The Bank of England has stated that the stronger than expected recovery could see the 7 per cent unemployment benchmark for considering a rise in interest rates arrive sooner.
In its latest Inflation Report, the Bank said that the ‘stronger near term outlook’ meant that ‘unemployment was likely to fall more quickly than anticipated in August’ - on the same morning that this was issued unemployment ticked down to 7.6 per cent from 7.7 per cent.
But while the outlook for when unemployment may fall to 7 per cent has been brought forward from late 2016 to early 2015, crucially the Bank highlighted this would not automatically trigger the base rate rising from its record low 0.5 per cent.
The Inflation Report said: ‘The Committee reiterated that reaching the unemployment threshold would not necessarily trigger an immediate policy response. Rather the setting of policy at that point would depend on the outlook for inflation relative to the target and on the need to provide continued support to output and employment.’
When will interest rates rise? The Bank of
England's November inflation report shows money markets suggesting
mid-2015 and economists later that year.
The Inflation Report said: ‘In that regard, the Committee noted that its projections conditioned on the assumption that Bank Rate remained at 0.5% implied that no policy action was taken when the unemployment threshold was reached.'
A growing divide emerging on when a rise would come had led to suggestions forward guidance conditions could be changed in the November Inflation Report - just three months after they had been first laid out.
This forward guidance said that the bank would consider raising rates when unemployment fell to 7 per cent, with knockout clauses in case unless runaway inflation looked likely or there was a threat to financial stability. It expected the unemployment condition to be met in late 2016.
Money markets had suggested that a rise would come slightly sooner than the Bank thought - after a spike to a whole year earlier in late summer - while a growing band of economists had forecast a first base rate increase as early as 2015.
Base rate was held once more at 0.5 per cent last week, while this week inflation fell to 2.2 per cent in October from 2.7 per cent in September and today unemployment eased to 7.6 per cent in October from 7.7 per cent the month before
Rate forecasts: The Bank of England shows how
the money markets have brought forward rate hike expectations - a 0.75%
base rate is now suggested in mid-2015 rather than early 2016.
But the NIESR week’s forecast of rates needing to go up sooner was not tied to unemployment . Instead an earlier rise was tipped to keep the economy from overheating. It said rates would move off their record low in 2015 - earlier than the Bank of England's late 2016 forecast.
The economists who believe the Bank will find it impossible to stick to its predication are looking at the property market, economy and confidence heating up.
The NIESR predicts an ahead of schedule increase to stop low rates from causing instability - with rising consumer spending and house price inflation the potential triggers. Strong GDP growth of 0.8 per cent was recently reported, while surveys across manufacturing and services point to a rapidly improving picture.
Jobs growth: Bank of England says the probability of unemployment falling to 7 per cent has increased since August
Holding steady: Consumer prices stayed at 2.7 per cent in September despite falls in petrol prices, food and airfares
Forward guidance, inflation and unemployment
The all important numbers are inflation and unemployment.Inflation had a suprise drop to 2.2 per cent in October from 2.7 per cent in September and unemployment has come down to 7.6 per cent from 7.8 per cent when forward guidance began in August.
The Bank of England has laid out a plan to keep rates at 0.5 per cent until 2016, unless unemployment falls to 7 per cent, the inflation outlook spike, or financial stability is threatened.
The inflation knockout conditions are if in the monetary policy committee's view, it is more likely than not, that CPI inflation 18 to 24 months ahead will be 0.5 percentage points or more above the 2 per cent target. Or that medium-term inflation expectations no longer remain sufficiently well anchored.
However, the Bank and other analysts argue that Britain has plenty of underused jobs capacity and unemployment may fall more slowly, as firms up the hours of those working part-time and more of those not currently actively looking for work start to do so.
Robust growth: Economists described the employment figures as showing economic conditions were continuing to improve
Forward guidance vs inflation
The UK interest rate outlook has undergone a transformation with this initiative from Mark Carney, which was launched alongside his first quarterly inflation report as Bank of England governor.He has pledged that rates will not go up as long as the unemployment rate remains above 7 per cent. The Bank itself projects a very slow recovery that will not see it fall below 7 per cent much before late 2016.
The move has been broadly welcomed by the markets and economists, although they have indicated the Bank may be overly pessimistic and rates could go up sooner than suggested.
While forward guidance has many supporters, there are fears that the Bank will be painting itself into an even tighter corner by saying when it expects to raise base rate.
