UK Interest Rates…. Have we seen the peak?
The right place to start is with some home truths.
Near zero interest rates from late 2008 to late 2021 were an anomaly, a pleasant happenstance, a party that had to end.
Some had the belief that near zero rates would last forever! They took on significant debt. Many did not. The reality was zero rates became unsustainable and circumstances changed.
Secondly the interest rate ‘normalisation’ that began in 2021 was inevitable and manageable. A rate hike cycle, especially one from a very low trough to its peak can take a few years to be achieved. So, it has proved this time, interest rates are likely to end 2023 at or near current levels of 5.25%.
One factor sustaining inflation is high public and private sector pay awards, that have increased income at precisely the right time.
The Bank of England economist Huw Pill recently described forward interest rates resembling “Table Mountain”, the famous Cape Town landmark. This means that rates could be kept on a plateau to achieve the desired 2% inflation target.
This view is consistent with experience, rates were kept low for a long time (13 years).
Given the 2% inflation target is possible in late 2025, monetary discipline is required until then.
What factors over 2024 can influence interest rates?
- Economic shock events.
- A sharp downturn. So far, the UK has experienced a ‘slowdown’ i.e. weak economic conditions, but if the economy quickly weakens then interest rates could be lowered.
- A sharp rise in unemployment, a sharp drop in inflation or, a property crisis. All three are possible influencing factors.
- Change in UK government – the UK has had considerable political instability since 2016 with 5 governments in 7 years. There could be a slowdown in the run-up to the next election, especially if PM Rishi Sunak waits until late 2024 or January 2025 to hold the next general election. Nor is the election necessarily a guarantee. A close result means another hung parliament as in 2017.
- Lower global interest rates. The US Federal Reserve could modestly lower US interest rates.
To sum up, UK interest rates appear close to their peak, however they are likely to stay high for a while yet. We expect the first interest rate cut to happen in the second half of 2024. High rates are needed to support sterling and achieve 2% inflation.
This environment is helpful for savers, and companies with significant cash balances. UK Government bonds also provide attractive returns.
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