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When will interest rates rise?

Economists tip no move until late 2015, as 'lowflation' concerns dominate

Inflation edged up to 1.3 per cent in latest figures and two hawks on the MPC continue to vote for a hike, but interest rates look to be going nowhere soon

Markets and economists have pushed back expectations of a first move from 0.5 per cent to late 2015 due to 'lowflation' worries - and only a sudden and sustained burst of inflation across developed economies is likely to be able to shift that outlook

The Bank of England's chief economist Andrew Haldane reiterated that any rise in the base rate next year is expected to be gradual and said the normal level of interest rates could be at around 3 per cent for many years to come, in an interview with the Bristol Post's Gavin Thompson.

Consumer prices inflation rose to 1.3 per cent in October from 1.2 per cent the month before, latest ONS figures showed. While the most recent MPC meeting minutes showed two members, Martin Weale and Ian McCafferty, voted for a rise again in November.

Howard Archer, chief UK economist at analysts HIS Global Insight, said: 'While the November MPC minutes are unlikely to hugely dilute increased expectations that the Bank of England will not be raising interest rates before late-2015, they suggest that a move around August is still possible'.

'We currently forecast the first interest rate hike from 0.50% to 0.75% to come next August, but there is clearly a very real possibility that the Bank of England will delay acting until the fourth quarter of 2015 or even early 2016.'

A pullback in both services and manufacturing sectors reined in economic growth to 0.7 per cent in the third quarter, official figures showed today (Wednesday 26 November 2014).

Economists had expected the recovery to ease off in the latter half of the year and the Office for National Statistics data confirms that growth in July-September slowed from 0.9 per cent in the second quarter.

Interest rates may remain stuck at 0.5 per cent until next autumn and inflation could fall below 1%, according to the latest Bank of England Inflation Report.

A drift into low inflation and troubles in the eurozone pushed back market expectations of when Bank Rate will be raised in the three months since the last report in August.

Bank Governor Mark Carney put the spotlight firmly on low inflation as he delivered the Inflation Report this morning, while also focussing on weak wage growth and continued slack in the economy.

He once again declined to be drawn on the exact timing of the first rate rise, but reiterated that when rates did start rising it would be slowly and gradually.

Market expectations highlighted in the Bank's report are that rates will start to rise in late 2015, moving gradually up to 1.7 per cent in three years' time.

Mr Carney said: 'We will decide when to tighten policy based on the inflation target.'


The outlook for rates is driven by downbeat expectations for inflation and global growth and continued eurozone struggles.

Howard Archer said: 'The most telling element of the quarterly Inflation Report regarding the prospects for interest rates is that consumer price inflation is only forecast to reach its target rate of 2 per cent in the fourth quarter of 2017 even if interest rates do not start to rise until October 2015.'

He added: 'We had been expecting the first interest rate hike from 0.50 per cent to 0.75 per cent to come in mid-2015 on the assumption that UK growth will hold up pretty well over the coming months.

'However, we are putting back our expectation of the first interest rate hike to August, as the Bank of England currently seems minded to sit tight on interest rates until later on in 2015 even if growth does hold up well - barring an unexpected marked pick-up in inflationary pressures.

'Indeed, it currently looks very possible that the Bank of England could hold off from acting until around year from now.'

Much of the current forecast for rates depends on inflation in the US, Europe and UK staying low for some time and growth failing to pick up. However, if things improve, or a surprise arrives, such as a eurozone form of major quantitative easing, then the outlook could shift again substantially.

The potential for major central bank surprises was highlighted less than two weeks ago, when the Bank of Japan sprung a shock scaling up of its stimulus plan.

Some economists have pushed rate forecasts back substantially - to potentially a year later than some more hawkish predictions earlier this year.

Nina Skero, economist at the CEBR, said: 'Andy Haldane, chief economist at the BoE and a contributor to today's report, stated last month that in light of cuts to global growth forecasts, increased geo-political risk, and weak inflationary pressures he is "gloomier."

'Despite today's lower forecasts, Haldane's remarks must be set within a broader context as the UK's economic outlook is perhaps gloomier, but certainly not gloomy.

'While certain concerns regarding the strength of the recovery remain, the country's economic performance and growth in the coming years is still expected to be relatively strong. Furthermore, low inflation should contribute to a boost in consumer spending power next year.

'Given the absence of inflationary pressures (both domestic and global) and weaker UK and international economic data in the later half of this year, Cebr expects an initial base rate rise in November 2015. The tone of today's Inflation Report as well as recent BoE rhetoric further justify this expectation.'

Chart 1.1

Lower for longer: The outlook for the UK, US and eurozone on interest rates, according to the BoE

Setting the tone on interest rates

The recent tone on interest rates from rate setters has been one of caution, although latest MPC minutes again showed two members voting for a rate rise in November.

The Bank of England can leave interest rates at rock bottom for some time because of weak wage growth and low inflation, deputy governor Sir Jon Cunliffe says.

