For consumers, the first UK interest rate rise is a warm-up act

Putting Brexit fears to one side, Britain appears to be doing just fine. Unemployment is at an all-time low, third-quarter GDP growth surprised slightly to the upside and stock markets and house prices are at, or near, all-time highs. The only real fly in the ointment is the weak pound, which has driven CPI inflation a full 1 per cent above the Bank of England’s 2 per cent target. That is hurting real wages. Surely interest rates must rise?

Bank of England (BoE) Governor Mark Carney, in his usual measured language, hinted at this in September and inadvertently whipped the currency markets into a brief frenzy when he said on the Today programme, ‘We can see that in coming months if the economy continues on this track, it may be appropriate to raise interest rates.’ He later added that a rate rise could come, ‘relatively near term’.

As non-committal as this language was, financial markets are now pricing in an almost 90 per cent chance of an interest rate rise to 0.5 per cent at the November meeting of the BoE’s monetary policy makers, and a 35 per cent chance of them being back at 1 per cent or more by November 2018. 

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The great unknown is whether Carney and the rest of the Monetary Policy Committee are genuinely on the same page as the markets. Loose monetary policy has kept interest rates super-low for a decade, and should rates rise in November to 0.5 per cent it will simply bring them back to where we were on the day of the EU Referendum vote in June 2016. The inflation report, published this week, will have a good deal of influence on their thinking.

Over the past five years there have been other occasions where the BoE has signalled an increase in interest rates, only to change its mind at a later date. This saw Carney dubbed the ‘unreliable boyfriend’ in a Treasury Select Committee – a rather unkind moniker that has stuck. The BoE’s risk is that having signalled that rates are going to rise, it may lose credibility should it once again do nothing. That lack of credibility could do more to harm the UK economy than a mere 0.25 per cent rate rise would. 

What is the impact on the consumer?

The key question for UK consumers and investors is in fact not whether the first rate rise should happen, but when, and if, the second should occur. As we have seen, a single rate rise is already priced in to markets, but the timing of a second is not. 

A rise in rates will indicate the start of a tightening cycle, but the shape of the curve is as yet undetermined. The last cycle brought interest rates from 3.5 per cent in September 2003 to 5.75 per cent in September 2007, pushing the average standard variable rate (SVR) mortgage paid by households to a heady 7.7 per cent. 

Financial analysts tend to rely on recent data to alter to their forecasts, and therefore the gap between the first and second rate rises will determine their outlook for the trajectory of longer-term UK interest rate policy. That will have a strong bearing on how investments are priced. 

Over the past year the UK consumer has become quite complacent, with unsecured debt - car loans, credit cards and personal loans – increasing by 10 per cent over the twelve months. The BoE will want to steadily slow that credit growth, but not so much that the consumer is shocked into reigning in spending. 

The risk to the consumer is that two rate rises in short succession - within three months - would catch the market by surprise, suggest that inflation looks sticky, and infer that the Bank of England has more to come. If that happens mortgage and unsecured lending costs will begin to rise rather faster than the market anticipates, as would financing for businesses. As a precautionary step, those with mortgages may be best placed locking in low rates while they can; there may not be another opportunity for some time.  

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