When will interest rates rise? UK narrowly avoids deflation as 'noflation' sticks instead


The UK economy failed to post expected deflation as CPI instead stayed flat for the second month in a row, according to new official figures

The consumer prices index rate of inflation stayed at the 0 per cent recorded in February despite forecasts falling petrol prices and the supermarket price war would turn the rate negative.

That left the outlook for rates firmly unchanged, with a first move still expected upwards in spring 2016. 

Rate expectations: The change in the market's thinking between November 2014 and February 2015. The chart above uses the Bank of England's OIS forward interest rates data 

Rate expectations: The change in the market's thinking between November 2014 and February 2015. The chart above uses the Bank of England's OIS forward interest rates data 

David Kern of the British Chambers of Commerce said: 'Continued low inflation is good news for the economy, particularly at a time when wage increases are modest and businesses are facing challenges. Contrary to expectations inflation has remained unchanged, however there is still is distinct possibility of deflation in coming months.

'If deflation is to emerge it should be short-term because of the strength of the UK’s largest sector, the service sector, where inflation remains above 2%.

'The main cause of low inflation in the economy is the fall in energy and food prices, which will help to ease cost pressures for consumers and businesses, and will support economic growth.

'To sustain business confidence we need a firm commitment from the MPC to keep interest rates on hold until at least early 2016.'

Howard Archer of IHS Global Insight said: 'With food prices still weak, utility price cuts still kicking in and oil prices still limited, we suspect the UK could experience mild deflation from April until mid-year, but we expect consumer price inflation to start trending up from the third quarter of 2015. 

When the base rate was cut to 0.5 per cent in 2009, many people imagined that emergency level would not hold for more than a year or so.

In fact, the Bank of England has not shifted course since and last week delivered its final verdict before the General Election, meaning rates have been on hold at 0.5 per cent for the Coalition Government's entire time in power.

A messy result in May's election could push a rate rise even further back. 

Mr Archer sees the next move as up, adding: 'We believe the odds currently favour the Bank of England hiking interest rates from 0.50% to 0.75% in February 2016.' 

Once rates start to move, economists and the markets expect a very slow shift upwards.

Archer said: 'We see interest rates rising gradually to 1.50% at the end of 2016 and to 2.50% at the end of 2017. This is based on our expectation that growth will hold up pretty well and that consumer price inflation will get back up to 2.0% by early-2017. 

'Even so, the Bank of England will not raise interest rates aggressively because of a combination of factors including still relatively high consumer debt levels and the potential impact on sterling.'

With all eyes on the outcome of the Election and whether it will be definitive, some suggest a messy vote could push a rate rise back further still.

Peter Hemington, head of corporate finance at BDO said: 'With prices poised to enter deflation, it’s no surprise that the Bank of England sat on its hands this month and kept interest rates untouched. This means the coalition government has enjoyed unchanged borrowing costs for the full length of its tenure.

'The most difficult to call General Election in modern times is exactly four weeks away. Protracted political uncertainty following an unclear result could have a dampening impact on the economy which may further delay any future rate hike.'

Bank of England Governor Mark Carney has made it clear that the next move in interest rates will be up as the Canadian looks to quash talk that rates could hit zero if deflation in the UK takes hold.

That followed the news that inflation had fallen to 0 per cent - noflation or flatflation, as some commentators have tried to label it

The question on economists lips was whether the Bank would follow other central banks into the realms of negative rates, but many suggest it is unlikely the Monetary Policy Committee will vote for a cut. 

Carney said at a Bundesbank conference in Frankfurt: 'We're still in a position where our message is that the next move in interest rates is going to be up.' 

Ben Broadbent, Bank of England Deputy Governor, said in a speech at Imperial Business School that current UK deflation fears are overblown.

The comments from the two banking chiefs come after Bank of England chief economist Andy Haldane surprised investors last week when he said a recent sharp slowdown in inflation meant the bank could cut rates further - a view that Carney has always been wary of.

Isolated: Bank of England chief economist Andy Haldane has emerged as an arch dove amid worries about deflation in the UK

Isolated: Bank of England chief economist Andy Haldane has emerged as an arch dove amid worries about deflation in the UK

Many economists dismiss fears that Britain is heading for a dangerous bout of deflation where falling prices sap demand as people delay spending in the hope of cheaper goods and services in the future.

