Why the Bank of England’s Refusal to Drop Rates Isn’t a Bad Thing
As of July 2016, the Bank of England’s base rate has been at an all-time low of 0.5% for an unprecedented seven years and four months. It’s now almost exactly nine years since the Bank began a series of incremental drops (from a high of 5.75% in July 2007) in response to the global financial crisis that was unfolding at the time. In the years since there have been dozens of predictions that the Bank’s Monetary Policy Committee (MPC) would start to increase rates again – usually accompanied with dire warnings of what a rate hike could mean for mortgage holders.
The Brexit effect
More recently, economic analysts have been suggesting an opposing scenario – that, at least in the short term, the Bank could be forced to drop the base rate even further. In the past few weeks and months, much of this speculation has been inextricably tied up with the EU membership referendum. Most economists predicted that if Britain voted to leave the EU, it would negatively impact both the UK economy and the wider international markets. The 24 hours following the ensuing Brexit vote certainly bore this out: the pound plunged to its lowest value in over 30 years, while global equity markets saw losses totalling over $2 trillion dollars in a single day. It made sense to assume that the Bank of England would cut interest rates in a move to bolster economic stability.
A sledgehammer solution
Some analysts were surprised, therefore, when the MPC met in mid-July and voted – by a majority of eight to one – to keep the base rate at 0.5%. The Bank of England’s chief economist, Andy Haldane, explained that although the Brexit decision had “increased materially the degree of uncertainty” around the UK’s ongoing economic recovery, they are viewing the immediate impact of the referendum result as a slowdown, rather than a crash.
At least in the short term, it would appear that the Bank’s response will be to deploy alternative monetary policies – such as quantitative easing – to bolster expectations and confidence, rather than slashing interest rates which could (rightly or wrongly) send a message to the markets that it’s time to panic. Haldane further stressed that any such measures will need to be delivered “promptly as well as muscularly”. He added: “I would rather run the risk of taking a sledgehammer to crack a nut than taking a miniature rock hammer to tunnel my way out of prison.”
What next for interest rates?
Earlier this year the consensus seemed to be that rates would rise again in the medium to long term, with analysts predicting a base rate increase around December 2019. The uncertainty introduced by the Brexit decision throws some doubt onto the accuracy of any such predictions, and some are still suggesting that a rate drop to 0.25% remains a possibility – conceivably as early as August 2016. This is certainly plausible; although the MPC voted not to change the base rate in July, by August the committee will have access to the quarterly inflation report, which will allow them to make a more informed decision about the way forward.
In the immediate future, at least, the interest rate picture remains unchanged for the average person in the street. Savings rates continue to be at an all-time low, while for those holding or taking out a mortgage, the unlikelihood of rate hikes in the near future leaves options a bit more open when it comes to making a decision about whether to opt for a fixed or variable rate mortgage.