UK: Deloitte Monday Briefing: UK Interest Rate Outlook

Last Updated: 19 November 2013
Article by Ian Stewart
  • The divergence between the UK economy and the rest of the world seemed to widen last week.
  • On Wednesday, the Bank of England raised its forecast for UK growth and the Bank's Governor, Mark Carney, proclaimed that recovery is "taking hold". The day before, in an almost unnoticed report, the Confederation of British Industry reported that confidence among small and medium sized UK businesses was at a 25-year high.
  • In contrast, growth in the euro area almost ground to a halt in the third quarter and, in a symptom of the level of concern about the region, the European Central Bank unexpectedly cut interest rates. The outlook for emerging markets is continuing to soften. Last week economists once again scaled back their forecasts for growth in 2014 in India, Brazil and Russia.
  • Stronger-than-expected UK growth has left Mr. Carney with a dilemma.
  • In August, Mr. Carney announced a new policy, Forward Guidance, designed to counter chronically weak UK growth. Under the policy, Mr. Carney signaled that the Bank would leave interest rates unchanged as long as the unemployment rate was above 7.0% and inflation was under control.
  • With the Bank not expecting unemployment to fall below 7.0% until mid-2016, the aim was to build confidence by signaling that interest rates would stay at rock bottom levels for three more years.
  • Since then unemployment has fallen faster than expected, to 7.6% in September. Today the Bank sees a 50% chance that the jobless rate could hit 7.0% in a year's time, 18 months earlier than forecast in August. An unexpectedly strong recovery has introduced a risk that the Bank might need to raise rates in just a year's time, towards the end of 2014.
  • Forward Guidance was designed to bolster activity, but has been launched into an economy that is recovering faster than expected.
  • As a result, interpreting when the Bank might raise interest rates, and in what circumstances, has become increasingly tricky.
  • Last week the Bank backed away from the idea that unemployment holds the key to the timing of rate hikes. Mr. Carney now says that a 7.0% unemployment rate is a "way station" on the road to higher interest rates, not a target. The Bank also downgraded unemployment as a gauge of spare capacity by raising its estimate of the number of hours people want to work.
  • The verdict of financial markets on all this is clear. They assume that rates are likely to rise sooner than implied by the Bank. Financial markets are pricing in rate hikes in the UK from about the middle of 2015, with base rates ending 2015 at the 1.25% mark, up from a current level of 0.5%.
  • In August, the Bank of England suggested interest rates might not rise till the latter part of 2016. Today, financial markets are factoring in base rates of around 2.25% by end the end of 2016.
  • The market belief that rates will rise earlier than the Bank implies is, in a sense, a thoroughly good thing in that it suggests that the economy is normalising. Base rates of just 0.5% are a symptom of an economy that is not working.
  • But some worry that uncertainty around Forward Guidance, and a shifting definition of what it means, could knock the Bank's credibility.
  • That is unlikely to be of concern to many in an economy which is, at last, growing.

MARKETS & NEWS

UK's FTSE 100 ended the week down -0.2%.

Here are some recent news stories that caught our eye as reflecting key economic themes:

KEY THEMES

  • The Bank of England raised the prospect of a rise in interest rates in 2015, with the UK's "unexpectedly strong recovery" meaning unemployment could fall below the 7% threshold needed to trigger a rise in rates
  • Confidence levels among small businesses are rising at the fastest pace in 25 years, according to survey data from the Confederation of British Industry (CBI)
  • Growth in the euro area slowed to a quarterly rate of 0.1% in the third quarter, driven by weak export performance
  • The Maltese government has approved a plan to attract "high-value" people to the small island by selling passports, and effectively EU citizenship, for €650,000
  • Japanese GDP growth slowed to an annual rate of 1.9% in Q3 2013, half the rate of growth seen in the previous quarter when growth was boosted by more significant government stimulus
  • Japanese consumer confidence fell unexpectedly in October, registering the largest fall since a record earthquake in 2011
  • The Independent reports that a number of fund managers controlling large investments in UK energy firms have warned that further political interference in the sector may make them reconsider their investments
  • SMS text revenues are set to fall from $120bn in 2013 to $97bn by 2018 according to forecasts by Informa Telecoms & Media, due primarily to the rise of 'over-the-top' (OTT) messaging apps on smartphones
  • Demand for gold fell to a 4-year low in Q3 2013 according to data from the World Gold Council, with the price of the precious metal having fallen as much as 38% from record highs in 2011
  • The Organisation for Economic Cooperation and Development (OECD) criticised the pace of economic reform in France, saying that the country had seen "no significant improvement" in its external position since 2008
  • The Irish Prime Minister Edna Kelly announced that Ireland will next month become the first of 4 European bailout countries to exit its rescue programme and return to international markets
  • The European Commission warned both Spain and Italy that their 2014 budgets may not comply with European Union's new debt and deficit targets
  • The Chinese government is to relax its decades-old one child policy and move to more market-based pricing, as part of a series of liberalisation reforms
  • Jefferson County in the United States announced that it is to sell $1.7bn of debt to avoid bankruptcy
  • Online retailer Amazon announced that the United States Postal Service (USPS) will begin delivering its packages to customer on Sundays in most US cities, offering a potential boost to the suffering postal service
  • The United States is set to overtake Saudi Arabia as the world's biggest producer of oil within the next 2 years according to estimates from the International Energy Agency (IEA)
  • Barclays Bank is to relocate 4 of its branches to Asda supermarket stores, and hopes to move another 4 branches next year, in an effort to make banking more convenient
  • The Swedish and Swiss consulates in Shanghai have launched a joint awareness campaign to help Chinese tourists tell the two countries apart, with the campaign website clarifying that Sweden is the land of "aurora borealis, ice hotels, sled-pulling reindeer, gay marriage, Vikings and stay-at-home dads" – Swede and sour

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