‘Three cheers for low inflation,’ is how Rob Wood, chief UK economist at Berenberg Bank, put it while Chris Williamson, chief economist at Markit, said that ‘rather than being a concern the drop in inflation is a boon to the economy providing households with greater spending power at a time when pay growth remains frustratingly weak’.

Wood went on: ‘Worriers might seize on this as evidence of a dangerous Japanese-style malaise stalking the economy, and inflation will very likely turn negative at some point in the next few months.

‘But cheaper imports, petrol and food are unmitigated good news for consumers and growth. The UK can sit back and enjoy the purchasing power boost that low inflation today is bringing without fearing any of the sillier claims of what deflation might bring, like households delaying purchases on the expectation that prices will be even lower tomorrow.’

Howard Archer, chief UK economist at IHS Global Insight, said: 'We remain firmly of the view that the next move in UK interest rates will be up, but not before the early months of 2016. 

'Despite only flat consumer prices in February and the now high probability of imminent deflation, we believe it is highly unlikely that the Bank of England will cut interest rates – although the Bank has stated that it now believes interest rates could be taken lower if need be. 

'The Bank of England considers that any deflation in the UK economy is likely to be brief and limited, and will actually provide stimulus to the economy through boosting consumers’ purchasing power. We believe that the Bank of England would only cut interest rates if there were several months of deflation and medium to longer-term inflation expectations weakened markedly. 

In its last inflation report the Bank of England hinted interest rates will not rise until spring 2016 if the UK economy stays on its current course.

Scott Corfe, head of UK macroeconomics at CEBR, said: ‘As far as monetary policy is concerned, low inflation is going to lead to even more inaction from the Bank of England - CEBR now expects the Bank’s Monetary Policy Committee to keep the base rate of interest on hold until February 2016.‘

That forecast is slightly earlier than the money market curve used by the Bank of England, which puts a rate rise later in spring 2016. But economists cautioned that a rise may come sooner if the Bank’s buoyant outlook for the economy arrived.

Delivering the latest Inflation Report, which included the strong possibility of a bout of deflation in the coming months, Bank Governor Mark Carney said base rate should rise in line with the market’s current expectations.

If rate rises came in 0.25 per cent increments, that would put the inflection point between a 0.5 per cent and 0.75 per cent base rate in May next year.

Mr Carney raised the prospect that if deflation became entrenched the Bank could be forced to cut rates and deliver more quantitative easing, but when questioned on the prospect of negative rates in the UK he reiterated that the most likely next move for base rate was up.

He added that prices falling in the coming months would boost disposable income and spending and the Bank has upgraded its growth forecasts.

The Inflation Report delivered an upbeat take on the current low inflation environment, with Mr Carney suggesting this would be ‘unambigously good’ for the economy.

Despite the arrival of a Bank document showing the prospect of a rate rise drifting further in the future than at the time of the last Quarterly Inflation Report in November, economists suggested the tone of the meeting was hawkish.

Investors judged the positive mood to indicate that betting on rates staying on hold until late 2016 was a long shot.

The Bank said it expected inflation back near its 2 per cent target by 2017 and above target inflation in three years. 

Low inflation should be a boon to Britain's recovery, according to CEBR's Corfe.

He said: 'Overall, this is good news for the economy. Unlike in the eurozone, where there is a risk of a negative spiral of falling prices and weakening economic performance, the UK’s bout of deflation is expected to be short-lived and virtuous, as the declining price of essentials increases household spending power. 

'Employee earnings growth is forecast to accelerate from 1.0% in 2014 to 2.1% in 2015 which, combined with low inflation, will bring the cost of living crisis in the UK to an end. This will support economic growth of 2.6% in 2015 – unchanged from current estimates for last year.

But he added that this could spell a headache for George Osborne. 'The interesting area is actually fiscal policy. Very low inflation, with some months of deflation, is going to create problems for the Chancellor as tax receipts are held back,' he said.

'Excise duty and VAT revenues, which are linked to underlying price growth, are going to struggle to grow significantly this year and may decline. The cooling UK housing market, where we expect price deflation, particularly for prime London property, is also going to bear down on stamp duty revenues. Expect the government to struggle with hitting its borrowing targets in the short term - inflating away the deficit just isn’t an option.'

Money markets are expecting rates to stay low for longer as the Bank of England forecasts inflation to remain near zero for the next two quarters.

The start of the year was a big one for monetary policy. The European Central Bank finally announced quantitative easing in the eurozone, with a plan to print €60bn-a-month, while at home in the UK the Bank of England's rate hike hawks backed down.

