990, to just over 5% in 20171. Be careful, this rate rise doesn’t signal a return to 1990 levels – make sure you shop around before you buy an annuity because you can’t change your mind.

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