He commented that the recovery 'has remained strong' but the central bank has 'now seen evidence of a slowing in UK growth and prospects for the global economy have deteriorated'.

He said subdued pay and inflation at home and the darker outlook overseas 'implies that we can afford to maintain the current degree of monetary stimulus [interest rates at 0.5 per cent] for a longer period than previously thought'.

The Bank's chief economist Andrew Haldane said in mid-October he was more downbeat about the outlook for Britain's economy. 'Put in rather plainer English, I am gloomier,' Mr Haldane said. 'This implies interest rates could remain lower for longer, certainly than I had expected three months ago.'

Chart 1.10


Consumer prices index inflation lifted slightly to 1.3 per cent in October from 1.2 per cent in September, the ONS reported.

Scott Corfe, head of macroeconomics at the CEBR, said: 'The double whammy of low commodity prices and retail competition is expected to keep CPI inflation below the 2% mark until 2016. Indeed, inflation is likely to veer below the 1% mark in the early part of 2015.

'On balance this is good news for the UK economy. It should provide a big boost to consumer spending power, helping to offset weaknesses in other areas such as exports. While consumer-driven economic expansion is not the sort of sustainable, balanced growth that policymakers should be pursuing in the longer term, it may be just what the UK needs to continue growing robustly in the face of global headwinds next year.

'Further, a weak outlook for price growth gives the Bank of England plenty of room to keep rates on hold for longer. Given the current global environment, we don't expect a Bank Rate rise until the final quarter of 2015.'

Wages and unemployment

Unemployment was 6 per cent in the three months to September, the same as the August figure - the lowest level since late 2008.

The ONS said that total average weekly earnings rose 1 per cent in the year to August, regular pay, which strips out bonuses, rose 1.3 per



Britain's growth is still robust and among the best in the developed world, but there are concerns that a slowdown may be on the horizon.

British manufacturing grew at the slowest rate in 17 months in September as demand weakened at home and in Europe. The Markit/CIPS UK Manufacturing Purchasing Managers' Index fell to 51.6 for September, its lowest level since April last year and below a consensus forecast of 52.5 in a Reuters poll.

Releasing revised figures, the ONS said on 30 September that Britain's economy grew more quickly than previously thought between April and June of this year. It revised its economic growth estimate up 0.1 per cent to 0.9 per cent for the second quarter.

But growth in the first three months of 2014 proved more sluggish that first thought with GDP revised down 0.1 per cent to 0.7 per cent. That means the overall effect of the revisions is no change to previous estimates for economic growth this year.

Britain's economy passed its pre-recession peak last year, recovering from the set-back of the financial crisis nine months earlier than was thought.

Estimates from the Office for National Statistics previously showed the economy only passed its previous peak, achieved in the first quarter of 2008, in July of this year. The revisions follow the inclusion of spending on illegal drugs and prostitution in growth data, believed to have added £10billion to economic activity, amongst the usual ONS revisions.

Slack and wages: the new keys to interest rates

Having initially formed its forward guidance on interest rates around unemployment, the Bank of England switched tack when this fall far faster than expected.

Earlier this year it identified the somewhat nebulous concept of slack in the economy as one of the new deciding factors on when rates would be ready to rise.

The Bank's 2013 August Inflation Report unveiled Forward Guidance Mark 1, which said the bank would not consider raising rates until unemployment fell to 7 per cent or lower. At that point unemployment stood at 7.8 per cent. It promptly dropped like a stone and figures that arrived on the same day as this latest Inflation Report showed it to be 6.4 per cent.

Most recent figures showed unemployment down to 6 per cent.

Over this period a robust recovery has also taken hold, with GDP growth on track for 3.5 per cent this year, according to the Bank.

Forward Guidance Mark 2 arrived in February this year. It put slack on the agenda, identifying that spare capacity in the economy meant that it could grow at a faster rate without requiring rates to rise.

Today the Bank said that some of this slack had been used up, but there had actually been more of it than first thought.

Mr Carney admitted there was tremendous uncertainty on slack and the Bank has now placed wage growth on the table as another key decider on when rates should rise.

Mr Carney said: 'Not surprisingly, there is a wide range of views on the Committee about the likely degree of spare capacity in the economy. In the Committee's best collective judgement, the degree of slack has narrowed somewhat, and our central estimate is now broadly in the region of 1% of GDP.

'In light of the heightened uncertainty about the current degree of slack, the Committee will be placing particular importance on the prospective paths for wages and unit labour costs.

'To be clear, the MPC does not have a particular threshold for wage growth; rather we will continue to monitor a broad range of data to assess overall inflationary pressures and the timing of the first increase in Bank Rate.

'The Committee's guidance remains unchanged: increases in Bank Rate, when they come, are likely to be gradual and limited.

'While that is an expectation not a promise, its clarity is helping businesses to plan, invest and hire, supporting the economic momentum we see today and will need tomorrow.

