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Wednesday, 7 March 2012

Three Years On...

Dr Brian Sloan, Chief Economist at Greater Manchester Chamber of Commerce

In March 2009 the Bank of England announced that its interest rate would be set at the historical low of 0.5%, after falling sharply from 5.0% just six months earlier. For some mortgage holders this was welcome in a period of low borrowing costs and one of relative stability that is a far cry from 1982 when interest rates were changed 36 times. Just how favourable the rate has become is perhaps reflected in the difference between then and now; in 1982 the rate fell from 14.3125% to 9.1250% before finishing the year at 10%.

Whilst those on tracker mortgages and standard variable rates enjoyed falling repayment costs on mortgages as the high street banks lowered rates, businesses continued to report that interest rates offered on loans did not reflect the low Bank of England rate and in many cases double digit rates were quoted to businesses seeking to invest.

What was clear in the run up to September 2008, when interest rates remained at 5.0%, was that households had started to repay debt and retail sales were hit. The record low interest rate resulted in a pause of that paying down of household debt but the level of debt remains above 130% of disposable income.

In a sense the nation has become complacent about interest rates and debt levels, but why is this significant? Because interest rates charged by the high street banks are starting to rise. The Bank of England highlighted the cost of banks’ financing in the recent inflation report, and along with the increased cost of capital resulting from increasing capital ratios to meet the new demands of regulators and costs of ring fencing operations, interest rates from providers are only going to move in one direction and will put further pressure on consumers.

Despite the period of interest rate stability the Bank of England has embarked on a programme of asset purchases, quantitative easing or as some would put it printing money. We don’t dispute the macro economic impact of the programme but would question the benefit to the regions and the longer term impact of the policy. With real interest rates rising, putting pressure on growth and the recovery, what policy levers are left for the Bank of England? Business investment must lead the recovery, but much of that investment will need to come from overseas. Government and the Bank must now work to set the right conditions for that investment, as credit and financing from domestic providers will remain constrained.

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