Analysts weigh the effects of rate hike on UK economy

The Bank of England is widely expected to raise interest rates for the first time in more than 10 years next week, after the next meeting of its monetary policy committee.

Analysts weigh the effects of rate hike on UK economy

Most economists polled by Reuters are not persuaded a rate rise is necessary, and its symbolic value is likely to overshadow its fairly modest effect on the economy.

The public reaction to a quarter-point increase in rates to 0.5% cannot be calculated precisely. The British public could take fright at a first rate rise since 2007, especially at a time of weak growth as the country prepares to leave the EU.

While the Bank of England has ruled out returning rates to their pre-crisis level of about 5%, public or market expectations that this rate hike would be the first of many could also give it a disproportionate public impact.

Britain’s economy is growing at around 0.3% a quarter this year, half its long-run average and a slowdown from 2017 after its weakest start to the year since 2012.

A Bank of England research paper from 2014 — which represents the views of its authors, not an official Bank of England position — estimates that raising rates by 1% reduces output by 0.6% over a two to three-year period.

A quarter point rise would trim a modest 0.15% from GDP — equivalent to six weeks’ growth at current rates. Other estimates are slightly higher.

Amit Kara, a forecaster at the National Institute for Economic and Social Research sees an effect of around 0.2% from a quarter-point rise, while Martin Beck of consultants Oxford Economics says it could be up to 0.3% after three years.

Credit Suisse economists think a quarter-point rate rise could boost the chance by around 5% of the UK economy tipping into recession, based on an analysis of factors that have contributed to downturns since the 1970s.

Sterling gained 4c against the dollar in the 24 hours after the Bank of England said last month it was likely to raise rates in the coming months, taking it above $1.36.

Currency strategists say a November rate rise is now almost entirely priced into sterling, so the pound is likely to rise only slightly on November 2 if the Bank of England acts as expected.

The main aim of a rate rise is to curb UK inflation, which hit a five-and-a-half year high of 3% in September. The Bank of England research paper estimates a 1% rate rise would lower the inflation rate by 1 percentage point after three years, so a quarter point rise would only put on modest downward pressure.

The current inflation overshoot is due to a one-off hit from sterling’s sharp fall after last year’s Brexit vote, which the Bank of England thinks will soon start to fade.

Most economists are more doubtful that wages are set to grow strongly, even with unemployment at a 42-year low.

The first impact many Britons will notice will be on their borrowing costs. Interest payments on the average variable rate mortgage will rise by £180 (€202) a year, according to Nationwide, one of Britain’s biggest lenders.

But fewer Britons than in the past will be immediately affected. The proportion of English households with mortgages has fallen below 30% from more than 40% a decade ago. And a record-low 40% of those mortgages are variable rate, down from 70% in 2001, Nationwide said.

Consumer borrowing has grown rapidly for the past couple of years, but still accounts for less than 10% of outstanding bank lending.

The interest rate on an average new personal loan is about 7.5%, so a quarter-point increase will make little difference to interest payments.

That said, a minority of households do struggle with debt and this month credit ratings agency Moody’s said higher interest rates could hurt poorer households.

The Bank of England says debt trouble is closely linked to unemployment.

Reuters

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