When will interest rates rise? Mixed messages from Bank of England as US Fed sits tight on first rate rise


Bank of England chief economist Andrew Haldane set the cat amongst the pigeons on Friday by speculating once more that the next interest rate move could actually be a cut rather than a rise.

In what was possibly more a bit of blue-sky thinking than a serious prediction, he pointed to ultra-low inflation and global economic uncertainty as reasons why the Bank's monetary policy committee might think twice about hiking rates in the coming months.

That sentiment runs contrary to noises made by Governor Mark Carney and fellow MPC member Martin Weale, who have been keen to prepare households for imminent, but incremental and gradual, rate rises.

However, even before Mr Haldane's intervention, economists had been predicting rates might be kept on hold for longer in the wake of a sinking oil price, China's stock market plunge and the UK's own stock market mini-correction. Particularly after the US Federal Reserve declined at its September policy meeting to begin its own 'normalisation' of monetary policy. 

Rate expectations: How the Bank Rate is seen moving now (the red line) and in May (the green line) based on data from the August Quarterly Inflation Report (Source This is Money / Bank of England)

Rate expectations: How the Bank Rate is seen moving now (the red line) and in May (the green line) based on data from the August Quarterly Inflation Report (Source This is Money / Bank of England)

Figures from the ONS have also showed UK inflation falling back to zero, taking price pressures out of the monetary policy equation, in the short term at least.

However, recent wage growth figures showed the fastest real pay increases since the financial crisis, which policy hawks on the MPC will point to as a portent of inflationary pressures to come. 

Martin Weale for one has recently singled out growing wage growth as a key reason for the MPC to consider an early rate rise. 


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Star fund manager Neil Woodford has also suggested rates would rise later than the consensus expects - something he has warned on for some time, along with potential problems in China.

In a blog post, Woodford wrote: 'We remain cautious of the global growth outlook and, on balance, believe that interest rate increases, both in the US and here in the UK, are further off than consensus has hitherto believed. Weak global growth and productivity, deflation and excessive debt remain our principal concerns.'  

More of the Bank's monetary policy committee are expected to vote for a rise in months to come, but they face a murky crystal ball as they decide whether to do so, with inflation at 0 per cent and concerns the recovery could still be knocked off course.

ONS statistician David Freeman said: 'While it's too early to conclude that the jobs market is levelling off, these figures certainly strengthen that possibility. Growth in pay, however, remains solid.' 

The outlook for a rate rise 

Howard Archer, economist at IHS Global Insight, said: 'How earnings develop over the coming months will play a crucial role in just when the Bank of England starts to raise interest rates. 

'Should earnings growth pick up markedly over the coming months, it would increase the likelihood that the Bank of England will raise interest rates early on in 2016. 

'A Bank of England rate hike in 2015 now looks highly unlikely given the developments of “Super Thursday".' 

The outlook for when interest rates will rise shifted forwards slightly to about February 2016, despite the Bank of England pushing back expectations of when inflation will return to target.

That forecast came as rate watchers were delivered a triple whammy of news to digest on Super Thursday, August 6, as the Bank's latest Quarterly Inflation Report landed alongside its August rate decision and the accompanying monetary policy committee minutes.

The inflation report suggested rates would rise in line with current market expectations, however, its data and charts flagged how those expectations had shifted in the past three months. Meanwhile, one MPC member voted for an immediate rise to 0.25 per cent.

Rates are expected to rise earlier in 2016 than previously though and climb higher sooner, as the chart using the inflation report's data above shows.

The Bank said inflation is ‘likely to remain close to its current rate’ of zero in the coming months as the falling oil price keeps a lid on overall prices.

In the inflation report, the bank said: 'The MPC judges that it is currently appropriate to set policy so that it is likely that inflation will return to the 2 per cent target within two years. Conditional on a gradual rise in Bank Rate, such as that currently implied by market yields, that is judged likely to be achieved.

'The MPC’s projections are conditioned on a higher exchange rate and a slightly steeper path for Bank Rate than those in the May Report. The conditioning path for Bank Rate rises from early 2016 to reach 1.7 per cent by 2018 Q3 around ¼ percentage point higher than in May.' 

The MPC voted to keep Bank rate on hold at 0.5 per cent but one member, Ian McCafferty, called for an immediate rise to 0.75 per cent, citing growth and wage pressure combined with less slack in the economy than thought as his reason. 

That result was considered more doveish than expected, with forecasts that two members could vote for a rise - some even suspected a 6 to 3 vote could be revealed. 

However, this was still  the first time this year that any MPC members have called for a hike and as the year continues more are expected to be convinced of the need to start moving off the emergency measures of the 0.5 per cent Bank Rate.

Howard Archer, said: ‘We believe that the Bank of England will most likely edge up interest rates from 0.50 per cent to 0.75 per cent in February 2016 – and the risks that there could be an earlier move have now waned markedly.

‘Further out, we see interest rates only rising gradually to 1.25 per cent by the end of 2016, 2.0 per cent by the end of 2017 and 2.50 per cent by the end of 2018.’ 

Cheap money: Mortgage rates have fallen to record lows as rate rise expectations slipped - but since Mark Carney's comments in July some of the best deals have vanished

Cheap money: Mortgage rates have fallen to record lows as rate rise expectations slipped - but since Mark Carney's comments in July some of the best deals have vanished

Interest rate essentials: a quick guide to things you need to know

Slack, wages and forward guidance

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

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. 

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

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.


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

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 pushed 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. 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.

Swap rates and money markets vs mortgages and savings

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.

> Read the Council of Mortgage Lenders' guide to swap rates

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.

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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