As 2013 draws to a close the bond markets have been quietly increasing UK government interest rates. The rate on a 10 year loan by the government has reached 3%, double the low point of 2012.
The official forecast by the OBR assumes gentle but consistent rises in the UK government’s borrowing rate. They measure the average rate on the UK government’s debt, and expect this to rise from 1.6% in 2012-13 to 3% next year to 4.2% by 2018-19. As so often with these predictions, the markets are taking the rates up faster and further than the official forecast suggests.
The OBR expects the Bank to keep official short rates down for longer. They are forecast at 0.5% this year, 0.6% next year and 1.2% in 2015-16, before rising to 3.1% in 2018-19.
The Governor of the Bank of England made a lot of his wish to keep official short rates down to very low levels for a couple of years or so. He wanted to reassure borrowers, and force investors to take more risks, by holding out the prospect of poor returns on deposits, bonds and other “safer” investments. He was keen to see more growth, which he recognised would require more money in circulation and more borrowing.
The markets immediately challenged his view by driving up government bond rates, and through a series of comments arguing that the property market would require higher rates earlier to prevent a bubble. The Governor responded by saying he could always take action other than interest rate rises to deal with any excess credit in the property market. He then showed what he meant by stopping Funding for Lending money being available for mortgages. He could take future action to demand higher capital ratios, special deposits or other quantitative controls to slow mortgage lending.
Recent polls show that higher interest rates would be popular.This is no surprise, as the number of savers is greater than the number of borrowers. Quantitative Easing has been seen as a kind of additional tax on the prudent. It has transferred income and wealth from savers to the state. The issue before those making the judgement about whether and when to raise rates is the issue of what impact an interest rate change would have on output and jobs.
It seems likely that 2014 will see more of the same that we have witnessed in the second half of 2013. Market forces are likely to raise interest rates on government debt higher, given the absence of further quantitative easing. The Bank is likely to keep official short rates down at very low levels, to be surer of the recovery and to assist with more jobs and better growth.
The Bank thinks there is currently no case to raise official rates to cut inflation. At last, after a period of excess inflation, it is coming down. Persistent weakness in many commodity prices, coupled with recent strength in the pound, gives a better inflation outlook. This implies the Bank will keep official rates lower for longer.
Meanwhile, the upwards movement in government bond rates may lead to some improvement in longer term savings rates generally, which will be most welcome for the prudent.