The question is not whether today’s interest rate is too much or too little but what is the message it sends out.
The Bank of England was widely expected to increase interest rates, but this was by no means an easy decision for them; while 7 voted for a rise, the remaining 2 voted against. Oddly, markets have reacted positively to the rate rise, with the FTSE increasing 0.8% and the REIT index increasing 1.45%. This is because industries have to a large extent already priced the expected rise into their models and it signals that another rate rise may be a year or so in coming.
However, this may not be the view of consumer borrowers, many of whom will not have experienced a rate rise before. They may take this as a sign of things to come. They may become over cautious, despite mortgages remaining generally-speaking affordable. The impact is not the immediate financial one, but concern over the future. Consumers may be scared into reducing their spending habits, leading to an over-contraction within the economy. Of course, the purpose of raising interest rates is precisely to slow down the economy and curb inflation but it may have a greater effect than the Bank anticipates, especially when one considers that rates have not risen for 10 years. Perhaps it would have been wiser to wait until after the forthcoming UK budget, and to see the effects of proposed US tax reforms.
The Bank’s decision to raise interest rates was largely influenced by concerns over high inflation but although UK inflation is currently 1% above its target, this is largely due to the 10% decrease in the value of Stirling following the Brexit referendum. Inflation is expected to decrease naturally over the coming months and the UK economy is still in a precarious state with great uncertainty.
Over 40% of UK households are currently on variable mortgage rates and let’s not forget that while this is a modest rise, interest rates have still doubled. It is likely that this will create a flurry of people fixing into a two to five year mortgage deal.
The effect of the rise may be limited as both the commercial and residential real estate markets are far less vulnerable to interest rate rises than they used to be. The commercial market has significantly pared down its reliance upon debt, and the banks are far more restrictive with residential lending than they used to be. Another saving grace is that further rate rises should be some time in coming.
What really matters, though, is how people perceive the rate rise, as consumer behaviour can have a significant effect on the country’s economic performance.
The Bank of England has announced the first increase in interest rates for a decade in an attempt to protect British households from the spiralling cost of living since the Brexit vote.