When will interest rates rise? and what will happen to property prices when they do?

When will interest rates rise? and what will happen to property prices when they do?

When will interest rates rise? And what will happen to property prices when they do?

 

Bank of England Governor Mark Carney has said he expects a judgement on whether rates must go up from their long-term floor of 0.5% around ‘the turn of the year’. In a speech he said that he expected rates to rise over the next three years, reaching ‘about half as high as historical averages’, or about 2%-2.5%. This pronouncement came despite data showing UK inflation falling back to zero in June – which means the rate has been around zero all year. This should take inflation out of the equation but some analysts warn that once oil and other commodity prices and wages start to rise again, inflation will rapidly tick up. Data after Carney’s speech showed a 3.2% rise in UK earnings suggesting real wages are rising substantially again.

 

Money markets agree with the outlook for rates rising in early 2016. Swap rates – a measure of how rates are seen to move in the future – have risen over recent months, yet remain historically low. On 16 July, five-year UK swap rates stood at 1.79%, compared to 1.62% a month ago and 1.53% a month before that. Compare that with yields on German ten-year bonds which have risen from below 0.1% to 0.8% in three months.

 

Speaking the day after the inflation report on 16 July, Mr Carney told BBC Radio 4’s Today programme that rates needed to stay low to deal with the “headwinds” the economy faced, including low productivity, fiscal tightening from government austerity and the uncertainty of the in-out EU referendum scheduled for 2017.

 

Our view is that low inflation will guide future rates and the behaviour of people who may wish to borrow in a upward-moving interest rate environment. The Bank’s move to reduce Funding for Lending for mortgages has made it clear that switching off the cheap money being pumped into the economy is a higher priority than raising interest rates. Property prices and the stock market have certainly done well off the back of Funding for Lending, that hasn’t happened in the overall economy. Productivity is the key with identified spare capacity in the economy as a reason for keeping rates down. The more that productivity improves, the greater the scope of the Bank of England to keep monetary policy very accommodative. The Bank of England is currently assuming that productivity will pick up only gradually. This will temper the ability of borrowers to leverage property so whilst base rates may quadruple to 2%, property prices won’t.

 

Even when the economy has returned to normal levels of capacity and inflation is close to the target, the appropriate level of Bank Rate is likely to be materially below the 5% level set on average by the Committee prior to the financial crisis. Should the economy take another serious turn for the worse, more quantitative easing could occur, but it looks highly unlikely. The question now is if and how to unwind it, rather than whether more will arrive.

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