The Bank of England vote to keep rates on hold in January was unanimous for the first time since July after two policymakers dropped their call for higher rates in the face of tumbling inflation.

Monetary Policy Committee member’s Martin Weale and Ian McCafferty, both external to the Bank, had called for an end to record-low interest rates since August but they said in January that a rate rise now might cause below-target inflation to become entrenched.

In February and March the base rate was kept on hold at 0.5 per cent once more. 

The question now is whether rates will now even rise at all in the UK this year?  

The Bank of England has suggested that the UK is seeing a better type of low inflation than the struggling eurozone's but is concerned that Britain's recovery could still be derailed by lifting base rate from its record low 0.5 per cent level. 

The falling oil price, a supermarket price war and slipping energy costs have all contributed to pushing inflation down to 0 per cent.

That is substantially below the 2 per cent target level the Bank has and with concerns over slow wage growth still dominating its thinking, the consensus is that base rate will not rise until at least the second half of 2015. 

ECB QE puts the prospect of a UK rate hike further away, as the Bank will not want to risk the pound staging a sharp rally against the euro. 

There will be a larger than expected programme that will see €60bn-a-month of bonds purchased until September 2016, with the aim of lifting inflation back towards the ECB's 2 per cent target. 

Mr Draghi said it was likely that the money paid to buy bonds under QE would find its way into the financial system and be invested or lent out. The ECB’s negative interest rate of -0.2 per cent on its deposit facility would mean that investors would have to pay to stash the funds they receive there.

The astonishingly sharp slump in the oil price has caught markets by surprise and combined with fears of slowing growth, eurozone problems and Russian woes to keep central bankers awake at night. 

Slack and wages: the new keys to interest rates

Having initially formed its forward guidance on interest rates around unemployment, the Bank of England switched tack when this fall far faster than expected.

Earlier this year it identified the somewhat nebulous concept of slack in the economy as one of the new deciding factors on when rates would be ready to rise.

The Bank’s 2013 August Inflation Report unveiled Forward Guidance Mark 1, which said the bank would not consider raising rates until unemployment fell to 7 per cent or lower. At that point unemployment stood at 7.8 per cent. It promptly dropped like a stone yet rates remained on hold.

Forward Guidance Mark 2 arrived in February 2014. It put slack on the agenda, identifying that spare capacity in the economy meant that it could grow at a faster rate without requiring rates to rise.

The Bank says that some of this slack had been used up, but there had actually been more of it than first thought.

Mr Carney has admitted there was tremendous uncertainty on slack and the Bank has now placed wage growth on the table as another key decider on when rates should rise.

Mr Carney said:  ‘Not surprisingly, there is a wide range of views on the Committee about the likely degree of spare capacity in the economy.

‘In light of the heightened uncertainty about the current degree of slack, the Committee will be placing particular importance on the prospective paths for wages and unit labour costs. 

‘To be clear, the MPC does not have a particular threshold for wage growth; rather we will continue to monitor a broad range of data to assess overall inflationary pressures and the timing of the first increase in Bank Rate.' 

Mortgage limits: The Bank of England says it will toughen up on how many big mortgages lenders can make, but loans of more than 4.5 times salary remain below the proposed cap.

Record lows: Interest rates may be tipped get off the floor soon, but remain they still have a long way to go to get back to normal

Record lows: Interest rates may be tipped get off the floor soon, but remain they still have a long way to go to get back to normal


Forget unemployment or the property market, it may actually end up being inflation that guides rates – low inflation that is.

Britain may suffer from a persistent inflation problem but it might be easing for now. And the US, Europe and Japan are all more worried about deflation than inflation.

With wages falling in real terms and cheap mortgage cash through Funding for Lending being cut, the Bank may decide the medicine of low rates needs to be prescribed for longer.

The Bank’s move to hack back at Funding for Lending for mortgages has made it clear that switching off the cheap money being pumped into the economy is a higher priority than raising interest rates.

The fear has always been that all this cheap money will send inflation soaring above 5 per cent and then it will stick there. But while property prices and the stock market have certainly done well off the back of it, that hasn’t happened in the overall economy.

There is a chance we will manage to see a better than expected recovery and low inflation at the same time.

Companies grateful for the end of the consumer recession can make more money from simply selling more stuff to more people - and may feel less pressure to raise prices than in a normal strong upturn.

