Three reasons interest rates won't rise this year

 

 

2015 was widely expected to be the year the rate-setters at the Bank of England finally started to normalise monetary policy. For much of last year, all the talk was of when, rather than if, interest rates would rise as the recovery picked up speed and unemployment began falling at a record rate.

Inflation calculations from the Bank's most recent quarterly Inflation Report were also conditioned on an October 2015 hike.

But a series of developments in the global economy means we will probably be living in a world with a 0.5pc main bank rate for a while longer. 2016 is now the date we should expect a tightening in monetary conditions, according to respected forecasters, the EY Item Club. They are the latest to think the Bank's Monetary Policy Committee will "err on the side of caution, and keep interest rates on hold until the first quarter of 2016."

So what's changed? Here are some of the reasons the MPC is going to be voting for no change for the rest of the year:

1. Oil will bring deflation
The global collapse in oil prices was the most dramatic economic development of 2014, and the descent has continued this year with the price of crude more than halving since the summer.
Its impact on the UK's main consumer price index will be dramatic, according to EY.
They predict that the falling cost of energy will push the UK into outright deflation over the next few months, with consumer prices only returning to positive territory by the end of the year.
The cost of a litre of unleaded petrol will fall to around £1.02, from £1.31 in July, according to the think-tank's calculations. This will help reduce the CPI by 0.8 percentage points in the early part of the year. Falling energy will also have a ripple effect in other parts of the economy, helping bring down production costs for the country's manufacturers.
"Having been lashed by fuel food prices for so long", this lowflation is all good news for consumers, says the report. But the undershoot in the Bank's price stability target of 2pc is likely to elicit more letters of explanation from Governor Mark Carney to the Chancellor.
As noted by Peter Spencer - chief economic adviser to EY - low inflation will also bring about a strange "inflationary paradox" for Mr Carney. More spending power for consumers should help boost growth and ease unemployment. On these measures, the Bank should probably think about hiking rates to prevent the economy over-heating. But the MPC's hawkish members will continue to be out-voted in 2015 with circumstances making it "virtually impossible" for the committee to agree on a rate rise, say EY.

2. We're still worrying about the eurozone
For all the many strengths of the UK's recovery, bleak prospects for the global economy continue to pose a risk for monetary policymakers. And nowhere looks more bleak than the UK's biggest export market right now- the eurozone.
The demand-starved currency bloc has already slipped into outright deflation, raising market hopes of a new programme of quantitative easing to be launched as early as this week The effect of such action is likely to weaken the value of the euro - which will be a positive for Europe's exporters - but hurt the UK's manufacturers. Such developments should continue act as a cause for caution from the MPC, says the Item Club.

3. The politics 
This year's general election is likely to cause more market anxiety than usual. The prospect of another hung parliament and a potential vote on Britain's EU membership are both likely to spook investors. The distance between the two main parties on economic policy also makes any outcome difficult to predict. These concerns could be particularly dangerous for Britain says EY, as the UK is so "heavily dependent upon its reputation for political stability to finance the huge deficits in its government and balance of payment accounts."
Such risk factors would also have to be taken account of by the Bank of England, which would be unlikely to hike interest rates at a time of political upheaval.
Whither interest rates?
The combination of low inflation, political uncertainty, and global weakness will push back any tightening of monetary policy for another year yet.
Markets are now expecting a hike in the first three months of 2016, according to EY’s forecasts, with the main policy rate standing at 1.5pc at the end of 2016, and eventually being hiked to 2.5pc in 2017.

http://www.telegraph.co.uk/finance/economics/11354469/Three-reasons-interest-rates-wont-rise-this-year.html