How beneficial are low interest rates to the economy?

It’s now been more than four years since interest rates were reduced by the Bank of England to help stabilise the economy. It’s certain that the majority of us didn’t think that we’d still be looking at a base rate of 0.5% in 2013!

There are some obvious benefits to low interest rates, notably for those who have mortgages and loans. However, from a saver’s perspective this long period of low rates has been of no benefit and there is seemingly no light at the end of the tunnel. Clearly the impact is even greater for those individuals who rely on savings for income. The recent rise in the FTSE can be largely attributed to the impact of poor interest rates. With such low returns on cash, investors pumped over £780 million into the UK’s largest companies during March alone in an effort to improve their returns.

Unfortunately the markets went into sharp reversal in June as the US Federal Reserve confirmed that they will rein back on its asset-purchasing programme. They also stated that providing the US economy continues to improve, Quantitative Easing (QE) would end in mid-2014. This has led to speculation as to when interest rates may rise and the recent selling on the equity and bond markets.

These continued low interest rates are having an effect on how people spend. It may be that many have continued to live their lives as they did prior to 2009, using capital to subsidise their lifestyle, thinking that the reductions in income would be a short-term issue. However, as time goes on, people begin to change their spending habits and we cut back. The initial benefits to the economy of lowering borrowing are counteracted by the very people who have money to spend, actually spending less.

UK consumer price inflation rose to 2.7% in May, up from 2.4% in April. An increase in interest rates would also help to dampen inflation.

These and a number of other issues have so far been set aside by the Bank of England’s Monetary Policy Committee, as they see that any rise could have an impact on economic recovery and perhaps more importantly would cost jobs. But, subject to any major global upsets, the UK economy is looking stronger; 2% economic growth is predicted for next year along with a 0.8% increase in GDP this year. Perhaps not as good as we had seen prior to the so-called “financial crisis”, but certainly more along the lines of what we’ve come to expect.

 If these latest forecasts are correct, then this will certainly spark debate about bringing the 2016 date for an expected rise forward, perhaps as early as next year. To ensure that any rise doesn’t have a negative impact on the economy, increases need to be spread over a longer period of time.

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