Why Britain’s interest rate will still be below 1% in a year’s time
NOW that the economy is growing strongly again, Britons can worry about something slightly different: when will interest rates rise, and by how much? Savers, who have endured five years of pitiful returns since the Bank of England cut its rate to 0.5%, are desperate for an increase. Borrowers dread one. A rise of one percentage point would mean extra mortgage, credit-card and personal-loan payments of around £14 billion ($24 billion), or roughly £500 for every household.
Both camps have taken heart recently—and traders have been thoroughly confused—as Mark Carney, the Bank of England’s governor, has seemed to waver between hawkish statements and dovish ones. But those longing for an early rise are more likely to be disappointed. Despite surging house prices and a much improved labour market, interest rates will probably stay below 1% for at least another year.
The Bank of England’s monetary policy committee (MPC) is supposed to ensure that inflation returns to 2%. It is now just 1.5%, which would normally imply that interest rates should be cut, not increased. Inflation expectations are drifting down, too. Six months ago a poll of large firms by Deloitte, a consultancy, showed that bosses expected inflation to overshoot the MPC’s 2% target; in the most recent survey most expected inflation to hit it. Consumers concur: a regular poll by GfK NOP, another consultancy, shows that inflation is expected to be 2.6% in a year’s time, the lowest since 2010 (see chart).
Nor is there much wage pressure. Pay including bonuses was just 0.7% higher in early 2014 than a year ago. Wages are falling in finance and construction, two industries still recovering from the crash. Even sectors where pay outpaces inflation—wages are up by 2% in retailing and manufacturing—are hardly red hot, and the rate of increase is starting to slow.
This trend has flummoxed economists. During five consecutive quarters of growth, fully 299,000 unemployed Britons have got jobs. Over 100,000 who had not been seeking work have joined the hunt, making the active workforce—now 30.5m—bigger than ever. Why has this hiring spree not forced up pay?
The answer is a combination of spare capacity and flexible wages. The staggering losses of 2008-09—unemployment shot from 5% to 8% in just over 12 months—mean there are still 2.2m people looking for work. All those would-be toilers make it harder for people who have jobs to argue for a pay rise. And a new paper by João Paulo Pessoa and John Van Reenen of the London School of Economics shows how flexible wages have made labour a cheaper input, allowing firms to substitute bargain-basement workers for costlier machines.
Before the crash, pay rises of 3% or more came only when unemployment was around 5% (see chart). Getting back to that level requires another 520,000 unemployed Britons to find work. Even if jobs keep being created as quickly as they are now, that would not happen until the second half of 2015. If the low-price, low-wage trend continues, a rate rise to calm the labour market could still be a year or more away.
The fevered London housing market is a headache for the MPC, creating pressure for the regulators to slow the boom by raising rates soon. They are unlikely to do so. For a start, others are helping to cool credit markets. Lenders are pushing up their rates: mortgages are costlier than they were six months ago, and personal loans and credit cards are pricier than their 2011 lows. Hefty loans are becoming scarcer. New mortgage rules mean banks must quiz customers about their ability to repay if interest rates go up. Borrowers are thus being encouraged to behave as if official rates are going up even before they do.
And the Bank of England has new powers to deflate housing bubbles. On June 26th Mr Carney announced that it would ask lenders to cut down on mortgages with loan-to-income (LTI) multiples above 4.5. That will have the greatest impact in London and the south-east, the only regions of Britain where LTI multiples can rise so high. With these new methods calming the sole market that is overheating, a rate rise could still be a year away.
The low-rate recovery is mixed news for George Osborne, the chancellor of the exchequer. Persistent low pay allows his Labour critics to point out that Britain’s recovery has done little to help workers. He can answer by pointing to the healthy employment figures. (The larger workforce also boosts tax receipts, helping Mr Osborne trim the deficit).
But grumpy savers, many of them Conservative voters, are a political problem: 50% of over-60s reckon they would be better off after an interest-rate rise while just 7% think they would be worse off, according to a recent poll. The magic elixir for coalition ministers would be a combination of growth, higher pay and rising interest rates. They are unlikely to get it.
This article appeared in the Britain section of the print edition under the headline "Don’t hold your breath"
