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UK economy ready to withstand rate rise

UK economy ready to withstand rate rise

With the end of ultra-low interest rates looking increasingly certain, the debate has turned to how well the UK is positioned to withstand tightening monetary policy.

After more than five years of 0.5% base rates, many commentators are anticipating the first hike will arrive by the end of the year, or early 2015 at the latest.

What seems more definite than timing, based on rhetoric from Bank of England governor Mark Carney, is that when rates do move higher, they will do so in small, gradual increments to ensure economic progress to date is not derailed.

‘UK interest rates cannot stay at these historic low levels forever,’ said Patrick Connolly, certified financial planner at Chase de Vere.

He added: ‘The Bank of England has been wary of raising rates too soon for fear of stunting economic growth. If rates rises are signposted and increased gradually over an extended period of time, the UK should be positioned to cope and with limited, if any, negative impact for investors.’

Carney has repeatedly stressed any decision on rates is not pre-set and will be data driven. This stance was reiterated in the July Monetary Policy Committee minutes, which showed the decision to keep rates on hold was unanimous.

Howard Archer, chief UK and European economist at IHS Global Insight, said the marked rise in consumer price inflation to 1.9% in June from 1.5% in May, ongoing appreciable falls in unemployment and overall signs that the economy was still growing at a healthy rate were supportive to expectations that interest rates will rise before the end of 2014.

He said: ‘Supporting the case for an early move is the view that with expansion becoming more established, there is less chance of a small interest rate hike derailing the recovery and leaving consumer price inflation below its 2.0% target in the medium term.’
However, there is a school of thought that feels a premature tightening in monetary policy might leave the economy vulnerable to shocks, with the effectiveness of any further stimulus uncertain, added Archer.

The last 12 months have seen a clear recovery in corporate profits alongside a broader economic upturn, asserted James McCann, UK & Europe economist at Standard Life Investments.

He believes the UK’s economy should be able to endure a rate rise, highlighting the gross operating surplus of the UK corporate sector was up 3.5% year-on-year in the first quarter of 2014 and the compensation of employees has also rebounded over recent quarters and is currently growing more 4% year-on-year.

‘Overall, the improvements in both corporate profits and wages should ease concerns that measured increases in interest rates will derail the recovery,’ he said.

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