“Interesting” Times: The Guessing Game About Interest Rates Continues

When the United States Federal Reserve – the Fed – announced an interest rate hike in late 2015 as an attempt to “normalise” the US economy, the rest of the world took notice. Not surprisingly there was much speculation initially about how this fractional rise might ultimately affect the UK, and to date there is still no clear answer. To the contrary, though the experts agree that an increase is inevitable, they continue to revise their predictions about when rates will rise, and by how much. A number of global financial events have added to the uncertainty. And nearly all the speculation is framed in the question that is on everyone’s mind, always: are we headed for another financial crisis?

A big shift in interest rate predictions

Throughout much of 2015, the British financial media were abuzz with speculation and advice about the expected interest rate rise. It was generally expected that rates would start rising by the end of 2015. After the Feds made their announcement, however, the prediction was that the UK Bank Rate would rise in December 2016 or January 2017.

But many have changed their tune again in response to dwindling oil prices and stock market volatility. In January of 2016, leading Bank of England policymaker Gertjan Vlieghe, citing a fall in oil prices and shares in London, said that ultra-low interest rates could well persist for years to come. He said that policymakers should “be prepared for the possibility that real interest rates will remain well below their historical average for a very long time”.

In light of more recent developments, however, the predictions shifted again, even more dramatically than before, with some experts saying the first rate increase won’t come until summer 2019. (Are you beginning to see a pattern here?) Some of the factors involved in this shift include concerns about the ripple effects from the plunge in China’s economy, plummeting oil prices, an apparent slowdown in the growth of the UK economy, and what is seen by many is inaction by the BOE to stimulate that growth.

The big banks: More capital, but bigger stakes

Interest rates are just part of the larger picture, of course, and it’s almost impossible to peruse any of the financial media without some doom-and-gloom warning that we are headed for another 2008-style meltdown, a warning seemingly reinforced by the banks’ own behaviours that mirror many that were exhibited as a result of the 2008 crisis. All eyes are on the big banks, which are under more pressure than ever.

It should come as no surprise that the banks remain cautious in their lending decisions. In addition to the “once burned, twice shy” mindset caused by the global collapse, lenders are keenly aware how historically high unsecured individual debt has risen, and how great an effect it would have on the banks’ bottom lines should a significant portion of borrowers and cardholders default on their debt.

And while consumers might be rejoicing over the drop in the price of fuel, the low sell price per barrel of oil is having a negative ripple effect on other industries, many of which have outstanding loans and lines of credit with the banks. Should these businesses begin to fail, the ripples could well become tsunamis.

The myriad pressures to which the bankers are subjected are amplified by the fact that many of those pressures find their source in events that are well beyond the bankers’ realm of influence, much less their control. And when consumer demands are in direct conflict with what bankers have come to accept as prudent banking practice, it is surprising that all bank executives and regulators haven’t developed high blood pressure and bleeding ulcers.

One wonders whether it might be a good idea to raise interest rates a bit, sooner rather than later, if only to soothe some of the pressure on the banks and restore a degree of confidence on the part of British savers and lenders alike. Evan a small upward move could incentivise business investment and by extension free up some lending capital. And while there are numerous arguments that can be reasonably made against such an action, it should be kept in mind that the lack of confidence shared by consumers and lenders alike could give rise to negative effects that might far surpass any damage that small incremental increases in the rates might cause. At this point, it is as much a matter of guesswork and a hope for positive outcome as anything even remotely scientific. As such, we’re probably wise to prepare for whatever we might even imagine coming to pass because it just might do so.

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