Bank base rate – the moveable feast continues · Latest News · R&BS

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Bank base rate – the moveable feast continues

The last few months have been a curious time for the economy. Recent positive economic indicators have created a mood of optimism, but this has been tempered by a dragging undercurrent.

Commentators (not least Mark Carney, Governor of the Bank of England) have been talking up the positives, and they seem to be willing a rise in interest rates which would confirm their belief that the economy is finally on the road to recovery, much to everyone’s relief. 

But, as we have stated previously, despite repeated predictions of when the first rise would happen, it has proved to be elusive time and time again. Once again, there are tentative signs that the most recent prediction of a rise in May 2016 may also be wrong, with some now hinting that the rise may not be until August or September 2016.

Even the Bank of England’s Chief Economist, Andy Haldane, has intimated that given current low inflation and fragile confidence, that a cut in interest rates is just as likely as a rise. Interestingly, this is at odds with the Bank of England Governor, Mark Carney’s views, who commented earlier this year that it would be ‘extremely foolish’ to cut rates.

We know that the Bank of England’s role is to maintain control over inflation, and, depending on the strength of the trend in opposing upside and downside factors in any one direction, this will influence the Bank’s decision.

The influencing factors

So what has been causing this new shift? We consider some of the key factors below:

  • Consumer spending. The priority for most consumers throughout the continuing credit crisis has been debt reduction. Real wages remain below pre-crisis levels and job insecurity remains. The windfall benefits from big falls in fuel, energy and food prices have not translated into an increase in spending but rather diverted elsewhere or saved. The general trend is one of caution and against a back drop of Government public spending cuts, it is unlikely that consumers will be liberal with their own spending.
  • Business investment. Business investment has been subdued. Despite borrowings being at their lowest levels ever and improved trading conditions, businesses, similarly to consumers, appear to be reducing their debt and stashing their cash rather than spending, which has dragged down the economic recovery.
  • Economic growth. Growth in the UK for the first three months of 2015 has been lacklustre, and, although it is anticipated to bounce back, growth may be threatened by the uncertainty around the EU referendum and the effect upon both business investment and consumer spending.
  • Government spending. With a new government, long overdue austerity measures will be implemented, so we will start to see cuts in public services and welfare payments estimated at £12bn. This, no doubt, will hit consumption over the next year and beyond, leading again to less consumer spending.
  • Wage growth. Wage growth is very much under the spotlight as this is potentially one of the greatest drivers of upward inflation, but this growth is against the trend seen over the last 18 months, with wages still remaining below their expected levels. Net migration into the UK of lower-skilled, lower-paid workers entering the job market is providing labour supply and introducing ‘slack’ into the job market, so this will generally help to keep wage rises in check. Evidence collated by the Bank of England from businesses around the country has highlighted that wage negotiation increases are expected to be modest, adding further weight to the argument that wage increases are not expected to exert the upward pressure on inflation previously expected.
  • Sterling. The continuing strength of Sterling will continue to have a downward effect on inflation. The general opinion, including the Bank of England’s, is that there is a less than 50% chance of inflation hitting its target in 2 years’ time. So, the balance of risk for those setting wages is very much skewed downwards, further mitigating the potential upwards pressure on inflation from wage increases.
  • Eurozone. Added to the mix is the continuing crisis in Greece and the unknown impact this will have on the UK’s own fragile economy.

The Bank of England maintains the view that growth will improve and that wages will continue to outstrip inflation, but at present, the most recent data suggests a swing very much in the direction of downward pressure on inflation.

Despite some positive signs of an economic recovery, it is clear that considerable caution remains within the mindset of business decision-makers and consumers, which is limiting investment and spending, thus hampering the recovery of the UK economy and the last thing required in this environment is an interest rate increase.

What this means for farming and rural businesses

Any news which implies that borrowing costs will remain low is good news for farming businesses or indeed any business with borrowings.

Many businesses will be borrowing on a variable rate of interest, taking advantage of the historically low base rate, however, there will come a time when this will change, but establishing when that might be and when it might be prudent to lock into fixed rate borrowing, is an important question.

At R&BS, we monitor the main high street banks’ ‘fixed rate cost of funds’, which tend to rise and fall according to the anticipated rise in the Bank of England base rate. So, if there is a trend in economic data towards upward inflationary pressure to stimulate a potential rise in base rate at some time in the future, then fixed rate cost of funds will rise, or, if the trend is downwards, they will fall. The lag between the rise in the cost of the fixed rate cost of funds and the anticipated timing of the base rate rise usually extends to many months. 

Interestingly, fixed rate cost of funds have reflected the rise and fall in the expectation of a rise in base rate over the last 8-10 months. Towards the end of 2014 when predictions expected base rate to rise in 2015, fixed rate cost of funds were on the rise. They then ebbed back again to April 2015 when things became a little more uncertain, but since then they have bounced back and have continued to rise over the last couple of months as the economic ‘good news’ has been pedalled.

The magnitude of this most recent rise has been on average 0.38% (based on a loan of £100K, this would equate to an increase of £22 per month) compared to the low in April 2015. Putting this into context, the average fixed rate cost of funds still remains 0.37% below the most recent high at the end of 2014. So, the implication is that banks still do not believe that there is significant upward pressure on inflation to stimulate a rise in base rate for some time.

Given the renewed potential shift in economic data, we anticipate that fixed rate cost of funds offered by the banks will continue to follow its undulating trend. There appears to be insufficient upside forces to dictate the need to lock into fixed rates just yet…….but continue to watch this space.

If you are looking to review your banking, loans or mortgage rates, please give us a call or email us to find out more.

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