Bill Jamieson: No reason to raise interest rates

Chancellor George Osborne warned last week that '2016 is the year of mission critical'.
Chancellor George Osborne warned last week that '2016 is the year of mission critical'.
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A SLOWING economy, a “cocktail” of serious threats and an exchange rate continuing to strengthen and choke exports: hardly the scenario for a rise in interest rates.

But that is the dilemma that the UK now faces. Cautious remarks by chancellor George Osborne last week have put us on alert that, far from the sunny uplands portrayed in his Autumn Statement just a few weeks ago, prospects for a strengthening recovery are not as assured as we have been led to expect.

He warned that, the year ahead is likely to be one of the toughest since the financial crisis and that, far from “mission accomplished” on the economy, “2016 is the year of mission critical”.

Where does all this leave the outlook for interest rates?

Against such a backcloth there would seem to be the slimmest case for embarking on rate increases. But the move towards higher interest rates in the US has fuelled speculation that the UK may not be far behind, with many now expecting the Bank of England to announce a rise in the late spring or summer of this year.

Traditionally interest rates have been raised to cool an economy showing signs of overheating. That could hardly be said to be the case now. Estimates of third quarter UK GDP growth have been nudged down to 0.4 per cent and it now looks as if the economy overall grew by 2.2 per cent last year – down from previous estimates of 2.4 per cent and broadly in line with the long term trend rate of growth. Forecasts for this year are also now being shaded down – to 2.4 per cent – hardly a rate that suggests a need to combat “over-heating”.

No matter how earnest the assurances that this would be only a modest 0.25 percentage point rise to 0.75 per cent and that any further rate rises would be slow in coming, the wider world well knows that a rate rise would mark a fundamental turn in official policy.

And it would be breaking with historical precedent if such a move would be confined to a “one-off”.

Rate movements tend to come in cycles. And a turn in the cycle would put households and businesses alike on alert that the era of ultra-low interest rates is over. That in turn would herald a more cautious assessment of future spending and investment.

The case for a rise in rates largely rests on concerns over rising house prices and continued increases in household and personal borrowing. Last week the Nationwide reported that house prices rose by 0.8 per cent in December, pushing year-on-year gain up to 4.5 per cent.

While the pace of price rises in Scotland is generally more modest, it is the overall picture across the UK that concerns the bank’s rate-setting monetary policy committee.

The figures from the Nationwide – trailing data from the Halifax pointing to a 9 per cent rise in house prices year-on-year in the three months to November – has reinforced predictions that 2016 will see prices rising by around 6 per cent.

At the same time, consumer borrowing continues to grow. Last week the British Bankers Association (BBA) reported that unsecured consumer credit rose sharply in November to £713 million from £422m in October – an eight -month high and its second highest level since 2007.

Net borrowing on credit cards during the month rose to £318m from £149m in October. Meanwhile, there was a net increase of £395m in personal loans and overdrafts in November, up from £273m in October.

The marked rise in unsecured consumer credit follows ONS data showing that the household savings ratio dipped to 4.4 per cent in the third quarter – the equal lowest rate since 1963. 

This will fuel concern that consumers are borrowing more and saving less to finance their spending. And it lends credence to the charge that the UK’s economic recovery – such as it is – owes altogether too much to ever rising personal and household debt.

Finally, there is a powerful argument for raising interest rates as a signal that the UK economy has not become chronically dependent on ultra-low money costs and that we are at last getting back to “something approaching normality”. This has been the official rhetoric for some three years, but every earnest exhortation to bring on the “now normal” has been pushed back by the need for recovery reassurance – and external events. There was the Greek debt crisis. Then the Euro crisis. Then the China slowdown. And then, of course, the continuing low level of inflation, now running at just 0.1 per cent and, with the oil price continuing in freefall, unlikely to take off any time soon.

“Now’s the time to act”, some will argue. MPC member Ian McCafferty has already been voting for a rise and it is unlikely he will change his mind at the meeting on Thursday.

However, few on the MPC are likely to join him at present. Their concerns are threefold. First are the pointers to a weakening UK growth trend. Second, the persistent strength of sterling has been a major dampener on export demand and may have been the main cause of the slowdown in the manufacturing sector, which has now recorded three consecutive quarterly declines. The pound has weakened in recent weeks. But is this enough – or sustained long enough – to cause MPC members to change their view from “hold” to “hike”?

Finally, the international background is looking more fragile. Economists at Investec have lowered their world GDP forecasts for this year to 3.4 per cent from 3.6 per cent. For these reasons, I suspect the MPC will continue to hold off an interest rate rise for as long as it possibly can. «