Interest rates: News and predictions

Interest rates: News and predictions

By Andrew OxladeT:@andrew_oxlade
UPDATED: 08:46 EST, 1 June 2012

We wish we could give an exact forecast on the future of the UK base rate, but we can't. We CAN, however, arm you with the right information and views from those in the know so you can make your own call (this round-up is updated every few days). This is Money Editor Andrew Oxlade explains all.

When will the MPC make the first move? Interest rate futures on money markets give an indication of shifting sentiment. They moved dramatically in 2011. At the extremes, they pointed to an immediate rise in spring, but by the end of the year indicated 2015 for the first increase.

In early 2012, modulated between a mid-2014 and late-2015 prediction.

But the fresh turmoil in the eurozone has pushed the 'first rise' prediction way into the future in recent weeks.

Today (30 May), the markets imply the first rise will be in July 2016,which is a step back from the January 2017 - further out than at any stage of the crisis - than was suggested earlier this week.

At the end of last month the 'first rise' prediction, in contrast, moved as close as summer 2014. The Bloomberg chart below (28 May) emphasises how far the prediction has shifted on a month ago.

How projections for interest rates have shifted in the last month - Source: Bloomberg

The ramifications of the new dangerous phase in the euro crisis - the woes of Spain - appear to have hit home in May, hence the market's new ultra-dovish view on rates. In fact, the International Monetary Fund wants (22 May) to see a cut to 0 per cent.

It was a very different story in April when inflation fears were sharply on the rise: it emerged that Adam Posen, the MPC's biggest fan of low rates, had finally changed his mind on QE (18 April).

Official figures (17 April) showed the consumer price index, which had been falling, rose from 3.4% to 3.5%. But rate rise fears ebbed as dramatic events unfolded in Greece and Spain.

And then the UK CPI inflation figure (22 May) came in at 3%, below the expected 3.1%. A week earlier, the Bank of England published its quarterly Inflation Report (16 May) with the forecast that inflation will fall back under its 2% target in 2013.

The charts below are taken from the Inflation Report's of May (top) and February (bottom) and indicate what the market predicts for the base rate. It shows how rate rise fears have stalked the market, but ebbed away...

Why 'swap rate' money markets matter to savers and borrowers

When markets move a decent amount - and the move holds - it can affect the pricing of some mortgages and savings accounts. When swaps price a rate rise to come sooner, fixed rate savings bonds tend to marginally improve in the weeks that follow. But it also puts pressure on lenders to withdraw the best fixed mortgages.

As for using swaps as a forecast, we've consistently warned on this round-up that they are extremely volatile and should be treated with caution - they are a more a guide of swinging sentiment rather than an actual prediction.

This market forecast is watched closely by the Bank of England which references it in its quarterly inflation report. The latest forecast chart, published on February 15, is below. It also shows how expectations of a rise had moved further out.

Important note: Markets, economists and other experts haven't had a great record of making the right calls in recent years: 2010 predictions 2008 predictions. This is Money has always advocated caution with any sort of prediction (including our own!). There's no guarantee that those who have made correct calls in the past will make them in the future. [More: Whether to trust predictions]. We'd also urge consumers not to gamble with their personal finances when it comes to predicting swings.

Recent history of rates and predictions

The MPC voted to 'hold' again in May, with the bank rate remaining at 0.5% well into a fourth year. A rise still looks a long way off, with the mainstream predictions for the first increase ranging from 2013 to 2016.

The Ernst Young ITEM Club, a group of economists, expects rates to start rising in a year if 'global input cost inflation increases again and the domestic economy begins to recover in the manner in which we anticipate'.

It expects rates to return to the 'normal' 4 per cent or 5 per cent by 2015. It's prediction is set out in this chart:

The Ernst Young ITEM Club's predictions for mortgage rates and the base rate is far more hawkish than the money market prediction

At the other extreme, the Centre for Economic Business Research, which has previously been marginally ahead of the curve in understanding low rates were with us for the long-term. On 16 January, it said interest rates would remain on hold until 2016.

Capital Economics (9 March), another one of the more useful forecasters, said the base rate would not move until 2015.

So why such a long delay?

Economic prospects have steadily worsened in the past year - and a weak economy makes an increase in borrowing costs an unlikely option.

