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Are interest rates headed up?

by Robyn Hall Wednesday 03 February, 2010

It's never a safe bet to try and second guess what will happen when the Bank of England's Monetary Policy committee meets to decide what it will do with interest rates.

But with the announcement due out at noon today, we take a look at the background.

We may have officially moved out of recession last month but our economy is still in a fragile state, having previously contracted for six consecutive quarters, the longest period since quarterly figures were first recorded in 1955. Indeed, we were the last major economy still in recession with Germany and France coming out of recession last summer and Japan and the USA coming out of recession last year.

Inflation

The UK recovery is all about consumer confidence and the easiest way for the MPC to bolster this will be to hold interest rates steady.

But with inflation also rearing its ugly head again last month could we be in store for a rise in the base rate? The rise in the Consumer Prices Index to 2.9% in December from 1.9% in November has certainly led some commentators to believe interest rates would have to go up.

Yet minutes from the Bank's previous meeting showed that the spike in inflation was indeed expected.

And then there's the whole issue of quantitative easing (QE) to take into account.

The Bank of England's QE programme swaps high street banks' assets, such as bonds, for cash, so that the banks would lend more money to both individuals and businesses.

But so far all the evidence seems to suggest that the banks are sitting on the cash rather than lending it out. That means the effects on the economy have yet to be seen.

That being the case it's difficult to see what kind of state the UK economy is really in. To do that we need a period without quantitative easing, without the car scrappage scheme and without any changes to VAT to see what's really happening.

While it seems inevitable that inflation will shoot through the 3% ceiling, wage inflation is far from matching that figure. And with a general election just around the corner it seems unlikely that the bank will look to move rates this half of the year.

One thing is certain though and that is that the next move in interest rates will only be up. For borrowers on tracker rates that could be cause for concern. Just last week Santander reported that demand for its tracker deals had plummeted as more homeowners started to look at fixed rates.

"A significant number of people could remortgage in the next six months and among those considering their next deal there is a potential for a fall in demand for tracker deals," Phil Cliff, director of mortgage marketing at Santander said.

"Borrowers have seen a large number of highly competitive fixed deals come on to the market recently and with many commentators predicting a base rate rise this year, homeowners now seem more inclined to play it safe with a fixed rate deal."