End of an era as rates rise

Mark Carney warns of ‘uncomfortable new normals’ as Bank of England eases off emergency support for economy

THE Bank of England has called time on nearly a decade of rock-bottom borrowing costs as it hiked interest rates above 0.5pc for the first time since the financial crisis in an attempt to tame inflation.

The base rate had been at 0.5pc or lower since March 2009, when it was slashed to combat the recession that followed the credit crunch. Mark Carney, the Governor of the Bank of England, said the new rate of 0.75pc signalled the start of three years of rising borrowing costs, amid a tight labour market and real wage growth.

“Today, employment is at a record high, there is very limited spare capacity, real wages are picking up and external price pressures [from the fall in the pound] are declining,” he said.

Growth has rebounded from a weak start to the year as the weather has improved and underlying economic momentum has been sustained, he said.

After a series of tight decisions to hold rates, the Bank’s nine-member Monetary Policy Committee (MPC) voted unanimously in favour of a rise to put the brakes on inflation, which is running at 2.4pc. The target is 2pc.

Mr Carney said he expected three more interest rate increases by 2021, pushing the baseline cost of borrowing up to 1.5pc and bringing some relief for savers who have struggled to make a return.

Sterling initially jumped on the news but slid back as the panel of economists said they will “walk, not run” towards higher rates and signalled there is little prospect of a return to pre-crisis levels. “There are a few uncomfortable new normals to reconcile ourselves with,” the Governor said.

Interest rates used to run at around 5pc but the Bank now estimates that in the long term, the “equilibrium” rate – which is neither stimulating the economy nor dampening it – will be around 2.5pc.

Britain and other developed economies face long-term lower growth as a result of ageing populations and weak productivity growth, which depresses demand for loans and investment.

The trends mean there are likely to be more savings chasing fewer productive investments, allowing banks to pay lower interest rates. Productivity growth has fallen from more than 2pc per year before the crisis to just 1pc now. Wage growth is down from as high as 4.5pc before the crash to barely 3pc today. And the economy’s “speed limit” – the pace at which it can grow without generating too much inflation – has fallen from as high as 3pc to only 1.5pc per year.

“We have to reorient ourselves to the current realities,” Mr Carney said as he sought to explain why interest rates are rising despite weak GDP growth.

He said savers are unlikely to get the full benefit of the rise in the base rate as banks will seek to recover profit margins that were squeezed in the financial crisis. “Historically, you never get full pass-through of rate changes to sight deposit rates – those take time,” said Sir Dave Ramsden, a deputy governor at the Bank.

“We have seen some pick-up in instant access deposit rates but it is not full pass-through.”

Mortgage rates are likely to rise more quickly, however. The typical homeowner with a variable rate deal faces an extra bill of £260 per year due to the rate rise.

Around 95pc of new mortgages are agreed on a fixed rate, delaying the effect of the higher base rate.

Businesses warned higher rates could harm confidence and investment. Suren Thiru, head of economics at the British Chambers of Commerce, said: “The decision to raise interest rates, while expected, looks ill-judged against a backdrop of a sluggish economy.”