3rd December 2010
As the UK economy recovers, the benign interest rate environment that has put cash in people's pockets may shift. As it is, Schroders is predicting that interest rate rises may start as soon as November 2011. Inflation has been unexpectedly persistent, while the deflationary pressures that have ensured rates remain low – including public sector job losses and a lacklustre private sector- have consistently proved to be weaker than predicted.
But at the moment, there is little sign that the Bank of England plans to change its ‘no change' stance. Even where economists are predicting a hike, it is relatively mild. Schroders, for example, do not see interest rates rising above 2% by the end of 2012. Mortgage rates – the most important rate for most people – are likely to remain at historically low levels for some time. This is Money keeps investors up-to-date with the latest views from economists and also provides an excellent run-down of the key influences on interest rates:
Equally, people tend to forget that there is also an upside to higher interest rates. As isitonlyme points out in response to the Telegraph article above, the average UK taxpayer is being asked to: "Save for a deposit on a house – no loans without 20%. Save for your kids education – a degree for GBP 30 – 50 k. Save for your retirement – the state won't keep you. Save again to help your now grown up kids buy a house." He logically concludes that people desperately need an incentive to save. There will certainly be many winners from a hike in rates.
The more pressing worry is what a hike in rates might do to financial markets. It is likely that any rate rise will be interpreted by markets as the start of a new round of rate rises, rather than a one-off precautionary rise. The reaction could be knee-jerk and severe, and hit those very assets that income-seekers have sought out to replace their lost income stream from savings accounts.
However, a few things should encourage investors not to panic: Firstly, the last thing the Bank of England will do is threaten the recovery by raising rates prematurely. If rates are going up, it is because the economic environment is a whole lot better. Secondly, even with rates at 2%, the yield available on high yield bonds and equities looks extremely attractive so any knee-jerk sell-off by markets of high yielding assets is likely to be short-lived. Rising interest rates is not a catastrophe and investors would do well to remember that during any ensuring volatility.