Interest Rates

31 July 2007


Managing Director, Worldwide Financial Planning Writes:

Much talk has taken place about the impact of interest rates and where/what effect this will have on the consumer, and it’s easy to rush into a mad panic – why not, the monetary policy committee (MPC) seems to be.

A study of the July minutes of the MPC made interesting reading. Point four had commented implied inflation forward rates were 10 basis points higher than the May inflation report and 60 basis points higher than two years previous, which was considerably more than the US or Europe. The note also commented there was a little confusion as to why this was caused.(1)

Point 15 indicated that retail sales had fallen back in June, which is comforting and proved that consumption might be softening. The Bank of England confirmed there was little change in the demand for unsecured lending (not good), but the supply of credit had actually tightened which was positive.(1)

Once again the key issue was that only a third of one percent of increase had actually made its way through to borrowers as many are on fixed rates. This effectively means that the MPC struggle to slow down spending and consumption as many are on lower fixed rates and interest rate hikes have no impact on their outgoings. There is no doubt it will begin to have an effect, as these borrowers will be mindful of the future that faces them when they come off that protection, only to be clobbered by a massive increase in payments.(1)
There was evidence that the housing market was again under pressure as there were fewer new buyer enquiries.(1)
Point three noted that CPI inflation had fallen to 2.5% in May as expected, and they also expected this to fall to below the 2% target over the next year. Interestingly that projection had been conditioned on the belief that a further 25 basis point rise in July was expected to 5.75% which of course happened.(1)
The MPC had commented there was an upside pressure on inflation caused by the impact of stronger demand growth on companies prices, the evolution of inflation expectations, prospects for energy and import prices, and a degree of spare capacity in the economy.(1)
More worryingly for future rates was the fact that Uk output growth continued to be strong and total personal credit continued to grow strongly and therefore the level of household debt was increasing.(1)
Point 29 commented that whilst most of the rises in mortgage rates had not passed through to households, when it did, demand would slow, possibly quite sharply…you’re not kidding.(1)
The members of the committee who were concerned about this also commented that the level of debt in households was something that needed a gradual rather than sharp approach, obviously to avoid a recession and in turn deflation/stagflation, which would be a disaster.(1)
On a few occasions the MPC commented that the August inflation report would prove very fruitful in determining the trends moving forward, so watch out for that.(1)
The committee voted 6:3 in favour of a 0.25% rise but there was no clear presumption that rates needed to rise further. Indeed the six who voted in favour of the rise commented that they wished to have it now so as to avoid the need for a future rise for more than what was needed.(1)
In some ways this contrasts slightly with other sentiment. Tony Nutt the highly successful Jupiter fund manager commented that he expected rates to go as high as 6.5%.(2)
This could prove tricky for the borrower with the £120,000 mortgage who fixed at 4.25% two years ago. They will be used to paying £425 per month only for their new rate of £775 per month, a colossal 82% increase. For someone earning £25,000 per year, this is effectively a disguised tax hike of 16.8%. To say this will slow down spending is a little bit of an understatement.
(1) Minutes of the Monetary Policy Committee meeting July 07
(2) Jupiter fund group


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