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Stuart Tomlinson On Interest Rates - February 2011

In this edition of our news briefing Stewart Tomlinson, a director of McParland & Partners Limited, Financial Management, gives his personal views and predictions on interest rates.

As an experienced financial planner I am frequently asked by clients, business connections and friends of my views on interest rates. Readers will be aware that the UK base rate has been at an all-time low of 0.5% since March 2009. Many clients ask the question because they rely on bank and building society interest to supplement their incomes. Others ask, because they have large mortgages and have become accustomed to lower monthly interest payments. In my state the agent friends asked the question, because they believe an already fragile housing market might be compromised by hikes in interest rates.

Interest rates in the past have been the Bank of England's prime weapon in any battle against inflation. If interest rates are increased in theory this reduces the supply of money in the economy and reduced consumer spending should reduce demand for goods and services and therefore inflation. There is no doubt the UK is suffering from the effects of inflation, that it is not the classic variant where too much money is chasing too few goods, thereby causing prices to rise. Inflation over the past 12 months has been just under 4%, but 1.7% of this has been caused by tax increases; the VAT and fuel duty. Sterling is weak when measured against the euro and the US dollar. This means imports cost more. Commodity prices have also risen, but to a large extent this is caused by increased demand by emerging economies such as India.

Some economists take the view that national economies need to grow and such growth should take precedence over public spending cuts and tax rises to reduce budget deficits. This is the stance taken in North America where 45% of the population pay no taxes on income. The US has also embraced quantitative easing with far more enthusiasm than the UK. Their objective seems to be if we keep the economy growing other problems will solve themselves eventually. The UK stance has been to embark upon limited quantitative easing, whilst simultaneously cutting public spending and increasing taxes. It has been suggested that cuts in public spending could result in significant increases in unemployment. A combination of a rise in interest rates and rising unemployment would have catastrophic consequences for UK economic growth. The GDP figures for the last quarter of 2010 word dire and cannot be explained in full by heavy snow in December. GDP stands for gross domestic product and is a measure of economic prosperity; increasing GDP is good news, but falling GDP is bad news for the government and UK plc!

In my opinion the Bank of England's Monetary Committee, who have the unenviable job of setting interest rates, are unlikely to increase interest rates this year based on evidence currently available. My opinion is based on empirical evidence and does not take account of political and emotional factors. If Mervyn King, the Governor of the Bank of England loses his nerve and submits to the inflation hawks, then rates will rise and very soon. What this will do for the UK economy is anyone’s guess, but don’t rule out a double dip recession.

Whilst this prediction is good news for borrowers it is not welcome news for those who rely on bank and building society interest to supplement income. There are strategies that can help those in this position and as experienced Independent on Financial Advisers McParland & Partners Limited, Financial Management, can provide the appropriate advice. We are only a telephone call away.

February 2011