Interest rate update

Uncertainty appears to be the watchword among policymakers at the Bank of England (BoE). Recent events have provided few hints on the possible direction of interest rates and the timing of any potential movements, and the Monetary Policy Committee (MPC) remains divided on future strategy.

Rates were kept on hold for the 24th month in a row in March. However, minutes of both the February and March meetings show a split has begun in the Committee. Three members have twice voted for an increase of at least 0.25 percentage points, while another continues to vote for an expansion to the currently dormant quantitative easing programme.

Despite that, external speculation about further quantitative easing measures appears to have abated, at least for the time being. Current inflationary pressures reduce the scope for injecting more money into the economy, as this would likely fuel prices. The Consumer Price Index remains stubbornly high, well above the BoE’s target of 2%, and registered a further rise during February, to over double that target, ie: 4.4%.

Nevertheless, the MPC is limited in how much it cool inflation by raising interest rates; although they remain at their lowest level since records began more than 300 years ago, it is difficult to increase them without impacting the UK’s fragile economic position. The economy shrank by 0.6% in the final quarter of 2010 and government spending cuts, coupled with the increase in VAT from January, are likely to further impact any prospects for economic expansion, particularly in the construction sector, and the full effects of these are yet to be seen.

Although inflation remains significantly above target, the MPC’s expectations for inflation in the medium term remain "anchored". It is not until 2013 that they expect it to fall back below 2%. With the lack of any other clear signal, the path of interest rates is therefore likely to be influenced by other events in the world economy albeit with one eye on what happens once the government spending cuts properly take hold.

For the moment then, low interest rates continue. Such a strategy will continue to be welcomed by borrowers; however, it will prolong the headache for savers, particularly those who are looking for a low-risk home for their money. Whilst the rest benefit from lower repayments on borrowing, those who focus on deposit accounts are getting little return on their money and inflation continues to eat away at its real value.