The prospect of low rates for years exists despite inflation remaining painfully high - it hit a peak of 5.2% (11 October) but is slowly easing lower (bar the odd blip), down to 3% in the latest figures (22 May) Policymakers are adamant it will fall back further this year, and fall under the 2% target by 2013, although their stance has been less assured than it was earlier in the year.

In early 2011 markets suggested a rate rise was imminent. But predictions for the first rise have since taken huge strides into the future:

- In March 2011, a rise was seen as imminent;
- In June 2011, markets pointed to the first rise in summer 2012;
- By early August, it was early 2013;
- October - early 2014;
- November - early 2015;
- Mid-December - late 2015;
- Mid-January - early 2016;
- Early February - late 2014;
- Mid-March - early 2014;
- Mid-April - early 2015;
- Mid-May - early 2015.

Our tweeting on rates: @andrew_oxlade | @predict_rates

• Join the debate: What next for rates?
• Our 10-year forecast for Britain

This is Money: View from the Editor

Regular readers of this page will know we've warned for several years that rates would remain low for a very long spell - and that readers should beware of false dawns on rising rates; we've seen many (see below).

View from Money Editor Andrew Oxlade

We stand by that position. The prospects for the economy remain so poor Why we face a decade of trouble] that the MPC will be nervous about raising rates in 2012 and 2013, even if inflation remains high (and it probably won't).

The one signal that the MPC may not be able to resist is a rash of pay rises. If such a trend gathers pace, it would spark more price pressure and possibly begin an inflationary spiral. This is unlikely but worth watching out for.

For now, there's no indication that pay demands are on the rise. Vocalink's pay index - reliable data based on take home wages paid into bank accounts - has been falling for several months, down from a peak of 3.3% last summer to just 1.8% in April.

One other thing to watch is inflation expectations. A BoE index for August showed them on the rise (15 September) but it fell in the latest index publication, in December. If expectations become embedded, workers will start to demand bigger pay rises. For now, rate rises remain a distant prospect.

Today's best rates: Isas | Fixed-rate bonds

Rate rise predictions: Money markets and economists

Swap markets reflect the City's bank rate expectations - not in an exact way, but they indicate trends in forecasting.

I've listed some historic swap rate prices and displayed charts below to show how the market moves as economic prospects shift.

The clearest pattern emerges from the five-year swap chart, showing how markets had begun to believe in a rate rise in the spring of 2010 and 2011, but then show how that belief ebbed away in the second half of last year.

1 May
• 1.33% - one year
• 1.35% - two years
• 1.67% - five years

10 May (after MPC 'hold')
• 1.34% - one year
• 1.36% - two years
• 1.63% - five years

16 May (after BoE Inflation Report )
• 1.36% - one year
• 1.38% - two years
• 1.56% - five years

22 May (after inflation figures )
• 1.31% - one year
• 1.28% - two years
• 1.49% - five years 

28 May
• 1.25% - one year
• 1.20% - two years
• 1.41% - five years

30 May
• 1.26% - one year
• 1.20% - two years
• 1.40% - five years

One-year swap rates (which influence one-year fixed-rate bonds)
Since January 2011

Five-year swaps (influences 5-yr savings bonds and fixed mortgages)
Since January 2010

Views from economists

Howard Archer of IHS Global Insight (22 May) said: 'While it will take more than one month of improved inflation data to   ease the Bank of England’s recently heightened concerns over its stickiness, April’s sharp drop nevertheless facilitates further Quantitative Easing by the central bank if the economy continues to struggle for growth or is seriously affected by events in Greece.

And the signs are that the Bank of England is keeping the door fully open to more QE given the major uncertainties over both the growth and inflation outlooks. Meanwhile, interest rates seem set to stay down 0.50% for some considerable time to come. We do not expect interest rates to be hiked until at least late-2013, and very possibly not until 2014.'

More analysis:
What it all means for mortgage rates
What it all means for savings rates
What next for the economy?

Beware false dawns

In early 2010, markets prematurely began pricing in a greater chance of rate rises because of rising UK inflation. They did the same again in early 2011. But as we've repeatedly argued on this round-up, deflation rather than inflation has remained the greater long-term threat. Treat claims of rapidly rising rates with caution!

More: How rate rise hopes dried up last year

What decides rates?

