Interest Rate Saga Continues

Posted by siteadmin on Wednesday 6th of September 2017.

When, in early August, the Bank of England (BoE) Monetary Policy Committee (MPC) voted 6-2 to leave base rate at 0.25%, a long-running interest rate saga continued. It began in March 2009, when the MPC cut base rate to a mere 0.5% to help borrowers, banks and the economy after the global financial crisis. March 2009 also saw the FTSE 100 at a six-year low around 3,500. Since then, the base rate was halved, in August 2016, to 0.25% and the FTSE 100 has more than doubled, topping 7,500 at times this year.

So, why the mixed messages from BoE base rate and the FTSE 100? Well, it depends which theory you believe. Low interest rates help businesses that rely on borrowing for their working capital, improving their prospects. Also, any of their customers with borrowings will have more spending power when interest rates are low, providing another boost.

Low interest on bank deposits compared to dividend yields on selected blue chip shares also leads many investors to invest more heavily in shares, despite the risk of values falling. Therefore, the rise in the FTSE 100 may, in part, result from the low interest rate policy. Even so, it may seem puzzling that investors have been so optimistic while the MPC has held onto what were regarded as emergency interest rate levels.

BoE hesitancy over interest rates may be partly due to its role becoming more complex. Its key target remains 2% Consumer Price Index (CPI) inflation, now exceeded, but it cannot take a blinkered approach. Governor Mark Carney’s 2013 guidance said he wanted unemployment below 7% before raising the base rate. When joblessness fell faster than expected, other deciding factors persisted, including sluggish GDP growth as the squeeze on households real income weighs on consumption, combined with ongoing Brexit uncertainties. August 2017 was still not the right moment for most MPC members, who next meet on 14 September.