It is already hamstrung by the nation's high levels of mortgage debt and the more mortgage lending that is done at low interest rates now, the harder it will be for homeowners to stomach rates returning to anywhere near normal.
Luckily, for those borrowers but unfortunately for savers, economists don't predict a rise anytime soon.
When will rates rise? The benchmark chart from the inflation report shows how money markets expect rates to rise.
QE vs Funding for Lending
Should the economy take another serious turn for the worse, more QE is forecast, but if it continues along the current path the Funding for Lending scheme is tipped to be the most likely stimulus for the near future - allowing banks and building societies to take cheap cash from the Bank and pass it on to mortgage borrowers and businesses.It has driven mortgage rates down substantially, albeit with the best benefits delivered to those with big deposits, but banks are still being accused of hoarding cash and shunning small and medium-sized businesses.
Figures are being skewed by mammoths Lloyds Banking Group and Royal Bank of Scotland winding down their historical loan books and Spanish giant Santander easing back on its former mortgage expansion policy.
One group undeniably hit very hard by Funding for Lending has been savers. Returns on savings accounts have dived since its launch in a race to the bottom that has seen big cuts in the best deals on offer.
The best easy access savings rate now stands at just 1.6 per cent, whereas before the launch of Funding for Lending savers could get between 2.5 per cent and 3 per cent.
Mind the gap: How base rate and inflation have
moved over the past 24 years - the dramatic slashing of rates since the
financial crisis shows how far from normal we are.
Rollercoaster ride: The inflation report chart
shows how money market and economists' expectations of when a first rate
rise will come have moved.
HOW DO YOU FORECAST FUTURE INTEREST RATE RISES?
We
can't - no one can. But we look at overnight swap rates to work out
roughly when money markets forecast the Bank Rate will start to rise
from the rock-bottom level of 0.5 per cent.
This is very far from a precise business - not only do financial traders make wrong predictions all the time, but swap rates are only a snapshot of their views at a given moment in time.
Money market forecasts often diverge from reality, as well. For instance, swap markets for some time predicted a cut to 0.25 per cent within the next few years, well before a hike to 0.75 per cent is likely to materialise.
However, this was considered most unlikely to happen even though the Bank rate-setters dutifully discussed it every month. Economic experts say that for practical reasons it could curb lending rather than increase it, making it counterproductive as a method of promoting recovery.
The overnight swap rates move substantially. Take a look at the following chart, which appeared in the May Bank of England inflation report and illustrates interest rate projections in May compared with February. There is almost a two year gap between the outlook just a few months apart.
Like the Bank of England, we
use the overnight index swaps curve to look at what the money markets
are predicting for interest rates, and importantly how this is shifting.
Economists also make predictions of when rates will go up, which are often quite different from those signalled by the money markets.
We frequently quote their views here too if they help shed light on the issue for readers.
You can then consider all the available information and make your own best guess on when interest rates will rise.
This is very far from a precise business - not only do financial traders make wrong predictions all the time, but swap rates are only a snapshot of their views at a given moment in time.
Money market forecasts often diverge from reality, as well. For instance, swap markets for some time predicted a cut to 0.25 per cent within the next few years, well before a hike to 0.75 per cent is likely to materialise.
However, this was considered most unlikely to happen even though the Bank rate-setters dutifully discussed it every month. Economic experts say that for practical reasons it could curb lending rather than increase it, making it counterproductive as a method of promoting recovery.
The overnight swap rates move substantially. Take a look at the following chart, which appeared in the May Bank of England inflation report and illustrates interest rate projections in May compared with February. There is almost a two year gap between the outlook just a few months apart.
Outlook: The Bank of England's May Quarterly Inflation report mapped out the market's expected path for Bank Rate.
Economists also make predictions of when rates will go up, which are often quite different from those signalled by the money markets.
We frequently quote their views here too if they help shed light on the issue for readers.
You can then consider all the available information and make your own best guess on when interest rates will rise.
Why 'swap rate' money markets matter to savers and borrowers
When markets move a decent amount - and the move holds - it can affect the pricing of some mortgages and savings accounts. When swaps price a rate rise to come sooner, fixed rate savings bonds tend to marginally improve in the weeks that follow. But it also puts pressure on lenders to withdraw the best fixed mortgages.As for using swaps as a forecast, we've consistently warned on this round-up that they are extremely volatile and should be treated with caution - they should be used more as a guide of swinging sentiment rather than an actual prediction.
