Posted on: 12 May 2016
Back before Christmas, buoyed by the fairly decent economic data in 2015 and the fact that the Fed had increased its interest rate by half a percentage point, the expectation was that Mark Carney would follow suit. But then 2016 happened. And the likelihood is that we won’t see an interest rate rise any time soon.
So, exactly why are Mark Carney, Janet Yellen and their peers holding back? And what is the outlook for interest rates?
For a start, global data shows that economic growth around the world has slowed considerably following the wobbles experienced by China last year, and that this is keeping inflation low. In addition, the weakness in the oil price hasn’t helped. And although it’s now stabilized at around $45 a barrel, inflation remains modest.
Shop prices continue to fall, due to intense competition and low consumer demand. Added to that, is the fact that wage growth has failed to take off as expected - even though unemployment is low. In fact, UK economic data has shown the economy slowed in Q1 2016 and April appears to have been even worse. The EU Referendum is another issue, depressing sentiment about the economy, delaying business investment and putting downward pressure on sterling.
And suppressing interest rates does have negative effects. For a start, it’s reflected in bond market yields, which have fallen to new lows – the ten year gilt yield is now just 1.5%.
Many economists are still predicting that rates will go up this year after a ‘remain’ vote in the referendum. But that’s not guaranteed. The Bank of England has warned that an ‘out’ vote in favour of Boris and his supporters will result in a high possibility that sterling will fall in value and inflation will kick in. If that happens, the Bank of England could be forced to put interest rates up to rein in inflation.
So at Duncan Lawrie, we remain cautious about the prospects for a rate increase in 2016, having seen the same views aired at the start of every year for the last five years.
Unfortunately, we fear that there are longer-term structural problems with the UK economy that are holding back growth. High housing market valuations limit the movement of labour and so lower productivity. Household debt levels remain very high (Office for Budget Responsibility (OBR) currently has net unsecured personal debt at approximately £447 billion). An ageing population is also weighing on growth.
And even if interest rates do go up, they are likely to be raised very slowly and will remain low for some years. According to Andy Haldane, Chief Economist at the Bank of England, negative interest rates are still possible. This controversial policy has now been adopted by Japan and some European countries in an attempt to stimulate inflation and stave off recession. But results so far have been less than encouraging.
Even the US, where rates were expected to be raised throughout 2016, may find it difficult to raise rates again this year, partly due to the Presidential election as well as slowing growth.
The uncomfortable reality is that most Western economies are still not yet strong enough to shoulder higher interest rates. The only way to break free from this dependency on stimulative monetary policy is through economic reform, but this is politically unpopular whether in Europe, the UK or the US. Only Japan is making a concerted effort.
In our opinion, it would be prudent to conclude that there remains a high probability that interest rates will remain very low for several more years.
All data has been compiled by Duncan Lawrie from sources believed to be reliable. Full details of sources are available on request.
The comments and figures in this document are generally applicable but you should always take specific advice to suit your individual circumstances before taking any action. Errors and omissions excepted.
The value of investments and income generated may fall as well as rise, and investors may not get back the amount invested. Past performance is not a reliable indicator of future results.