Watching the commentary on the potential movement in The Bank of England (BoE) base rate in 2015 was remarkably entertaining, even though it never showed any real sign of moving.
Throughout the year commentators worked hard to talk up the economic positives to prove the financial crisis was behind us and we were on the road to economic recovery; only for hopes to be dashed time and time again.
There was mild potential for a rise up to the first quarter of 2015 and the General Election lifted expectations, as it was hoped this might bring certainty. But despite the British economy performing well, it has been in isolation, as the world economy fell apart with the crisis in the Eurozone and Greece, the slowing global demand and oil prices hitting rock bottom.
Since our first interest rate bulletin of 2015 which discussed the changing prospects of a rise in the BoE base rate, the prospects moved further and further out throughout the year. There aren’t many positives on the horizon that are likely to put an upward pressure on inflation and therefore the BoE base rate and cost of borrowing.
There needs to be a significant shift for a rise in base rate to come back on the agenda and, in our opinion, any rise is now out of sight.
Prospects for 2016
2016 has not started well. George Osborne delivered a different speech from his autumn statement which in contrast and, surprising for our politicians, was honest, realistic and warned us to be prudent and careful. Financial markets have crashed and the global slowdown is beginning to bite.
In his ‘Turn of the Year Speech’ the Governor of the BoE, Mark Carney, was also downbeat and believes inflationary pressures are off the table.
He highlighted three areas the bank would focus on as it navigated the inflationary playing field:
- economic growth
- high wages, higher spending
- inflation at 2%
Progress in all three will increase inflationary pressures stimulating the need for a gradual rate increase to bring inflation on target. Considering each in turn:
1. Economic growth
UK growth has been steady during 2015 at a little below pre-crisis levels, but below expectations. Data suggests credit conditions have improved, which has raised business confidence and resulted in strong investment. This trend will continue.
Spending growth accelerated in 2015 and real income growth was the highest since the financial crisis. Consumer confidence is allegedly the highest in a decade.
The UK environment for economic growth appears to be fertile, but against the backdrop of a global slow down, there are no signs this will flourish and be a threat to inflation.
2. Higher wages, higher spending
Employment and wage rises have been a clear focus for the BoE. Employment hit a new high of 74%. But rather unexpectedly this has not led to a rise in wages. One suggestion is that a significant proportion of the rise in employment is in lower paid jobs occupied by younger workers and migrants. Furthermore, low inflation encourages less generous increases in salaries as there is little justification. As a result, the wage increase concern and the increase in spending appears to be waning.
As a consequence, wage growth and subsequent spending do not appear to be a threat to inflation.
3. Inflation at 2%
Core inflation has continued notably below the target of 2% and, although it holds potential, there are no obvious factors driving this up at the present and in fact rather more the opposite. The BoE’s central forecast anticipates that inflation might exceed the 2% target in two years’ time, and then there would have to be a gradual increase in the base rate to control this move back to target.
Outlook for an interest rate rise
Although the UK appears to be in a relatively stable and comfortable position, we are buffeted by headwinds of the global economy against which we are not immune. These represent a downward and dragging effect on UK inflation and the prospects of an interest rate rise.
Despite several factors moving back to normal following the financial crisis and the improvement in the availability of credit to businesses, and improvements in employment, wages and consumer confidence, Mark Carney does not see any threat to inflation from any of, or a combination of, these areas. He cites the sharp slowing in Chinese growth, fragility in other emerging economies, a fall in global commodity prices, the collapse in oil prices and global deflationary pressures as the influencing factors.
The time frame for inflation to return to target is expected to be two years and in the interim the BoE has to manage this situation according to the volatility, shocks and uncertainty. Mark Carney compares the BoE’s job to driving a car, but adjusting the speed to the road conditions ahead… which is very prudent.
Needless to say, a rate rise is certainly out of sight with the estimate now being late 2017, the vaguest it has been for the last three years. Interesting times!
What this means for farming and rural business
As we have explained before, at R&BS we monitor the major banks fixed rate costs of funds. These tend to pre-empt a rise in bank base rate.
Since November 2015 these have taken a dive by over 0.2% across all terms of borrowing. This is a considerable drop which clearly reflects the banks’ expectations. Although it’s a big drop, the cost of funds has returned to where they were in spring 2015 when a rate rise was still on the cards. Nevertheless, the trend is downward reinforcing that a rate rise is not featuring on the agenda now.
For farming and rural businesses experiencing a slump in commodity prices, continuing low interest rates and a low cost of borrowing will bring considerable relief.
With fixed rate cost of funds so low it is a great time to grab the best long-term fixed rate possible, perhaps the best in a lifetime. However, in our opinion, it might still be too early to make this decision and for the moment it might be best to stick on a variable rate of interest, certainly for as long as the downward pressures of inflation remain.