Interest rate rises: good or bad?

It has been something that has been dominating the finance and business pages of the broadsheets for weeks, if not months in some cases; whether the Bank of England should raise the base interest rate in order to stimulate the economy.

Interest rate rises: good or bad?

It would wholly depend, we suspect, on where the publication sits on the ‘right-to-left’ political scale as to whether they agree it’s a good or bad idea, but broadly speaking there is consensus on what the risks and the benefits are.

It could have big implications on the future of the chancellor Phillip Hammond too, who is said to be currently fighting for his political life whilst preparing himself for a make or break budget next month. Having scrapped the Spring budget this will be the chancellor’s first Autumn budget and all eyes across Westminster and beyond will be on where he sets his financial priorities as we gear towards Brexit.

The EY ITEM Club, an influential forecasting body, this week said that the bank should hold back on raising interest rates until the UK’s economic prospects look brighter, arguing that with growth set to remain stuck in low gear for the rest of this year and into 2018, policymakers should avoid a hike that risks weakening the “fragile” outlook.

But what does that actually mean in practice? According to Sky News, inflation figures due out on Tuesday could add to the pressure on the Bank’s Monetary Policy Committee (MPC) to act if, as expected, the rise in the cost of living climbs to 3%.

But how does it all work? According to the Bank of England website, when the Bank of England’s Monetary Policy Committee (MPC) changes its official interest rate – known as Bank Rate, it is attempting to influence the overall level of activity in the economy in order to keep the demand for, and supply of, goods and services roughly in balance. Doing so results in a rate of inflation in the economy consistent with the Bank’s 2% inflation target.

When demand for goods and services in the economy exceeds supply, inflation tends to rise above the Bank’s target rate of 2%. On the other hand, when supply exceeds demand, inflation tends to fall below the Bank’s 2% target.

By changing Bank Rate – the rate of interest that the Bank of England pays on reserve balances held by commercial banks and building societies – the Bank of England is able to influence a range of other borrowing and lending rates set by commercial banks and building societies, and hence spending in the economy, in order to keep inflation on track to meet the 2% inflation target.

A reduction in interest rates makes saving less attractive and borrowing more attractive, which stimulates spending. Lower interest rates can also affect consumers’ and firms’ cash-flow – a fall in interest rates reduces the income from savings and the interest payments due on loans. Borrowers tend to spend more of any extra money they have than lenders, so the net effect of lower interest rates through this cash-flow channel is to encourage higher spending in aggregate. The opposite occurs when interest rates are increased.

Changes in Bank Rate also affect the price of financial assets and the exchange rate, which affect consumer and business demand in a variety of ways.

If the bank were to raise these rates, we’d likely see mortgage rates increase slightly and this could have a marginal effect on yields and profits on property investments. For the wider economy, it means that consumers can get a better return for their money so conversely means that there’s more money in people’s pockets for rent and other bills.

As we’ve seen, the buy-to-let (BTL) market across the UK is currently booming as property ownership rates continue to plummet and more people look to rent their homes. This in turn won’t have a massive effect on whether these tenants demand increases or decreases but, rather, means that they will have more money to offset rent increases.

Rent increases only need come once they affect mortgage rates significantly, and so, in our opinion, rate rises are nothing to fear as we see inflation likely rise to 3% this year.

Rising inflation and rising prices for things like food and other essentials means tenants typically have less money for rents and as such then avoid looking to move home or upscale, and so rate rises can only be seen as a sign that the economy is healthy and ready for the challenges ahead.


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