ii comments on interest rate decisions at home and across the Atlantic

We analyse the thinking behind the central banks’ rulings.

Commenting on the Bank of England’s decision to hold interest rates at 0.1%, Myron Jobson, Personal Finance Campaigner, interactive investor, says: “How low can interest rates go? Not much lower it seems from the Bank of England’s viewpoint, having slashed interest rates from 0.75% to 0.25% then to just 0.1% - all in the space of 8 days in March to mitigate the economic impact of the coronavirus pandemic. 

“At a time where savings rates are as low as a pitiful 0.01%, adding just 10p on an initial deposit of £1,000 in the first year where interest is applied annually, a further cut to the base rate could have spelled even more bad news for savers. On the flipside, lower interest rates result in cheaper loans for businesses and households. 

“Last time rates were cut in a similar vein was back in August 2016 to help quell the storm of uncertainty following the Brexit referendum, and remained at then historic lows for 15 months before creeping back up. It will be interesting to see how long the base rate will remain at rock bottom this time around. Covid-19 is a different kettle of fish, and policy makers will have to continue to make bold decision to mitigate its impact on the economy.”

On the Federal Reserve's latest economic forecasts suggest that interest rates will remain near zero at least through 2023, Tom Bailey, ETFs Specialist, interactive investor, says: “The decision from the Federal Reserve to hold interest rates at their near-zero level will come as a surprise to no one. Although the Federal Reserve said it expects the economy to retract by less than previously expected, there is still a sense that the US economy requires ultra-loose monetary policy. The current inability of the US Congress to agree on new fiscal relief furthers this need for accommodative monetary policy. 

“Interestingly, the Federal Reserve also suggested that there would be no rate rises for at least three years. The central bank pledged that interest rates will be kept at their current levels until the unemployment rate falls sufficiently and inflation has risen to 2% or more. By the Fed’s own projections, this will not happen until at least 2023. Markets, reasonably, have interpreted this as the Fed saying not to expect any rate hikes until then.

“The Federal Reserve also addressed a recent new change to their policy mandate. As the Federal Reserve previously announced, it will no longer strictly target an inflation rate of 2%, instead opting for an average rate of 2% over a longer period of time. This means that in the shorter term, the central bank will tolerate inflation above 2% to make up for periods when it has been below. That also means, in theory, the Fed will be less inclined to start tightening rates when employment levels start rising. 

“This policy change reflects a wider rethink among central bankers about some of the core assumptions of monetary policy. Conventional theory held that low unemployment rates inevitably resulted in higher rates of inflation – the so-called Phillips Curve. It was the job of central banks to try and balance the two, raising rates to slow the economy when unemployment rates were deemed too low. However, over the past 10 years, very low rates of unemployment failed to result in higher inflation, suggesting the old relationship between the two no longer holds.”