An end to rising energy costs will take the heat off businesses, while a stronger pound will reverse imported inflation.

Meanwhile, very slow wage increases in the past will make even a 2 per cent pay offer look reasonable for many and slack in the employment market may discourage workers from demanding more money or companies from having to pay it.

The Bank of England is looking for any possible reason to keep rates lower for longer. Low inflation might just be it.

- Simon Lambert, Dec 2013

Productivity is the key

Economists are also looking to productivity as the bank identified spare capacity in the economy as a reason for keeping rates down.

Howard Archer explains: 'The extent to which the weakness in the UK’s productivity has been structural rather than cyclical has vital implications for the economy’s growth potential and for policy.

'If productivity fails to pick up appreciably over the coming quarters, it indicates that the economy has less potential to grow without generating inflationary pressures and that interest rates will need to rise at an earlier stage and likely at a faster rate than currently envisaged. The more that productivity improves, the greater the scope of the Bank of England to keep monetary policy very accomodative.

The Bank of England is currently assuming that productivity will pick up only gradually.'

The revision of forward guidance

The Bank of England expects the base rate to rise from 0.5 per cent in late 2015.

The new normal level for rates is expected to sit at 2 to 3 per cent - below the 5 per cent it was judged to be from the late 1990s to the financial crisis.

In a dramatic revision of its forward guidance policy in its February inflation report, the Bank called time on its assertion that it would consider a rate rise when unemployment hit 7 per cent, and said slack in the economy meant the base rate, or Bank Rate as it is officially dubbed, needed to stay low.

It said that interest rates will only rise gradually and even when the economy returns to normal are likely to be substantially below 5 per cent.

The report stated:

  • Despite the sharp fall in unemployment, there remains scope to absorb spare capacity further before raising Bank Rate.
  • When Bank Rate does begin to rise, the appropriate path so as to eliminate slack over the next two to three years and keep inflation close to the target is expected to be gradual.
  • Even when the economy has returned to normal levels of capacity and inflation is close to the target, the appropriate level of Bank Rate is likely to be materially below the 5% level set on average by the Committee prior to the financial crisis.

In August 2013, when the policy was outlined unemployment stood at 7.8 per cent.

Moving up: The number of mortgages being taken out by those with smaller deposits is climbing.

Moving up: The number of mortgages being taken out by those with smaller deposits is climbing.

Forward guidance: a short history

The UK interest rate outlook underwent a transformation with this initiative from Mark Carney, which was launched alongside his first quarterly inflation report as Bank of England governor.

He pledged that rates will not go up as long as the unemployment rate remains above 7 per cent. The Bank initially projected a very slow recovery that would not see it fall below 7 per cent much before late 2016, this was then changed to 2015 as unemployment fell swifter than expected. It now looks likely to arrive even sooner.

That led to a revision of forward guidance, with the unemployment threshold removed and a focus placed on spare capacity in the economy and removing this slack.

The Bank said interest rates would only rise gradually and even when the economy returns to normal are likely to be substantially below 5 per cent.

QE vs Funding for Lending

Should the economy take another serious turn for the worse, more QE could occur, but it looks highly unlikely. The question now is if and how to unwind it, rather than whether more will arrive.

The Funding for Lending scheme overtook QE in 2012 and 2013. This was designed to allow banks and building societies to take cheap cash from the Bank and pass it on to mortgage borrowers and businesses.

The Bank has since switched off the taps on more funding for mortgages through this, although lenders can still tap into their existing allocation.

The jury is still out on whether Funding for Lending was a winner.

It has driven mortgage rates down substantially, albeit with the best benefits delivered to those with big deposits, but banks are still being accused of hoarding cash and shunning small and medium-sized businesses.

Figures are being skewed by mammoths Lloyds Banking Group and Royal Bank of Scotland winding down their historical loan books and Spanish giant Santander easing back on its former mortgage expansion policy.

One group undeniably hit very hard by Funding for Lending has been savers. Returns on savings accounts have dived since its launch in a race to the bottom that has seen big cuts in the best deals on offer.

The best easy access savings rate now stands below 1.5 per cent, whereas before the launch of Funding for Lending savers could get between 2.5 per cent and 3 per cent.


We can't - no one can. But we look at overnight swap rates to work out roughly when money markets forecast the Bank Rate will start to rise from the rock-bottom level of 0.5 per cent. 

This is very far from a precise business - not only do financial traders make wrong predictions all the time, but swap rates are only a snapshot of their views at a given moment in time.