This is Money has always advocated caution with any sort of prediction (including our own!). There's no guarantee that those who have made correct calls in the past will make them in the future.
We'd also urge consumers not to gamble with their personal finances when it comes to predicting rate swings.
Some swap rate prices and and charts are displayed below to show how the market moves as economic prospects shift.
One year ago - 2012
• 0.91% - one year
• 0.80% - two years
• 1.03% - five years
8 August
• 0.82% - one year
• 0.80% - two years
• 1.07% - five years
2 October
• 0.75% - one year
• 0.71% - two years
• 1.00% - five years
21 November
• 0.67% - one year
• 0.70% - two years
• 1.06% - five years
12 December
• 0.65% - one year
• 0.66% - two years
• 1.00% - five years
This year - 2013
16 January 2013• 0.67% - one year• 0.72% - two years• 1.12% - five years19 February• 0.64% - one year• 0.69% - two years• 1.19% - five years
6 March (after Bank of England raised possibility of negative interest rates)
• 0.57% - one year• 0.59% - two years• 1.05% - five years
19 March
• 0.57% - one year• 0.61% - two years• 0.97% - five years
28 March (after big chill and Cyprus crisis heightened triple-dip threat)
• 0.60% - one year• 0.61% - two years• 0.95% - five years16 April (after inflation sticks at 2.8 per cent)
• 0.58% - one year• 0.58% - two years• 0.93% - five years
25 April (after UK narrowly avoids triple-dip recession)
• 0.57% - one year• 0.58% - two years• 0.92% - five years
16 May (after Sir Mervyn King upgrades growth forecast)
• 0.59% - one year• 0.62% - two years• 1.05% - five years
24 May (after lower than expected inflation figures)
• 0.59% - one year• 0.635% - two years• 1.06% - five years
10 June (after better economic news)
• 0.625% - one year• 0.735% - two years• 1.28% - five years
24 June - money markets spike
• 0.754% - one year• 0.961% - two years• 1.787% - five years
1 July (as Mark Carney arrives)
• 0.671 - one year• 0.815% - two years• 1.552% - five years
31 July
• 0.606 - one year• 0.696% - two years• 1.400% - five years
7 August (forward guidance arrives)
• 0.637 - one year• 0.750% - two years• 1.573% - five years
20 August
• 0.654% - one year• 0.819% - two years• 1.751% - five years
29 August
• 0.647% - one year• 0.824% - two years• 1.716% - five years
5 September
• 0.682% - one year• 0.954% - two years• 2.00% - five years10 September
• 0.679% - one year• 0.932% - two years• 1.98% - five years
30 September
• 0.649% - one year• 0.835% - two years• 1.732% - five years
16 October
• 0.615% - one year• 0.810% - two years• 1.83% - five years
28 October
• 0.640% - one year• 0.805% - two years• 1.664% - five years
6 November
• 0.590% - one year• 0.845% - two years• 1.755% - five years
Five-year swaps (influences 5-yr savings bonds and fixed mortgages)
Since January 2010
Beware false dawns
In early 2010, markets prematurely began pricing in a greater chance of rate rises because of rising UK inflation. They did the same again in early 2011. But as we've repeatedly argued on this round-up, deflation rather than inflation has remained the greater long-term threat. Treat claims of rapidly rising rates with caution!
What decides rates?
The BoE's Monetary Policy Committee meets once a month and sets the bank rate. Its government-set task is to keep inflation below 2% (and above 1%), looking two years ahead. So if inflation looks likely to pick up, it raises rates.
Viewpoint: Why rates WILL rise
When inflation was worryingly high in 2011, these views gained traction.
One popular theory is that Western governments want to create inflation to try and erode their record debts, created in part by bailing out banks. Billionaire Warren Buffett (right) warned about this in August 2009 well ahead of the pack (as usual).
One controversial economist warned inflation would force the MPC into a series of rate rises, taking the bank rate to 8% by 2012.
Weak sterling in 2010 and 2011 also added inflationary pressure: falls in the pound make it more expensive for Britons to buy foreign goods, effectively importing inflation. [ what next for the pound?] And we're also importing inflation from booming China.
Others point out that rapid rate rises are rarely expected. Insurance service RateGuard points out periods of quick-fire increases in the chart below.
This round-up was created in 2007 by Andrew Oxlade and downloaded more than 13 million times. His involvement ceased in December 2012 and it is now updated by the ThisisMoney team.
Bank of England
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