The Interest Rate Debate

By Jonathan Samuels, CEO of Dragonfly Property Finance,

Among homeowners and pensioners as much as economists and analysts, it's one of the most asked and talked about questions at present: when will the Bank of England raise interest rates?

This is a difficult, almost impossible question to answer, as there are just so many conflicting variables and data sets emerging by the day. Nationwide Building Society hit the nail on the head when it said there is a fog surrounding the economy, which is hiding its exact position and path.

The problem for Threadneedle Street is that for every argument to raise Bank Rate, there is an equally robust argument to keep rates at 0.5 per cent, where they have now been for 27 consecutive months. For every positive, if you like, there is a negative.

On the one hand, for example, we have high Consumer Price Index (CPI), at four per cent still double the Monetary Policy Committee's target — and despite the recent downtick, inflation could well spike back up given still volatile oil prices.

On the other hand, we have an economy that is flat-lining and still facing real challenges, in no small way due to the high street banks not lending to businesses, even viable businesses. Technically we may not be in recession, but for many businesses and consumers, it certainly feels like we are.

Likewise, while unemployment and, as seen last week, personal insolvency levels have fallen back of late, moving forward there is every prospect both will rise as public sector job cuts start to snowball — this is certainly what insolvency practitioners who are at the coalface are predicting. Again, for every bit of good news, you can come up with a piece of bad news to negate it.

On a purely quantitative basis, then, the MPC could just as well raise rates as leave them on hold. It may as well just throw the dice. But it is leaving them on hold. Why is this? In my opinion, it’s because the MPC, despite its quantitative remit and brief, is in fact assessing the landscape in qualitative terms.

As well as assessing what is right, it is also feeling what is right.

In short, the majority of the MPC’s members sense that raising rates at the current time could send already delicate consumer confidence into freefall.

Even a symbolic rise of 25 basis points to signal that rates can't stay low forever could see confidence and the economy tank.

It’s not hard to see why confidence is already so low. As well as the ever-present threat of unemployment and a flat property market, peoples’ disposable income is in reverse given high inflation. Therefore, to squeeze their finances further through increased mortgage payments could be the coup de grace for both confidence and the economy.

The moment people feel the roof over their head is under threat, they cease spending full stop. This is exactly the affect raising interest rates would have for a large part of the population, especially those stranded on SVRs with no hope of remortgaging. For these people, the interest rate decision each month is hanging over them like the Sword of Damocles.

The MPC is acutely aware that confidence is crucial to any sustainable recovery in the economy. It knows that a rate rise, particularly after such a prolonged period, will be quite a shock — and that this shock, if emitted too early, could reverberate through consumers and directly onto the high street, pushing us back into recession.

So, given the anaemic recovery and consumer nerves, realistically it could be 2012 before we see interest rates finally rise.