Base rate increases: the dawn of a new era?
3,774 days. 82 Monetary Policy Committee (MPC) meetings. 10 birthdays. All that and more has passed by since the last increase to Bank of England (BOE) rates in July 2007.
As was the case this week, the committee voted to increase base rates by 25 basis points (to 5.75 per cent) on that July summer's day. But it was an unrecognisably-different world back then. The economy was chugging along serenely off the back of the mid-2000s boom. Tony Blair had only vacated the Prime Minister's office the week before. One pound would have got you more than two US dollars. And Rihanna's "Umbrella" was the UK's number-one hit single.
A little over a month later, BNP Paribas sent shockwaves around the world by freezing £1 billion of funds in response to subprime mortgage defaults. Then Northern Rock was bailed out as autumn began to descend. And a year after that, the full ferocity of the financial crisis hammered the world, as Lehman Brothers filed for bankruptcy, paving the way for banking turmoil and the deepest recession in the UK since the 1930s. Just 20 months after that fateful base rate increase, the MPC cut rates to 0.5 per cent in March 2009 - a then 315-year record low, until rates were eventually cut further to 0.25 per cent last August.
Reflecting on this week’s decision
With all that water having gone under bridge, it was scarce wonder that the City - and indeed all parts of the UK - were on tenterhooks on Thursday, as the much-anticipated first increase to Bank rates in over a decade came to fruition. At Lending Works, a rates increase is something we've long advocated - both for the reason that long-suffering savers are due some respite, and our belief that it is essential to recalibrate an economy whose dependence on ultra-low rates risks fuelling a credit bubble.
We noted with concern the dovish tone struck by Governor Mark Carney in Thursday’s subsequent press conference, confirming that any future rate increases will be slow and gradual. Nevertheless, this long-overdue change of direction is a welcome one, and should (hopefully) mark the turning point after what has been dubbed by some experts as a ‘lost decade’.
What does it mean for consumers?
Having been squeezed for a long period of time, savers probably aren't going to be jumping for joy at this modest increase. Nevertheless, it is they who stand to gain most, with banks and building societies (in theory) set to respond by offering improved returns in the short term.
Less happy will be those with variable, tracker or discount mortgages, who are likely to see their monthly repayments increase very soon (indeed, some providers have ALREADY announced rate rise). For those with a £100,000 mortgage, an increase in repayments of roughly £17 per month can be expected.
Those with fixed-rate mortgages will be unaffected in the short run. The same will apply to those with existing credit card debt, personal loans and student loans (if taken out in the last four years). However, those who plan to acquire credit, or apply for a card balance transfer, in the near future may be subject to APR and/or fee increases, so best to act quickly.
Relevant to all consumers will be the impact on inflation, which has now nudged above 3 per cent. Other things equal, a rate increase should strengthen sterling, which, given that recent inflation has been attributed almost entirely to the currency's devaluation over the past year, should act as a curb.
Owing largely to Carney's press conference, the pound actually tumbled in response to the rates increase. However, provided there are no other external pressures on inflation (or sterling), it should begin to tail off in the coming months, which will allow consumers to get more for their money.
What does it mean for Lending Works customers?
The first thing to point out is that, as a peer-to-peer lending platform, our rates - both lender and borrower - are not directly tied to Bank of England rates. Instead, the base rate for our calculations is broadly determined by the supply of lender capital and the demand for loans. As such, there will be no knee-jerk response from ourselves to Thursday's MPC decision.
That said, market forces will invariably impact this equilibrium between lender capital and borrower demand. It is our expectation that banks and building societies will be slow to pass on the benefits of the base rate increase to savers. Conversely, the market for loans is likely to become less competitive. The reasons for this are two-fold: firstly, the bigger players on the high street are set to hike borrowing costs fairly soon. Secondly, Carney indicated concern that their lending practices have become too loose.
Lending Works exclusively writes loans for prime borrowers with high credit scores anyway, so nothing will change in this respect. In fact, in the likely event that banks begin to increase APRs on the loans they offer, borrowing through our platform will become even more attractive.
Increased demand for Lending Works loans would then have a positive effect on lender returns, which, in the absence of significant boosts to savings rates, may make the prospect of shopping further up the risk spectrum more appealing for those seeking a better return.
Although this is all theoretical, and a number of factors could disrupt such a hypothesis, it is very plausible that this BOE rates increase will be advantageous for Lending Works and its customers.
The wider economic outlook
As important as the wellbeing of our customers is, we also wish the very best for the wider UK economy. There is no perfect time to tighten monetary policy, and there will be winners and losers. And we respect the counter arguments citing mediocre economic growth, Brexit uncertainty and the risk of an adverse impact on retail sales in the lead-up to Christmas.
But the latter epitomises the dangers of a UK economy being propped up on the sand of increased household credit. It is, in effect, an artificial and unsustainable means to keep things ticking over, and a small rate increase should help to rein in those who risk living beyond their means.
More positively, there appears to be good news on the Brexit front, with ground ostensibly being ceded on both sides of the negotiating table this week. And while growth remains modest, it still exceeded expectations in Q3, and services and manufacturing remain resilient.
Perhaps the biggest bounce of all could be a shift in wage growth. Incomes have remained stubbornly low in recent times. But with full employment just about reached, and high levels of vacancies across many sectors, it is likely that workers will start reaping the benefits very soon (as Carney inferred on Thursday). Added to that, a labour market with limited slack is a catalyst for capital investment, which, in the medium term, can only be a good thing for productivity.
Although much of our optimism may be predicated on the hypothetical, that is indeed the very nature of economics, where nothing is fact until it actually happens. One thing is certain though - near-zero interest rates are not the foundations upon which a strong, dynamic and sustainable economy can be built. And with so many compelling reasons to finally begin the process of normalising rates, the question had simply become: if not now, then when?