In the UK interest rates reduced from 5% in 2008 to 0.5% during 2009. Since then the base rate of interest has stayed there and most of us have got pretty used to low rates, cheaper borrowing and (thankfully) lower mortgage repayments.
The Monetary Policy Committee (MPC) that decides on interest rates in the UK have been driven by inflation historically. The purpose of interest rates has been to control and manage inflation.
The thing is, with all the focus on ‘Inflation’ should we turn our focus instead to ‘Deflation’. If your money starts to be worth more tomorrow than it was yesterday, then what happens to consumer spending? How long do you put purchases off because with each day that goes by your £1 becomes more valuable?
Simplistic maybe. But there is a change of tact coming out between the lines, see these comments from Mark Carney, Governor of the Bank of England;
When asked about deflation; “It’s possible. The MPC provides a forecast, an updated forecast will come out in February and this is a question we’re looking at, and I would rather defer that until that forecast comes out”
This was followed by another question about deflation;
“It’s possible prices will fall in a given month, on a year-on-year basis. That’s possible. But broad based price falls across a broad range of goods and service, a change in people’s expectations, no. Because the Bank of England has the means, we have the will and we have our responsibility and we will take our responsibility to provide the necessary stimulus again to be absolutely clear, the path of policy though in order to achieve our target is likely to be one of limited and gradual interest rate increases”
All of a sudden the Bank of England (BOE) are looking at taking action to instigate inflation. If you take both quotes together then the summary position appears to be that interest rates will rise, albeit gradually, but take nothing for granted. It is also interesting that the BOE seem to be talking about foreign events and their impact on the UK.
These comments from the BOE were taken from an interview between Mark Carney and ITV news.
Back in 2010 the UK inflation rate was over 5%, base rates were at 0.5%. If base rates were only about inflation then you should have seen an increase, however we all know that at that time things were somewhat more uncertain and the world economy was, to say the least, complicated and fragile.
This month UK inflation has fallen below 0.5%. With oil prices falling then inflation could dip lower. Remember that even if oil prices stabilise, most of these reductions are yet to be passed on, there is a lag between oil prices falling and the consumer seeing the benefit in energy costs.
What It May Mean
There is very little certainty in economics. I remember HSBC’s senior economist once telling me that in economics you never make a forecast and give a timescale, always one or the other. As soon as you do both you will fail, do one then you will always be proved correct in the long run.
I guess this is what the BOE is doing. They are saying interest rates will rise at some point. They are saying that deflation may happen at some point. They are saying that things will change over the next 12 months, but not saying what.
If you want to learn anything from economic commentary then look between the lines, you will rarely find the answer within the text itself.
For UK SMEs the outlook is a little uncertain. By all means be cautious, but remember that the one thing that the BOE is saying is that any changes to interest rates will be gradual and slow. If low inflation, continued lower interest rates and oil prices stay where they are then it may be a good time to make that expansion, borrow those funds and finance that growth.
By Dave Farmer
Dave Farmer is founder of the award winning business finance specialist Lime Consultancy. Lime Consultancy are a Sussex based commercial finance expert.
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