Interest rates rise spark fears of next crash

Impending doom? The value of the pound fell following the Bank of England’s decision.

Could this be the beginning of the next financial crisis? Yesterday the Bank of England raised interest rates for the first time in a decade, reversing a cut made after the Brexit vote.

A return to normality, or a foolhardy move based on false optimism?

That is the question being posed to the Bank of England after it raised interest rates for the first time since July 2007. The official bank rate has been lifted from 0.25% to 0.5%.

Compared to historical levels the rise is very slight, but it could have a disproportionate effect on the British economy at a time of such uncertainty.

Seven of the nine-strong Monetary Policy Committee voted for the change.

The increase comes just after GDP figures showed a slightly better performance by the economy than anticipated, and it is expected to be the first of three small rises over the next few years.

The measure is mainly an attempt to reduce inflation. The Bank of England is tasked with keeping consumer price inflation at around 2%. But inflation has been running higher than that for much of 2017, and in September it hit 3% — the highest rate since April 2012.

So who wins and loses from the interest rate rise?

The main beneficiaries will be people with savings. The average easy-access savings account is currently paying 0.14% annual interest. So a deposit of £10,000 earns £14 a year. But if the rate rise is fully passed on, it would earn an extra £25 a year, making £39 in total.

But people with loans will pay more. For at least 4m households with variable rate mortgages, monthly payments are set to rise immediately; the loan’s interest rate is usually tied to the Bank’s base rate.

The household with a typical UK mortgage of £175,000 over 30 years on a variable rate will face increased payment of about £22 per month.

When interest rates are lowered, people have a greater incentive to borrow. More money to spend can increase demand and cause prices to go up, producing inflation. The Bank is seeking to reverse this effect.

But central banks also control the economy’s money supply and can use quantitative easing to counteract a downturn, as they have been doing since the 2008 financial crisis.

The difficulty for the central banks is getting the balance right, for example between consumer spending and real economic growth rather than an inflationary boom.

Is the interest rate rise a good move?

A point of interest

JP Morgan has warned that undoing quantitative easing could cause the next financial crisis. The bank’s head of strategy says that a big enough lack of money could lead to a "great liquidity crisis" and "asset declines" thus triggering a crash.

But Mark Carney, governor of the Bank of England, said: “This is a time to take the foot off the accelerator.” His focus was on reducing inflation. And as Michael Jacobs of the Institute for Public Policy Research points out, the interest rate is the Bank’s “only tool” to achieve that.

You Decide

  1. Was the Bank of England right to raise interest rates?
  2. Is charging interest immoral?

Activities

  1. Summarise this article in your own words — using no more than five sentences.
  2. All major economic decisions in the UK are being taken with Brexit in mind. Write down an imaginary conversation between someone who thinks Brexit will be good for the economy, and someone who thinks it will be a disaster.

Some People Say...

“The world has not learned the lessons of the last financial crisis.”

What do you think?

Q & A

What do we know?
Mark Carney, the governor of the Bank of England, has announced that interest rates are being raised for the first time since July 2007. The rise is very low by historical standards, from 0.25% to 0.5%, but has attracted much attention and speculation because of the economic concerns surrounding Brexit. We know that people with savings will benefit, while many millions will see a rise in their mortgage repayments and the cost of other borrowing.
What do we not know?
Whether there are more rate rises ahead. If all goes to plan there will be more rises over the next two years. The Bank aims for orderly progression to a more normal level of intererst rates. So it has also signalled that any future rises would be "gradual and limited" given the uncertainty of the economic climate.

Word Watch

Bank of England
The UK central bank, responsible for managing the country’s currency, money supply and interest rates, and overseeing the commercial banking system.
Monetary Policy Committee
Deputy governors Dave Ramsden and Jon Cunliffe voted against; they argued: “There was insufficient evidence so far that domestic costs, in particular wage growth, would pick up in line with the central projection.”
Slightly better performance
Britain’s economy grew by 0.4% in the third quarter of 2017; 0.3% had been predicted.
Inflation
The rate at which the general level of prices for goods and services is rising and, therefore the value or purchasing power of money is falling. The opposite is called “deflation”.
Mortgages
Loans against the value of property, to raise funds to buy that property under a legal agreement which secures the loan on the property. In other words if the borrower cannot make the repayments, the lender gets the property.
Quantitative easing
A central bank can try to stimulate business growth by releasing extra money into the banking system, for example by buying assets such as bonds.

Subjects

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