Despite the Bank of England base rate having remained at 0.5% for the last 6 years – and it’s forecast to stay low for a considerable time to come - you would think that there was little to talk about.
On the contrary, there have been some interesting talking points recently. They've particularly revolved around financial market shocks, slack and Sterling and their impact on inflation targets and bank base rate movements.
The Bank of England has warned that uncertainty in the global economy has heightened anxiety in financial markets, which has led to increased volatility.
Combined with a lack of flexibility within the markets, there is concern that any sudden shocks in any one financial market may not be absorbed in the way they have been before. This would result in the destabilisation of other financial markets further afield and for a longer period.
Slack is a term that the Bank of England has adopted in recent years and is now considered to be one of the major factors influencing the rate of inflation.
It is a rather arbitrary measure as it generally refers to the employment market. It seems to imply that as employment rises, job availability falls, wages then rise which results in more people working, earning more and spending more… leading to inflation.
Therefore, as slack diminishes, this will cause upward pressure on inflation and bank base rate.
The effects of this fall can impact quickly, so the Bank of England is keeping a close eye on this measure as slack continues to fall.
One of the most recent shocks to hit the UK shores is the rise of Sterling against the Euro caused by the eurozone Quantitative Easing (QE) scheme. QE has depressed the Euro, causing the pound to rise to a seven-year high.
The key issue is that the UK pound can now buy more Euro-priced goods. This could drive inflation lower and for longer, which would mean that the current prevailing low bank base rate would continue for some time.
The Bank of England considers that shocks, slack and Sterling are contributing risks to the inflation outlook in both directions.
In their recent assessment of the health of the UK economy, they consider the probability of the upside and downside effects at 50:50. Based on this assumption, the expectation is that although inflation will fall throughout 2015, it will rise back to target over the next 2 years in line with the Bank’s central forecasts. This could lead to a gradual increase in bank base rate.
Commentators continue to forecast that the first rise in bank base rate will be in 2016. However, the exact time expectation of a rise has moved out since January 2015 from the first quarter of 2016 to the first half of 2016 now.
The minutes of the Monetary Policy Committee (MPC) for March 2015 show that the members were unanimously in favour of keeping bank base rate at 0.5%. Two members (the usual two) considered the decision to be ‘finely balanced’, principally based on their ongoing concern about the effects of the rise in employment/the fall in slack.
The Bank recognised all the recent issues and pledged to continue to monitor the position as expected. They assured they would respond appropriately and proportionately to manage inflation risks.
What this means for farming and rural businesses
The trends and prospects of continuing low cost borrowing and low fuel prices remain, and the recent ascent in Sterling will see the cost of inputs drop. All these factors will bring benefits to the key cost concerns for the farming and rural business sector.
However, deflationary pressures on food prices and market conditions continue to hit farm prices. Unfortunately too, the further strengthening of the £ against the Euro will make UK exports more expensive and imports cheaper. This will affect the competitiveness of UK agricultural commodities (and on the whole) both at home and in Europe and these factors will affect farm prices and ultimately income.
A prevailing strong £:€ in Autumn 2014 impacted on the Single Farm Payment Scheme (SFP) therefore reducing the amount of payments for 2015/2016 from the European purse.
This shows the importance for business owners to be aware of the factors that could impact upon their business and allow for them in their business planning. Wherever possible, they should get expert advice to help the business and to navigate the market. They should also embrace and adopt any available tools or insurances to reduce or mitigate income and expenditure risks and or volatility.
One such example of an available tool is hedging the new Basis Payment Scheme payments and taking advantage of the exchange rate to protect farm support payments. This is detailed in our blog by Graham Sanders.