'The MPC's expectations for gradual and limited rate increases are shared broadly by markets. The path of Bank Rate implied by market yields, and on which this forecast is conditioned, rises by only 15 basis points per quarter and reaches only 2.25 per cent by the end of the forecast period.'

Productivity is the key

Economists are also looking to productivity as the bank identified spare capacity in the economy as a reason for keeping rates down. Howard Archer explains: 'The extent to which the weakness in the UK's productivity has been structural rather than cyclical has vital implications for the economy's growth potential and for policy. 'If productivity fails to pick up appreciably over the coming quarters, it indicates that the economy has less potential to grow without generating inflationary pressures and that interest rates will need to rise at an earlier stage and likely at a faster rate than currently envisaged. The more that productivity improves, the greater the scope of the Bank of England to keep monetary policy very accommodative. The Bank of England is currently assuming that productivity will pick up only gradually.'

The revision of forward guidance

The Bank of England expects the base rate to rise from 0.5 per cent in late 2015.

The new normal level for rates is expected to sit at 2 to 3 per cent - below the 5 per cent it was judged to be from the late 1990s to the financial crisis.

In a dramatic revision of its forward guidance policy in its February inflation report, the Bank called time on its assertion that it would consider a rate rise when unemployment hit 7 per cent, and said slack in the economy meant the base rate, or Bank Rate as it is officially dubbed, needed to stay low.

It said that interest rates will only rise gradually and even when the economy returns to normal are likely to be substantially below 5 per cent.

The report stated:

  • Despite the sharp fall in unemployment, there remains scope to absorb spare capacity further before raising Bank Rate.
  • When Bank Rate does begin to rise, the appropriate path so as to eliminate slack over the next two to three years and keep inflation close to the target is expected to be gradual.
  • Even when the economy has returned to normal levels of capacity and inflation is close to the target, the appropriate level of Bank Rate is likely to be materially below the 5% level set on average by the Committee prior to the financial crisis.

In August 2013, when the policy was outlined unemployment stood at 7.8 per cent.

Forward guidance: a short history

The UK interest rate outlook underwent a transformation with this initiative from Mark Carney, which was launched alongside his first quarterly inflation report as Bank of England governor.

He pledged that rates will not go up as long as the unemployment rate remains above 7 per cent. The Bank initially projected a very slow recovery that would not see it fall below 7 per cent much before late 2016, this was then changed to 2015 as unemployment fell swifter than expected. It now looks likely to arrive even sooner.

That led to a revision of forward guidance, with the unemployment threshold removed and a focus placed on spare capacity in the economy and removing this slack.

The Bank said interest rates would only rise gradually and even when the economy returns to normal are likely to be substantially below 5 per cent.

QE vs Funding for Lending

Should the economy take another serious turn for the worse, more QE could occur, but it looks highly unlikely. The question now is if and how to unwind it, rather than whether more will arrive.

The Funding for Lending scheme overtook QE in 2012 and 2013. This was designed to allow banks and building societies to take cheap cash from the Bank and pass it on to mortgage borrowers and businesses.

The Bank has since switched off the taps on more funding for mortgages through this, although lenders can still tap into their existing allocation.

The jury is still out on whether Funding for Lending was a winner.

It has driven mortgage rates down substantially, albeit with the best benefits delivered to those withbig deposits, but banks are still being accused of hoarding cash and shunning small and medium-sized businesses.

Figures are being skewed by mammoths Lloyds Banking Group and Royal Bank of Scotland winding down their historical loan books and Spanish giant Santander easing back on its former mortgage expansion policy.

One group undeniably hit very hard by Funding for Lending has been savers. Returns on savings accounts have dived since its launch in a race to the bottom that has seen big cuts in the best deals on offer.

The best easy access savings rate now stands below 1.5 per cent, whereas before the launch of Funding for Lending savers could get between 2.5 per cent and 3 per cent.

Why 'swap rate' money markets matter to savers and borrowers

When markets move a decent amount - and the move holds - it can affect the pricing of some mortgages and savings accounts. When swaps price a rate rise to come sooner, fixed rate savings bonds tend to marginally improve in the weeks that follow. But it also puts pressure on lenders to withdraw the best fixed mortgages.

As for using swaps as a forecast, we've consistently warned on this round-up that they are extremely volatile and should be treated with caution - they should be used more as a guide of swinging sentiment rather than an actual prediction.

Important note: Markets, economists and other experts haven't had a great record of making the right calls in recent years.

This is Money has always advocated caution with any sort of prediction (including our own!). There's no guarantee that those who have made correct calls in the past will make them in the future.

We'd also urge consumers not to gamble with their personal finances when it comes to predicting rate swings.

Rate rise predictions: Money markets and economists

Swap markets reflect the City's bank rate expectations - not in an exact way, but they indicate trends in forecasting.

Some swap rate prices and and charts are displayed below to show how the market moves as economic prospects shift.

Published on 08 December 2014

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