Interest rates to stay low for a while yet

Announcing on Wednesday what he called “phase two” of forward guidance, Mark Carney, the governor of the Bank of England, stated that interest rates are unlikely to rise before 2015, as the Bank believes the economy is not yet strong enough to support an increase.

Despite that, the Bank revised up its 2014 growth forecast to 3.4%, from an estimate of 2.8% in November. It also raised its forecasts for 2015 and 2016 to 2.7% and 2.8% respectively.  

The Bank also announced an end to the link between the unemployment rate and interest rate rises. Instead, it has decided to use a wide range of economic variables, including wage growth and business investment to assess the UK’s ability to support a rate rise.

The Bank believes that the UK economy is currently running at c.1.5% below its potential, and that it would need to improve on this before any rate rise would be considered.

Further, the Bank added that any future rate rises would be gradual and would settle at between 2% to 3% in the medium term – significantly below the historic average of c.5%.  

Whilst Mr Carney would not comment on the timing of future rate rises, the markets currently expect rates to rise in the second quarter of 2015, and possibly to 1.9% by the end of 2016.

Whilst this new version of forward guidance, tied to the size of the ‘output gap’, is more complicated and harder to measure, the clear message from the Bank is that the aim will be to keep interest rates low for as long as possible.

Overall, this is encouraging news for investors and borrowers. For the latter, it may slow down the recent rate increases that have started to creep in on the mortgage front.   

A further period of stable low interest rates will be well received by the stock markets and should help support the current rally. It is also good news for bond investors, who will be encouraged by the continuing low interest rates and low inflation.

Of course, the problem for many is how to generate income in this low interest environment. Many have turned to equity income funds, which give access to blue chip companies that aim to improve profits every year and hence pay good dividends. Equity income funds can provide yields of around 4% net. In the short term, the value of your capital can fluctuate but long term there is the possibility of capital growth as well.  

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