Déjà vu or is this time different for interest rates?


Déjà vu or is this time different for interest rates?

RBS Economist Sebastian Burnside talks about inflation and changes in interest rates

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Sebastian Burnside
Economist, RBS 
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Households and businesses need to work out what rising interest rates could mean for their finances.

August 2014. The economy was growing strongly, unemployment was falling and house prices were on the up. Two members of the nine strong MPC started voting for rates to rise and kicked off a wave of speculation over when Bank Rate would climb above 0.5%. But the excitement was short-lived. A halving of the oil price sent inflation negative and crushed expectations of rising rates before the year was out. Fast forward 12 months to today. Does the same fate await the sole dissenting MPC member, who recently called for rates to rise now?

It’s easy to see why some people think rates should rise. The economy has grown for 10 straight quarters, for only the third time in the last 60 years. That shows just how bumpy growth has been in the past. The Bank of England has expected falling unemployment to mean rising wages for the last 2 years and that’s finally happening. So, you can see the logic of slowly lifting interest rates. But history suggests it isn’t that simple.

14 of the 20 central banks in countries part of the Organisation for Economic Co-operation and Development have raised rates since 2009. Economies stretching from Australia to Sweden have put rates up to fend off the threat of inflation. Yet something quite astonishing has happened to them all. Every single one of them has reversed those rate hikes. New Zealand deserves a special mention here for it has tried on two separate occasions to get rates back up towards normal levels and it’s in the middle of unwinding its latest attempt right now.

It’s possible that these 14 independent central banks all misjudged conditions in their domestic economies in different ways. But it’s far more probable that they all underestimated the significance of global factors affecting their economies. That’s a mistake the Bank of England will want to avoid, especially since the Governor’s home country of Canada is currently cutting the rate rises instigated under Carney.

What should we do about all this? Households and businesses need to work out what rising interest rates could mean for their finances. It makes sense to be armed with that information, whatever happens. But this time round rate rises would affect the economy in subtly different ways. There are fewer people with mortgages than there were in 2007, 1.2 million fewer. And yet there is more mortgage debt. So the burden of rate rises will fall more acutely on a smaller number of people. Understanding who they are will help businesses navigate a world of rising rates.

But most importantly we need to keep this in perspective. The coming months will see commentators trading views on precisely when rates should rise. Opinions will be strongly held and that strength is often taken to imply confidence. It shouldn’t. Recent history is littered with the junked forecasts of experts. The events of 12 months ago are an excellent reminder of that.
 

This article first appeared on The Scotsman on 7th August 

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