UK Interest Rates: Will Merv swerve a rise?

Other / Jack Houghton / 08 February 2011 / 2

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Will Mervyn King increase interest rates?

"For my money an MPC rate rise is imminent, and, at [8.4], it might be worth throwing a few quid at it happening as early as this week."

Jack Houghton muses on the possibility of a short-term long-shot in a rare foray into financials betting

A large proportion of the estimated 12million mortgage holders in the UK will have wrestled with a classic risk-reward conundrum in the last two years: hold on to a standard or variable rate mortgage levied at bargain basement prices; or change to a long-term fixed rate product that is more expensive in the short-term, but provides certainty for the future.

In what has felt like an increasingly high stakes game of poker, I cashed in before Christmas, switching to a five-year fixed rate deal - the cards looking like they were about to get too rich for me.

Time will tell whether the decision was wise, or simply lily-livered. And that time might be as soon as Thursday, when the Bank of England's Monetary Policy Committee (MPC) meets to set interest rates.

Since March 2009, when the Bank lowered its base-rate to 0.50 per cent, the Betfair market on MPC decisions has been largely ceremonial, with little money exchanged and the price on the retention of the existing rate rarely trading above [1.02].

Nearly two years' on though, things are different. Although analyst consensus thinks a rise unlikely this month, the market is not as confident: at the time of writing, 0.50 per cent is available to back at [1.2] and 0.75 per cent is a viable second-favourite at [8.4]. What's more, the price on a quarter-point rise has tumbled over the course of the month - being backed at a one-time high of [50.0].

There are a number of factors that make that [8.4] attractive. First, in January's MPC meeting, Martin Weale joined long-time advocate of a rate hike, Andrew Sentance, in voting for a 0.25 per cent increase. This is evidence of an evolving view on the panel, with only three more members needed to move in the same direction to force an increase.

And economic results may persuade those three sooner rather than later. Set against news last month that the economy had shrunk in December have been a string of recent positive indicators - a surge in manufacturing output; a growth in the construction industry; and better than expected growth in the services sector.

Adding to rate-rise speculation are increasingly inflated inflation figures. The Bank of England stuck to the line last year that inflation was high because of unrepresentative short-term influences - oil prices, high import costs, VAT changes. But those "short-term" influences have yet to wane. So, in January, Bank Governor, Mervyn King, warned that inflation might hit anywhere between four and five per cent over the next few months.

With the Bank committed to keeping inflation below two per cent, these comments suggest a base-rate rise is on the horizon. That is unless, of course, the conspiracy theorists are to be believed, who say that the UK Government will actively encourage inflation in order to reduce its budget deficit and spiralling debt.

Personally, I doubt they will. Economic growth wins more votes than soaring prices, and Ministers will be as keen to secure the votes of those on fixed incomes as their counterparts in the Bank of England are to guard against hyperinflation.

For my money an MPC rate rise is imminent, and, at [8.4], it might be worth throwing a few quid at it happening as early as this week.

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martin avis | 08 February 2011

does it really matter if there is a small increase now? Interest rates will be low for years to come. Simple fact is that in reality most people can only just about afford their mortgage having bought over last five years. Hiking rates up would mean we would see people living in cardboard boxes on the street with soup kitchens at every corner, with the government left to bail out the banks for a second time. Forget it.. Mortgages need to stay affordable.
Ellen | 08 February 2011

Keeping interest rates low are keeping prices high, including house prices. It's a false bottom and it has to be taken away sooner or later. Those who will be worst effected are those who have taken out a mortgage in the last few years. Everyone else are paying inflationary prices to keep it going and savers a subsidising the overstretched. The longer the low interest policy goes on, the more damage it will cause. Inflation is bad for business and keeping interest rates low does not compensate for that.