Money market forecasts often diverge from reality, as well. For instance, swap markets for some time predicted a cut to 0.25 per cent within the next few years, well before a hike to 0.75 per cent is likely to materialise.

However, this was considered most unlikely to happen even though the Bank rate-setters dutifully discussed it every month. Economic experts say that for practical reasons it could curb lending rather than increase it, making it counterproductive as a method of promoting recovery.

The overnight swap rates move substantially. Take a look at the following chart, which appeared in the May 2013 Bank of England inflation report and illustrates interest rate projections in May compared with February. There is almost a two year gap between the outlook just a few months apart.

Please note this chart is used to illustrate market movements and is not the up-to-date outlook for rates. 

Outlook: The Bank of England's May Quarterly Inflation report mapped out the market's expected path for Bank Rate.

Outlook: The Bank of England's May Quarterly Inflation report mapped out the market's expected path for Bank Rate.

Like the Bank of England, we use the overnight index swaps curve to look at what the money markets are predicting for interest rates, and importantly how this is shifting.

Economists also make predictions of when rates will go up, which are often quite different from those signalled by the money markets.

We frequently quote their views here too if they help shed light on the issue for readers.

You can then consider all the available information and make your own best guess on when interest rates will rise.

Why 'swap rate' money markets matter to savers and borrowers

When markets move a decent amount - and the move holds - it can affect the pricing of some mortgages and savings accounts. When swaps price a rate rise to come sooner, fixed rate savings bonds tend to marginally improve in the weeks that follow. But it also puts pressure on lenders to withdraw the best fixed mortgages.

As for using swaps as a forecast, we've consistently warned on this round-up that they are extremely volatile and should be treated with caution - they should be used more as a guide of swinging sentiment rather than an actual prediction.

Important note: Markets, economists and other experts haven't had a great record of making the right calls in recent years.

This is Money has always advocated caution with any sort of prediction (including our own!). There's no guarantee that those who have made correct calls in the past will make them in the future. 

We'd also urge consumers not to gamble with their personal finances when it comes to predicting rate swings.

Rate rise predictions: Money markets and economists

Swap markets reflect the City's bank rate expectations - not in an exact way, but they indicate trends in forecasting.

Some swap rate prices and and charts are displayed below to show how the market moves as economic prospects shift.

Money market trading


1 July (as Mark Carney arrives)

0.671 - one year0.815% - two years1.552% - five years

31 July

0.606 - one year0.696% - two years1.400% - five years

7 August (forward guidance arrives)

0.637 - one year0.750% - two years1.573% - five years

20 August

0.654% - one year0.819% - two years1.751% - five years

29 August

0.647% - one year0.824% - two years1.716% - five years

5 September

0.682% - one year0.954% - two years2.00% - five years

10 September

0.679% - one year0.932% - two years1.98% - five years

30 September

0.649% - one year0.835% - two years1.732% - five years

16 October

0.615% - one year0.810% - two years1.83% - five years

28 October

0.640% - one year0.805% - two years1.664% - five years

6 November

0.590% - one year0.845% - two years1.755% - five years


21 January

0.615% - one year

0.99% - two years

2.02% - five years

11 February

0.595% - one year

0.92% - two years

1.90% - five years

25 March

0.62% - one year

1.03% - two years

1.99% - five years

8 April

0.62% - one year

1.03% - two years

1.97% - five years

17 April

0.62% - one year

1.05% - two years

1.97% - five years

1 May

0.64% - one year

1.08% - two years

2.02% - five years

28 May

0.66% - one year

1.10% - two years

1.97% - five years

11 July

0.82% - one year

1.34% - two years

2.17% - five years

1 August

0.83% - one year

1.35% - two years

2.18% - five years

One-year swap rates (which influence one-year fixed-rate bonds)

Since January 2011  

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Five-year swaps (influences 5-yr savings bonds and fixed mortgages)
Since January 2010

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Beware false dawns

In early 2010, markets prematurely began pricing in a greater chance of rate rises because of rising UK inflation. They did the same again in early 2011. The same thing then happened in early 2012. But as we've repeatedly argued central banks fear deflation more than inflation.Treat claims of rapidly rising rates with caution!

What decides rates? 

The BoE's Monetary Policy Committee meets once a month and sets the bank rate. Its government-set task is to keep inflation to a 2% target (and nowadays also maintain financial stability). So if inflation looks likely to pick up, it raises rates.

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