Central banks have surprised markets to degree by opting for limited rate hikes of 25-basis points. The Federal Reserve Bank and the Bank of England are two of the world’s premier monetary authorities which have now reversed policy in favour of rate tightening. Just recently (November 2, 2017), the Bank of England opted for a 25-basis point rate hike, raising the bank rate to 0.50%.
This was the first time since 2007 that the BOE’s MPC opted for monetary tightening. The impact of interest rate movements on personal finances, business finances, and overall economic activity is substantial. However, it should be remembered that stakeholders tend to price the effects of a rate hike into indices, commodities, stocks, and currency valuations well ahead of time. This explains why we are unlikely to see much of a ‘jump’ in the GBP, or the USD when the BOE or the Fed raises rates accordingly.
Nonetheless, indications in the UK economy suggest that labour market tightening is currently underway. This bodes well for employees given that there are now recruitment difficulties in the labour market. A survey by the BOE shows that there is increasing confidence in the UK economy as companies struggle to attract and retain employees across the board. The average declines in UK real wages have continued for 6 months on the trot, according to the ONS (Office for National Statistics) thanks in large part to the depreciation of the GBP.
Further, UK unemployment is at a multi-decade low. Mark Carney – BOE governor – remains confident that UK real wage growth will pick up in coming months, but cautions that lacklustre growth will prevail over the short-term. Extensive surveys recently conducted by the BOE with some 700 businesses across the UK indicate that there is stable economic growth in the country.
Customers urged to verify interest rates on savings accounts
One of the biggest concerns in the UK economy is productivity, and this continues to be a bugbear for the stability of GDP growth prospects. Brexit-related pressures are degrading the purchasing power of the GBP, and curtailing expenditure in the UK economy. UK customers are likely to hold off on big-ticket purchases such as vacations, vehicles, and real estate as long as real wage growth declines and inflation remains a concern. The increase in interest rates will also make it difficult to contend with the increasing burden of high household debt in the UK.
While the 25-basis point rate hike is marginal, it will make it a little more difficult for struggling households to repay their debts, while making it a little better for those with savings in their bank accounts to enjoy interest-related earnings on their investments. However, there were at least 6 UK banks, including HSBC, and Lloyds that did not immediately respond to the interest rate hike on Thursday, 2 November by increasing benefits to savers. Most all UK banks immediately hiked lending rates following the BOE decision, but they weren’t so eager to pass on these benefits to savers.
EU subject to low inflation
In the European Union, low inflation remains a concern. While headline inflation rates have risen slightly in 2017, this is largely due to rising WTI and Brent crude oil prices. However, inflation figures excluding energy and food costs are a different prospect altogether. In the European Union, the European Central Bank (ECB) has a negative benchmark deposit rate. In other words, commercial banks are charged a fee by the ECB to hold money with them. This reduces bank profits by making it a disincentive not to lend out money. Olsson Capital expert Samuel Goldfarb explains that, ‘…Negative interest rates are designed to encourage banks to loan money to accelerate the velocity of money flow through the economy. This is geared towards increasing the inflation rate.’
Much the same is true in Japan where the deposit rate is also negative. The European Central Bank has acted slowly in pursuit of quantitative tightening, and has only hinted at an easing of monetary expansion without actually giving details of rate hikes. In the United States, rising interest rates are now the order of the day. The Fed has embarked upon multiple rate hikes since December 2015, and yet the US interest rate remains at 1.00% – 1.25%. Towards the end of 2016, the Fed indicated that it would raise rates at least four times in 2017 – this did not happen. Had it been the case, the federal funds rate in the US would be in the region of 1.75% – 2.00%.
The implications of higher interest rates are improved returns on fixed-interest-bearing accounts, higher costs of loans, and a stronger USD. If economists are correct, the federal funds rate could reach 3.5% within the next two years. This will have far-reaching implications on borrowers, notably on mortgages which will rise well above their current 4% – 4.5% range. It will also have a detrimental effect on US household debt levels which are currently at an all-time high at well over $12.73 trillion (May 2017). The level of household debt in the US now exceeds the pre-global crisis level and it is rising fast. Sharp increases in student loan debt, and credit card debt are evident, with mortgage debt comprising the biggest component of the household debt burden.