The BoE's Monetary Policy Committee meets once a month and sets the bank rate. Its government-set task is to keep inflation below 2% (and above 1%), looking two years ahead. So if inflation looks likely to pick up, it raises rates.

Viewpoint 1: Why rates WILL rise

The 'inflation nutters' (not my words but those of BoE MPC member Adam Posen) fear that measures aimed at reviving the economy - rate cuts and masses of quantitative easing - have unleashed forces that will create rampant price rises and that rate rises will be needed to prevent hyperinflation taking hold. They also fear rising demand from emerging market economies will also push up prices. With inflation worryingly high in 2011, these views gained traction.

Warren Buffett was among the first to warn on inflation

One popular theory is that Western governments want to create inflation to try and erode their record debts, created in part by bailing out banks. Billionaire Warren Buffett (right) warned about this in August 2009 well ahead of the pack (as usual).

One controversial economist has warned inflation would hold and that the MPC will be forced into a series of rate rises, taking the bank rate to 8% by this year, 2012.

Weak sterling in 2010 and 2011 also added inflationary pressure: falls in the pound make it more expensive for Britons to buy foreign goods, effectively importing inflation. [ what next for the pound?] And there's always the danger that we could import inflation from booming China.

Others point out that rapid rate rises are rarely expected. Insurance service RateGuard points out periods of quick-fire increases in the chart below.

RateGuard warns of how interest rates, over the past 50 years, have sometimes risen rapidly.

Viewpoint 2: Why rates won't rise

Opinion: Inflation is a concern, but there's good reasons why rates will remain low

On the reverse of the coin, experts have argued that the economy is so weak  that rates need to be kept low for the foreseeable future. [ More on that view - 14 March].

The wait-and-see position has been taken by Mervyn King and most of the MPC since the spring of 2009. Several prominent forecasters agree. The ITEM Club repeated its view in July 2010, and again in January 2011, suggesting rates will remain on hold until 2014.

In April 2010, leading economist Roger Bootle actually argued for a CUT in ratesto 0% (more below). The bold view raised eyebrows - as happened when we suggested in 2008 that zero rates were possible - but his prediction may yet come true.

More is explained here: Why rates may remain below 1% until 2015.

We have also argued for several years on this round-up that readers should beware of false dawns on rising rates and that low rates were here to stay for a long spell.

And then there's rate rises without a rate rise...

If state debts are viewed as unaffordable, it pushes up gilt yields - the interest rates markets charge the government for borrowing - and wider rates expectations. Such a scenario could create the possibility of British consumer rates rising even without a bank rate increase: read more.

...and don't forget the Taylor Rule

A popular formula for calculating a correct central bank rate is the Taylor Rule [ Wikipedia definition]. It, rightly, showed U.S. and UK rates running too high through the Noughties. More recently, it suggested the UK bank rate should be raised rapidly. But critics argue it doesn't take all factors into account, such as the sterling slump of 2009 and 2010. This commentary from a Lloyds economist is worth a read. Chris Dillow on investorschronicle.co.ukexplained in 2010 why the Taylor Rule's suggested 4% bank rate shouldn't apply. The suggested rate in May 2012 was 3.5%, according to Citibank [read on the FT]

READ MORE:

- The economist who devised a new way to forecast inflation is worried about 2012
- What next for inflation? The experts who fear a price spiral
- Why mortgage tracker rates are rising already
- Countries with rates already rising
- Respected NIESR predicts 1.25% by end of 2011
- One City star on why rates should stay at 0.5%
- Economists: 'Interest rates up post-October 2011'
- 'Why a interest rate rise won't instantly hike mortgages'
- Rates to hit 5% - MPC man
- Rates at 8%? History tells us it could happen
- CBI: 2.75% rate in 2 yrs
- How inflation affects interest rates
- The BoE wants to scare you about rate rises
- What the recovery means for rates
- Why rates will remain low
- Lending rates could rise WITHOUT a bank rate rise
- Industry experts give Money Mail their 2010 rates predictions
- Rate rise by March? Bank Governor's hints suggest not
- BoE threatens rate rises - but would it really?
- The new inflation danger

More on QE:
- Why Warren Buffett is worried QE will spark inflation
- QA: What is quantitative easing and will it work?
- 'Why doesn't the Bank print money and give it to me?'

Central bank rates in the run-up to the crisis
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