ank Rate, at 0.5pc for more than seven years, looks set to remain fixed well into 2020, according to financial markets.
Take a look at our economy channel for in-depth coverage of the Bank of England’s latest views. Below we boil it down to the latest prediction and explain what it all means for savings and mortgages.
What are the latest rate predictions?
At the start of the year, the prediction had been for the UK Bank Rate to rise in December 2016 or January 2017. The US had just ordered the first rate rise for nine years and the UK wasn’t expected to be far behind. But fresh global economic gloom in 2016 and repeated “dovish” comments from the Monetary Policy Committee has dramatically moved the prediction. Now money markets imply that the first increase will come in May or June 2020 following dramatic swings in the forecast.
Why the big change in rate predictions?
Since the hawkish stance of last summer, much has happened to convince markets that rate rises will be further off than anticipated. These events include:
- the stock market turbulence, caused by China, in autumn and again in February;
- weaker UK economic growth;
- the return of UK deflation in September (although inflation returned and was 0.3pc in the latest measure );
- the plunging oil price;
- More dovish comments from the Bank of England.
More recently, the Brexit vote has become a large influence, with opinion polls and betting forecasts moving the forecast for the first rise – and the value of the pound.
The trend for pushing the forecast for the first rise further into the future, as seen in the chart, has been in place since rates were cut to 0.5pc in 2009. The chart above shows how it has played out in the last year; the prediction for the first rate rise keeps getting pushed back. At one point in July, markets believed a rise would have happened by now.
Commentators rashly suggested at the start of the year that a rate rise would happen soon, following the US rate rise decision in December but forecasts have since been moderated.
In February, Pantheon Macroeconomics forecast two rate rises in 2016, both coming after the Brexit vote. Now it says:
“The prevailing view in markets … that the Monetary Policy Committee is more likely to cut—rather than raise—interest rates this year continues to look misplaced because inflation pressure is building.
“The committee won’t raise rates until the EU referendum is out of the way and the current inflation rate has picked up to 1pc [currently 0.3pc]. But by this year’s second half, the upward trend in inflation will be clear.
“We still think August is the most likely month for the first hike, although it would not be a shock if the MPC dithered for a few extra months.”
In January, Capital Economics had been expecting two rate rises in 2016. It now expects one rise in November. Paul Hollingsworth of Capital Economics says:
“In the minutes of March’s meeting, the MPC expressed concern that uncertainty surrounding the EU referendum could ‘delay some spending decisions and depress growth of aggregate demand’. While the probability of a “leave” vote implied by bookmakers’ odds has risen recently encouragingly, there have been limited signs that Brexit fears are having a significant adverse impact on the real economy.
“Nonetheless, there is a possibility that the impact gets larger as the referendum nears. And the MPC may want to wait for the outcome of the vote anyway before thinking about raising rates.
“That said, markets have gone too far in expecting the MPC to hold off until the beginning of 2020 to hike interest rates. Note too that the probability of a rate cut before the end of the year implied by financial market has crept back up to close to 40pc.
“…we still think that a rate hike before the end of the year seems likely. We expect the first hike to come in November. But thereafter, we expect the MPC to tread cautiously, with only two hikes pencilled in for 2017. And our optimistic forecasts for productivity growth suggest that the MPC will be able to raise rates very slowly for a number of years without inflationary pressures building. If the UK does vote to leave the EU, then rates will probably remain on hold for longer. But they might not cut rates – after all if it leads to a sharp drop in the pound then inflation could build quite rapidly.”
It should be noted that Bank of England chief economist Andy Haldane, arch “dove” of the MPC, said last year that the case for UK raising interest rates was “some way from being made” and that negative rates may still be needed. He, and others, have repeated this view.
How quickly will rates rise?
Forecast as of mid-April
Forecast as of mid-February
Even after the first rise, the market is pricing in only very slow increases, far slower than seen in previous cycles of rising rates, as the archive chart (above) shows. Economists expect a rate of 1.25pc by the end of next year.
The Bank of England’s quarterly Inflation Report (Feb 4) captured market predictions, suggesting a notional rate of 1.1pc by the start of 2019. In the last report, in November, the market expected 1.1pc at the end of 2016, 1.7pc by the end of 2017 and 2.3pc by the end of 2018.
…and how forecasts have been so wrong
Poor forecasting has been a feature of the post-financial crisis years. The chart above captures just one snapshot.
Economists have largely failed to grasp the vast headwinds facing Western economies and the UK, and stood by forecasts that a base rate rise was around the corner.
The harsh reality of Britain’s economic situation – colossal state and consumer debts and the end of an economic expansion driven by baby boomers who are now retiring – could mean many more years of low rates (even if those low rates may be damaging in other ways). The global situation could also contribute further deflationary pressure.
In the near term there’s also a currency war to consider, as we’ve consistently warned in this round-up. China and Japan have been deliberating depressing the value of their currencies, making their goods cheaper to sell in Europe and the US. It effectively exports deflation. Expect more of the same and for others to join in.
So no rush to fix that mortgage?
Possibly, but it’s never wise to try to call future rates accurately (as economists should tell you). The cost of fixed-rate mortgages remains historically low compared with “trackers”, especially on longer-term loans, making it a simple choice: protection from rate rises at little extra premium. Industry figures show that more than 90pc of those buying and remortgaging are choosing fixed rates. See the latest best buy mortgages here and try the interest rate rise calculator here.
The price of fixed-rate mortgages could be about to fall, however. This is because “swap rates”, the rates at which lenders borrow for fixed periods on money markets, have tumbled again in recent weeks. These markets reflect the expectation of the Bank Rate in future.
Two-year swaps, which heavily influence the pricing of two-year fixed-rate mortgages, fell from 1.1pc on New Year’s Day to a four-year low of 0.69pc on February 11. It bounced back above 1pc but has fallen in recent weeks, today at 0.81pc.
Five-year swaps fell from 1.6pc to 0.85pc on February 29, an all-time low. It bounced back but has fallen again in recent weeks, at 0.99pc today.
We predicted here in February that these swings would lead to an influx of new, lower fixed-rate mortgage deals, which is exactly what happened in March. Now, with prices falling again in April, the current best buys should be around for a while longer – and could get even cheaper in coming weeks.
The chart, below, shows five-year swap prices over the past year.
Once again, we’ve warned for several years that you should take decent fixed rates while you can – which has proved right as they have steadily got worse as the reality of long-term low rates as hit home.
The best variable-rate savings account (non-Isa) pays 1.45pc (Renault’s RCI Bank – it paid 1.65pc at the start of the year) and the best two-year fixed savings rate is from Union Bank of India at 2.35pc (it’s a on a par with the 2.33pc best-buy available a year ago but only because the best rate has suddenly jumped higher from 2.2pc). Whether you fix or go with a variable rate it is a gamble, but 2.35pc may feel like a good rate if the Bank Rate still hasn’t risen by the end of 2016, which is highly likely, or even by 2017 or 2018, which is very possible.
…a final word on rate cuts
Banks may get to a point where they simply stop passing on lower borrowing costs because it pushes their business models to the brink. In this instance, a cut in Bank Rate or falls in swap rates may not be necessarily followed by cheaper mortgage deals or cuts in savings rates. We’re not at that point yet.