We last gave in interest rate update in January 2016. At that time, the Bank of England Base rate was at a historic low of 0.5% and had been at that rate for over 7 years. Analysts were predicting a possible rise in interest rates in late 2017.
A lot has happened since that blog. The biggest event in the UK was the result of the EU Referendum in June 2016. Confidence among businesses and households slumped and spending slowed down. In August 2016 the Bank of England cut interest rates to a new low of 0.25% in a package of measures designed to limit job losses, support growth in the UK economy and to prevent a post-Brexit recession.
In the months after the interest rate drop in August 2016, there was speculation the Bank of England could cut interest rates again. However, the UK economy has been resilient and the continued weakness of the pound has caused inflation to pick up. This has put any interest rate cut now out of the picture.
The Bank of England sets a target for inflation of 2%. Before the Brexit vote the Bank of England predicted inflation would struggle to get to its target 2% by 2018. The most recent inflation data (April 2017) put inflation at 2.3% for the second month in a row and the highest since September 2013.
Inflation has accelerated partly because of the fall in the value of the pound after the Brexit vote. This has raised import prices and feeds through to higher prices for consumer goods. Office for National Statistics (ONS) data showed food prices in March were 1.2% higher than last year, the biggest annual rise in three years.
It is expected that inflation will rise to about 3% by the end of the year. The Bank of England uses interest rates to control inflation. Higher borrowing costs reduce inflationary pressure. So with inflation above its 2% target and expected to rise further, you may think a rate rise is on the cards.
But it’s not so simple!
Are interest rates on the move?
At the Bank of England Monetary Policy Committee (MPC) meeting in March 2017, one of the MPC members voted to increase interest rates to curb inflation. Minutes of the MPC meeting said that it wouldn’t take much more inflationary pressure for other committee members to follow suit. Happening less than 24 hours after the US Federal Reserve raised their interest rates, it was questioned whether and when the Bank of England would raise rates.
The answer is not in the immediate future.
The rise in consumer goods prices are outpacing wage growth. The higher costs of essentials such as groceries is squeezing household spending and could lead to a fall in consumer spending on discretionary items, thus slowing the UK economy. The Bank of England may also remain tolerant of the inflation overshoot because of the uncertain outlook for the economy during and after the Brexit negotiations.
For these reasons, it is thought that the Bank of England are likely to tolerate higher inflation and to keep interest rates stable until at least the start of 2018.
What does this mean for farming and rural businesses?
It’s good news for farming businesses that interest rates and thus borrowing costs are forecast to remain lower for longer. Those borrowing on variable interest rates are benefitting, as are those who have locked into lower fixed rates. And while interest rates are low, it’s a good time to look to invest too. But there will come a time when those on variable rates may want to lock into fixed rate borrowing. With long-term fixed rates still very low, fixing could be a good option. But making the move at the perfect time is everyone’s wish!
R&BS receive and monitor the main high street banks’ ‘fixed rate cost of funds’. These tend to rise and fall according to inflation and economic movements, and generally anticipate any rise in the Bank of England base rate. A rise in the cost of the fixed rate cost of funds can happen many months before an actual base rate rise.
Some banks’ fixed rate cost of funds are currently moving upwards very slightly, and others are showing a very small drop. But there is no perceptible shift in the money markets that would indicate any foreseeable interest rate rise. However, it is always sensible to keep a close eye on these movements. Each business should draw their own conclusion on whether to fix now or to hold off for a while based on their current circumstances and their approach to risk.
It’s always a good idea for farm and rural businesses to regularly review their banking arrangements (overdrafts, loans, mortgages and HP) and borrowing structures to see if they are still the best for the business. R&BS can offer a review of business borrowing and suggest alternative solutions to make sure farm finances are suitable for the current circumstances and are putting the business in a strong position for the future.