Interesting Interest Rate Impasse

 

 

It’s in the news regularly and we can’t ignore its importance to savers, homeowners and businesses……but the current interest rate level is certainly a cause for debate, caution and concern.

 

In the past few weeks, both Janet Yellen (US Federal Reserve) and Mark Carney (Bank of England) have prepared the ground for a rise in interest rates, possibly by the end of the 2015. The age of rock bottom interest rates may finally be drawing to a close……but to be fair it’s been a long time coming.

 

Whilst this may start to wet the lips of savers eagerly looking forward to a return to past levels of interest rates……the excitement could be misplaced.

 

The time may well be right to start raising rates again given that the UK economy is approaching full employment and earnings (including bonuses) are growing at 3.2% per annum. However, both these central bankers have tempered their warnings by suggesting that the tightening interest rate cycle is likely to prove only gradual and exceptionally shallow by past standards.

 

For Mr Carney, the “equilibrium rate of interest” is likely to be about half the level of its pre-crisis average……suggesting a peak of just 2.25%. This can hardly be considered a Christmas come early for long term savers if inflation returns to its 2.0% level. In fact, that’s barely a real rate of interest at all. Unfortunately there are lots of good reasons for thinking much lower interest rates are indeed here to stay, not least another five years of relatively aggressive fiscal tightening.

 

To argue the contrary point of view might seem a stretch, but Mr Carney may be proved wrong. Firstly, policy-makers have a long history of misjudging these things or missing significant turning points until after the event. The Bank of England’s failure to foresee the financial crisis is a case in point. Secondly, rarely do interest rates rise in an orderly fashion to some kind of pre-ordained plateau. What instead tends to happen is that the central bank gets stuck behind the curve and is then in a panic forced to play catch up.

 

Plenty to consider on both sides of the argument but there is one thing for sure……interest rates will rise.

 

It’s just when and by how much that is left to debate!