Chicken and egg scenarios
While many had predicted that UK base rates would rise at some point during 2014, predominantly on the back of a promise made by the Bank of England (BoE) last year that it would review base rates when unemployment fell to 7%, doubts have emerged that the BoE will raise base rates even if unemployment falls below that level. Why? Well, despite falling unemployment, inflation, when measured by the Consumer Price Index or CPI, is dropping like a stone, down from over 5% two years ago to just 2% at the end of 2013. With inflation fast heading towards deflation the BoE will be unlikely to raise the base rate, even if the number of people returning to work is rising.
So why is inflation falling when the economy appears to be reviving? Perhaps because Sterling is getting stronger, which is making imports cheaper and considering that 40% of all food and drink we now consume is imported and most of the clothes we wear and items in our homes are not made in the UK, the value of Sterling directly impacts the CPI. This explains why we had such high inflation between 2008 and 2011, because Sterling weakened by 25% against the US Dollar during that time (from $2.00 to $1.50), making imports much more expensive.
On the plus side, such a weak sterling eventually led to rising exports, which gradually improved our economy and led to falling unemployment and caused many investors to believe that the UK would be one of the first developed economies to start raising its base rate, after almost five years at 0.5%.
Unemployment has already fallen to a smidgen above the BoE’s threshold
When forward guidance first arrived in August last year, the Bank said it did not expect unemployment to fall below 7% until 2016. More recently, the BoE readjusted its expectations and said that unemployment could reach the 7% threshold in early 2015, leading the Bank Governor Mark Carney to indicate the guidance model would probably keep the bank rate at rock bottom for about another 18 months.
However, the Minutes from the latest meeting (8th and 9th of January) were released on 23rd of January coinciding with the latest labour market figures from the Office for National Statistics, which showed that UK unemployment fell to 7.1% in the September to November period.
The Minutes revealed that the BoE is still clearly dovish reportedly stating that: ‘Inflation had returned to the 2% target...and cost pressures were subdued. Members therefore saw no immediate need to raise the Bank Rate even if the 7% unemployment threshold were to be reached in the near future.’
So much for forward guidance!
Is it time to follow the companies and borrow at a fixed rate?
Sainsbury’s is reportedly seeking a £1bn loan as banks offer the largest companies the lowest borrowing rates in more than five years, according to report by Bloomberg.
Interest margins on loans to large corporates in the UK dropped in the final quarter of 2013, the BoE said in its Credit Conditions Survey, stating that lenders expect spreads to fall further in the first three months of this year.
Sainsbury’s are not alone and it appears that many companies are locking into low interest rates in anticipation of rising base rates. In the US, Apple raised $17bn from a bond sale in April last year, a record for any company at the time, but earlier this month Verizon Communications borrowed $49bn through the sale of 10- and 30-year bonds!
The question is, if large companies are fixing their borrowing costs at the moment, should a landlord follow their lead? After all, even though the BoE is talking down a base rate rise, it clearly does not have a crystal ball with regards to the economy, as we have seen over the past few months with falling unemployment taking them by surprise.
The impact on UK households if base rates do rise could be severe, according a think tank formed by the Resolution Foundation, which forecasts that around 1m households would face ‘perilous debts’ if BoE base rates rose to 3%, with 2m forced to spend more than half their income on servicing a mortgage if rates returned to the 5% level that was common before 2007.
A homeowner that has been lucky enough to have a tracker mortgage at just 1% over the base rate would see the cost of a £150,000 interest-only mortgage soar from £188 a month to £500 a month if base rates rose to 3%, and to £750 a month if it hit 5%.
No surprise then that a new study by Nottingham Trent University has found that lenders profit more from variable mortgages than from fixed rate loans. Researchers suggest this is why the UK mortgage market has a shortage of long-term fixed rate products, which can protect borrowers from financial shocks.
It appears that the time to fix your mortgage rate has finally arrived…assuming your bank will let you!
