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BoE base rate: Small rise, little damage

Today's rise in the UK base rate will have only a small adverse effect upon the economy
November 2, 2017

The most important fact about today’s rise in Bank rate, from 0.25 to 0.5 per cent, is that it will probably have only a slight impact on economic activity. James Cloyne and Patrick Hürtgen, two Bank of England (BoE) economists, have estimated that a quarter point rate rise cuts output by only around 0.15 per cent. And BoE governor Mark Carney said the impact of today’s move should be “no larger than usual”.

Torsten Bell at the Resolution Foundation points out one reason why the effect will be so small. He says far fewer people are affected immediately by higher interest rates than was the case 10 years ago. This is because fewer have mortgages and many of those that do are on fixed-rate deals. He says that only around 11 per cent of families have variable rate mortgages, and those that do owe an average of only £70,000, implying that they will need to find less than £15 per month extra.

Offsetting this is the fact that there’s a minority of highly indebted people who will struggle. A recent survey by Survation found that 27 per cent of mortgage-holders said they couldn’t afford even a small increase in their payments. Meanwhile the Financial Conduct Authority has found that one in seven borrowers would struggle to pay their mortgage if repayments went up by less than £100 per month. However, their pain is mitigated by the fact that savers will get higher returns on their £1.37trillion of bank deposits.

Admittedly, higher interest rates at the margin encourage saving and discourage capital spending. Yet economists agree that these effects are small.

It is also unlikely that businesses and consumers will greatly rein in spending in anticipation of further rate rises. Mr Carney said these will be “at a gradual pace and to a limited extent”. Futures markets agree. They are pricing in a three-month Libor rate for December 2018 of only 0.85 per cent – only 0.4 percentage points above its current level.

In truth, of course, the BoE would not have raised rates if doing so had a big impact. In its statement accompanying the move, it forecast that economic growth would be only “modest”. It expects real GDP growth of just 1.6 per cent next year – the same rate as this. And a survey of purchasing managers in the construction sector this morning reminded us of the fragility of the economy. It showed that construction companies’ expectations for future activity have dropped to a five-year low.

Economists are debating whether today’s move is the right one: Roger Farmer at the NIESR says it is, but Oxford University’s Simon Wren-Lewis says it’s not. However, even if the move is a mistake, it is likely to be one of the smaller ones of economic policy-making in recent years.