How Do The Changing Predictions As To Interest Rates Affect You?

In response to the continued vigorous growth of the economy over the past year, and projections that the trend will continue for at least the next couple of years, some economists have projected that interest rates will begin to rise during the first quarter of 2016. This is understandable, as the rise in employment figures has boosted consumer confidence and increased the demand for credit in all areas, from credit card expenditures to home mortgages.

Bank of England responds

The Bank of England (BOE) would seem poised to raise the rates it charges lending institutions, if only to ensure that lenders’ responses to that demand don’t create another unsustainable bubble to plunge the UK into yet another crisis when it bursts. The rationale for such a response from the BOE would seem to be supported by the dramatic increase in housing prices, and the fact that the pace of new construction has increased in a manner consistent with those price increases. We’ve seen this kind of rise before, and the sting of the bursting of that bubble is still fresh in lenders’ memory.

But that response wasn’t exactly what was expected

BOE Governor Mark Carney reminded policymakers that domestic responses to Britain’s increasingly rosy economic picture must be tempered by the effects of higher but still slowly-increasing interest rates in the U.S., as well as the depressed price of foreign commodities, the continued low price of oil being chief among them. His projection is that interest rates would remain at or near their current level well into 2016, and perhaps even into 2017. The ultimate effect, according to Mr. Carney, will be that inflation will rise beyond BOE’s ideal levels by the end of 2018, the largest overshoot since February of 2013.

What this means to the average citizen

Mortgages – Regulators are rightfully concerned that such lower interest rates over such a long term, coupled with significant increases in housing prices, will drive up the demand for initial and second mortgage loans, which may in turn incentivise lenders to once again begin making high-risk loans in order to maintain their desired growth. If such a trend were to develop, it would be difficult for regulators to put the genie back in the bottle before yet another crisis occurred.

These combined factors could cause regulators to push for even more stringent lending guidelines or possibly an acceleration of increases in interest rates, in order to put a rein on demand, as well as lenders’ willingness to become more liberal in their lending policies. The potential result under this projected scenario could be a slowing of the housing market, as well as ancillary industries. This could ultimately have a negative effect on unemployment figures and, by extension, on consumer confidence.

Savings – Perhaps the most significant effect on savings will be to alter the trend as to what type of savings vehicle consumers will choose. A savings account that pays at a fixed rate below 2.5% might seem like a good choice if interest rates aren’t raised in reasonably short order. If those rates are increased significantly, however, people who have locked into a fixed rate that is significantly lower than what is paid against variable-rate accounts will be kicking themselves.

Best to take economic projections with a grain of salt

Canadian economist John Kenneth Galbraith once opined that, “The only function of economic forecasting is to make astrology look respectable.” Despite being tongue-in-cheek in his assessment of his own profession, he wasn’t far off the mark. While such projections are necessary – effective economic policy has to start somewhere – projections over the longer term in particular are incapable of assimilating all the variables that are capable of rendering them meaningless.

The prudent investor, and even the only slightly savvy saver, would be wise to follow the predictions regarding potential economic trends, but to also keep an eye on changes that occur in the short-term, as even seemingly minor factors or deviations from the projected trends can cause significant change to the greater economic picture. And the saver who is prepared to respond to those changes more rapidly than the inherently glacial pace of government just might be able to avert any damage done by the inversely rapid responses of the market.

Paul graduated in 2001 with a degree in Finance. Since then he has gone on to work for several of the UK's most well-known financial institutions.

An avid blogger and a huge football fan, Paul is here to guide you through the ins and outs of personal finance and perhaps save you some money in the process!

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