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This month we just passed the seventh year anniversary of Interest Rates being set at a record low 0.5%. The Budget announcement and Brexit have stolen financial press headlines to this milestone sneaked under the radar. The graph below (although slightly comical) shows the Interest Rate trend over recent years.
The 0.5% rate was set in 2009 during a time of financial crisis and it was a necessary measure to curb the impact on the UK economy. However for the last 7 years we have seen the economy settlement and unemployment is consistently falling and below pre-crisis level. We are currently in a low interest rate environment worldwide, this is fuelled by uncertainty, inflation being low particularly given oil prices have slumped.
There are problems with ultra-low interest rates and Central Banks should be concerned:
- Inflation erodes the value of savings. Despite inflation rates being low inflation adjusted interest rates are negative means savings are being eroded. This is concerning as people are not saving and considering the future including retirement.
- Low interest rates is encouraging more people to take on debt – this is what caused the financial crisis in the first place. Remember the credit crunch?
- House prices (particularly in London) are being pushed up. People who are already homeowners benefit from this but first time buyers and the younger generation simply cannot get on the property ladder.
- People are beginning to consider this rate the norm. This will make it harder for the Central Bank to increase interest rates which are in line or higher than inflation. The longer we continue the greater the risk is of addiction to low interest rates and subsequent economic shock when they do (inevitably) increase.
As the US Federal Reserve has (already) the Bank of England must consider a rate rise soon given economic performance is adequate. There always seems to be a short term issue which stops any increase happening and given the EU referendum in the UK we will be waiting some time yet before a decision is made. But, the role of the Central Bank is to take a long term view and not just look at Short term issues. Accordingly point 4 above supports that an interest rate rise should occur sooner rather than later.