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Points of View: Interest Rates

On Thursday the Monetary Policy Committee (MPC) voted 7 to 2 in favour of raising interest rates. This came as no surprise to investors who had priced in a greater than 90% chance of a rate rise. 

The market reacted counter-intuitively to the announcement. The yield on 10 year gilts fell 0.08% and sterling fell 1.4% against the dollar. Previously the Bank of England (BoE) had given guidance that rates might need to rise faster than markets anticipate. Instead, the latest announcement said subsequent rate rises would be gradual – a more conservation tone. The BoE also revised inflation figures downwards and made reference to a negative impact from Brexit on the economic outlook. 

One of the main concerns in raising interest rates is the impact it will have on household mortgage payments. The BoE estimates that the servicing cost of the average mortgage will increase by £15 per month once fully passed on by lenders. However, the overall impact of this will take time to filter through. Fewer households own a mortgage than previously and there has also been an increase in the number of households on fixed rate mortgages. 

The BoE faces the same problem as the US Federal Reserve, aiming to increase rates so as to prevent a sustained rise in inflation but not so quickly as to damage the economy. While the BoE have been clear that this rate rise is not a one-off but part of a sustained policy, the market’s reaction has been one suggesting further rate rises are further away than previously estimated. It is important for the BoE to get interest rates back to more normal levels to allow them more options for the next economic downturn. However, any further increases would put pressure on households and companies struggling to service their debt.

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