Interest rate to rise sooner than expected?

SavingsThe key UK interest rate has stood at 0.5% since March 2009 and, until recently, was widely expected to remain unchanged until at least the spring of 2015.

However, a combination of stronger-than-expected economic growth, a rapid drop in unemployment, and a surging housing market has placed renewed pressure on central bank policymakers. As a result, Bank of England governor Mark Carney has warned that an increase in interest rates appears likely to take place “sooner than markets currently expect”.

Carney acknowledged the “great speculation” over the timing of the first interest-rate increase but took pains to emphasise the central bank’s Monetary Policy Committee has “no pre-set course”. He stressed the timing of the first rise was less important than the pace of subsequent increases. Eventual increases are expected to be “gradual and limited”, curbed by sterling’s strength and weakness in key export markets.

A rate rise does not appear imminent, however. Carney confirmed there is further spare capacity in the economy to be used first and added: “The effects of an excessive or an excessively rapid tightening of monetary policy could prove damaging and difficult to undo.” In particular, higher interest rates could put pressure on households that have over-borrowed – at present, household debt is running at about 140% of disposable income, and higher rates could pose a threat to the UK’s financial stability.

Sterling’s value rose sharply against the euro and US dollar following Carney’s remarks at the annual Mansion House dinner. Looking ahead, although he emphasised monetary policy should be “the last line of defence against financial stability”, an increase in interest rates is probably closer than previously anticipated.

Meanwhile Chancellor of the Exchequer George Osborne has announced new powers that will allow the Bank of England to tackle the risks presented by the UK housing market. Osborne warned that soaring house prices pose the greatest potential threat to the UK’s financial stability, although he emphasised this threat was not immediate. These “powerful tools”, which will be granted to the BoE’s Financial Policy Committee by the end of the current Parliament, include the ability to limit mortgage loans relative to the borrower’s income or to the value of the property. The Chancellor also revealed reforms to planning legislation that are designed to boost housing supply by developing brownfield sites.

If you have any concerns about how a rise in interest rates may affect you, please get in touch.

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