James Barbour’s round-up: Interest rates, uncertainty and the underdog

Bank of England
James Barbour By James Barbour, ICAS Director Technical Policy

4 August 2016

James Barbour, ICAS Director Technical Policy, looks back some of the week’s key events.

When I took part in a webinar for a well-known accountancy magazine in October 2008 (post the collapse of Lehman Brothers), the UK base interest rate was 4.5%.

Although at that time it was clear that the UK Government was set to embark on a programme of quantitative easing and also cut the base interest rate, I could never have predicted that almost a full eight years later, the Bank of England’s Monetary Policy committee (MPC) would still be cutting interest rates  - but then again, I never thought that it would be possible for a club such as Leicester City to win the Premiership.

The decision on 4 August, 2016 by the MPC to reduce the base rate interest for the first time in seven years to 0.25% may have seemed almost inevitable in the current economic climate but will it have any impact?

At least some economists remain sceptical and believe that there may be greater merit in the BOE adopting more radical policies such as the bank funding tax cuts, providing cash direct to the public via helicopter payments or creating money to help fund large infrastructure projects.

I personally fall into the sceptical camp as to the merits of a further interest rate cut but, as with everything, only time will tell.

The MPC has announced that it is launching a Term Funding Scheme which is specifically designed to provide funding for banks at interest rates close to Bank Rate.

To be fair to the MPC they have recognised that as interest rates are close to zero, it is likely to be difficult for some financial institutions to further reduce their existing deposit rates, hence limiting their ability to further cut their lending rates. Therefore, the MPC has announced that it is launching a Term Funding Scheme (TFS) which is specifically designed to provide funding for banks at interest rates close to Bank Rate. The MPC believes that this action should:

  • Assist to reinforce the transmission of the reduction in Bank Rate to the real economy to ensure that households and firms benefit from the MPC’s actions; and
  • Provide participants with a cost effective source of funding to support additional lending to the real economy, providing insurance against the risk that conditions tighten in bank funding markets.

The BOE also highlighted in its Inflation Report that it expects there to be little growth in the UK economy the second half of 2016, and for this to slow to just 0.1% in 2016 Q3. It is also predicting a gradual decrease in household spending growth as consumers respond to a slowing in income growth, while investment spending continues to decline. Find out more about what the BOE is saying.

The UK is not alone in cutting interest rates this week, with the Reserve Bank of Australia also cutting interest rates by 0.25% to 1.5%. The reason for this cut certainly divided commentators but I personally believe that to some extent the cut reflects global economic conditions catching up with Australia.

We now await with interest the next US interest rate decision which will be made by the Federal Market Open Committee of the Federal Reserve Board (the Fed) on 21 September.

Sticking with the US, the number one issue at least in the media is not whether the Fed will raise interest rates in September but rather the ongoing US Presidential race saga.  As noted by Leicester’s triumph above, this is a year when the underdog has most certainly come to the fore.

Will Donald Trump be able to upset the odds and become the President of the US? Not, if the latest polls are anything to go by.

However, as the recent EU referendum and last year’s UK general election have shown, the polls cannot always be trusted. Uncertainty, would appear to be the new certainty. Business may not like it, but it looks like it will just have to get used to it and seize any opportunities that are presented.

Topics

  • Business
  • Opinion
  • USA
  • Australia

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