Why an interest rates rise in the UK is required soon
Bank of England governor Mark Carney has enjoyed a relatively unchallenged role since his arrival in London from an earlier senior role in the Canadian banking system.
His period as Governor has been remarkable if only because he has chaired the Monetary Policy Committee through an exceptional period of unusually low base rate for Bank of England lending.
The last decade has been historic.
After years of a gradual build-up of additional bank lending, ultimately to unsustainable levels, just over 10 years ago, the crash in UK property prices and a crash in the profitability and management of the balance sheets of several large banks brought the UK Government and the Bank of England into support mechanisms.
The financial crash of 10 years ago has now eased. Recovery is under way although the damage and wreckage of the fall in asset prices and the problems of living with negative equity have left a seriously changed financial world. Smart operators in the commercial property market are now enjoying the reversal of impairment charges to restore balance sheet viability.
Other operators, caught with excessive borrowing and fewer options to sustain or rebuild operations, have retreated.
The Bank of England must now live with the problems of building a more normal series of financial pressures. Quantitative easing must be reversed and interest rates brought back to a more logical basis influenced by money market forces.
Quantitative easing was a relatively painless method of trying to sustain the economy at the same time as the Treasury was trying to reduce the Government budget deficit. The official purchase of Government debt added extra liquidity to the financial systems and created a greater ability for private sector expansion.
Quantitative easing was paralleled by the reduction in base rate by the Bank of England. After several decades of conventional changes in base rate where a 3% rate would have been unusually low and, exceptionally, a rate of over 10% was not unknown, more recently the Bank of England has lowered its base rate below 1%, indeed to a fraction of 1%, to 0.25%.
Continuation of an artificially low base rate on a managed basis and moving away from levels more normally expected by money markets has been popular. But it has carried a cost. For borrowers who have enjoyed the cost reductions of borrowing at low interest rates there are, in contrast, other savers who have earned much less on their savings. House buyers have enjoyed lower mortgage repayment bills.
When (not if) base rate is increased, home buyers using mortgage finance will pay more. The problem will be that expectations on the level of interest charges have been changed by the near decade of low base rate.
There is a big downside to the fear of rising interest rates. The up-coming generation approaching retirement have begun to appreciate, or have been warned to expect, lower levels of pension payments as pension funds have seen the vulnerability to depreciation of the pension fund assets as their earning capacity has fallen.
Across the UK many pension providers are facing financial problems. Pensions, whether defined benefit or based on accumulated contributions, will be at lower levels than was reasonably forecast 10 years ago. The inherited funding problems for pension funds are a liability that has been worsened by the Bank of England low base rate policies. Even an increase in base rate of 2% or 3% will not necessarily remove the problems.
The Monetary Policy Committee of the Bank is now facing an uncomfortable but unavoidable choice. The sooner small increases in base rate are implemented, the better.