Bank Of England Could Hike Interest Rates In 2015, Should You Worry?

21/12/2014 08:17 | Updated 24 December 2014
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In 2015, the Bank of England could do something that it has refused to do over 70 times in succession, in a decision that would impact on millions of Britons.

The Bank's rate-setters on the Monetary Policy Committee (MPC) have kept interest rates at their historic low of 0.5% since March 2009, marking more than five years of cheap money for borrowers and limited rewards for savers. But as the recovery takes hold, the Bank has steadily been warning that Britons will have to prepare for the first rate rise since 2009, which is currently estimated to happen around next autumn.

So how could the next 12 months pan out? HuffPostUK asked experts to assess how worried the rest of us should be by a rate rise after so long.

Hiking interest rates would a momentous decision by the Bank of England's MPC. Since getting independence over interest rates in 1997, the Bank of England's rate-setters have voted only 18 times to increase rates, but 26 to cut them - as they ended up doing when the recession hit - and an overwhelming 166 times to keep them the same.

Two of the Bank's nine MPC members, Martin Weale and Ian McCafferty, have started to call for an immediate interest rate rise of 0.25%, and others are expected to follow as signs of the economic recovery bloom.

However some politicians - like Tory MP Mark Garnier - fear that the rate rise could be a "social catastrophe" as many borrowers would unprepared for the effects.

"There are individuals and families in my constituency who have to rely on everything being pretty safe for them otherwise their lives will go into crisis," he told HuffPostUK in August.

Governor Carney has himself warned that Britain’s high levels of mortgage debt left it “particularly sensitive to interest rates”.

“History shows that the British people do everything they can to pay their mortgages,” he said in June. “That means cutting back deeply on expenditures when the unexpected happens. If a lot of people are highly indebted, that could tip the economy into recession.”

The potential danger was underlined by the government's official forecaster, the Office for Budget Responsibility, which forecast in December that British households are on track to build up as much as 184% of their income in debt, well in excess of the 169% ratio reached in 2008, just before the financial crash.

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However, the Bank of England remain broadly optimistic about the effects of interest rates starting to rise, helped by top officials warning borrowers to prepare themselves.

Recent research by the Bank into household finances suggested that the vast majority of mortgage borrowers could handle interest rate rises of up to 2%. Officials found that if interest rates rose 2% as incomes rise, only 4% of borrowers - equivalent to 1.3% of households - would need to cut their spending or work more hours.

“These results do not imply that increases in interest rates from their current historically low level would have unusually large effects on household spending,” the BoE officials who wrote the report concluded.

However, if wages stay stagnant and continue to fail to outpace inflation, an interest rate rise would force nearly 40% of mortgage holders to take action.

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Bank officials have placed a special emphasis on waiting for wages to rise enough before they consider raising rates, with governor Carney suggesting that they could do it as soon as they have "confidence" that wages will rise "sustainably".

City experts are sympathetic towards the Bank of England's argument that rate rises should be managable as they'll happen in a "gradual and limited" fashion to a "new normal" of around 2.5%.

Philip Shaw, chief economist at Investec specialist bank, tells HuffPostUK: “When they do rise, interest rates are only likely to climb slowly and look set to remain at levels which are relatively low by historical standards.

"It may be that the housing market experiences bouts of nerves as homeowners’ mortgage costs begin to rise, but the economy can cope with this providing that swings are not too extreme. In any case what we are talking about is a gradual normalisation of economic conditions which cannot be a bad thing – especially considering the effects of the financial crisis.”

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The Bank's current 0.5% rate is a historic low...

Kathleen Brooks, UK research director at Forex.com, suggests that the chance of Bank of England rate-setters hiking rates next year is not a "done deal" given a wide variety of external risks that could weigh down Britain's recovery.

"With inflation falling on the back of a declining oil price, along with a moderating growth outlook, this reduces the need for a rate hike from the Bank," she explains.

Any rate rise, she argues, will only have a "small" impact for borrowers, adding: "We think that if the BOE is confident that the economy can cope with a rate hike next year then it could be good news for businesses and the consumer, as it would suggest a stronger outlook for the economy."

Other market watchers point out that next May's general election could complicate matters for the Bank of England. However, governor Carney has insisted that Bank rate-setters will be "blind" to any political pressures about when best to raise rates.

Mike Franklin, chief investment strategist at Beaufort Securities, sees the positive case for a rise in interest rates, but thinks that the Bank will have to act "carefully" in how it raises rates.

He adds: "On the plus side, those with savings will begin to enjoy a more realistic rate of return although it is questionable if this will exceed the rate of inflation so that real interest returns will remain negative.

"2015 will be a year of transition and adjustment and it is not clear that the economy will actually grow if its most important trading partner, Europe, continues to struggle."

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