HAMISH MCRAE: Never thoughts the Election – lower rates of interest!

  • The ECB decided to cut interest rates amidst European Parliament elections 

The cuts in global interest rates are coming through at last. The big one last week was the European Central Bank (ECB), which for the first time ever reduced its rates ahead of the US Federal Reserve.

The Bank of Canada moved too, and while the markets don’t expect the Fed to change anything at its meeting this week, a Reuters poll of economists suggested it would make two cuts this year, the first in September.

And here? Well, there is a powerful case for the Bank of England to make its first cut this month. Inflation for May is expected to fall to 2 per cent, or close to it, and in April, at 2.3 per cent, was already below the Eurozone’s latest figure, 2.6 per cent.

In the US it is 3.4 per cent so, despite all that stuff about the UK being an outlier on inflation, we are now doing relatively well.

Decision time: There is a powerful case for the Bank of England to make its first interest rate cut this month

Decision time: There is a powerful case for the Bank of England to make its first interest rate cut this month

Will the Bank move? There is a convention that central banks don’t make policy shifts in the run-up to elections, but that didn’t stop the ECB in the middle of the European Parliament ones.

In any case the Bank is supposed to be independent of politics. Sir Dave Ramsden, Deputy Governor for Markets and Banking, and the most market-savvy member of the Monetary Policy Committee, voted for a cut last time. I would trust his judgment, and would like to think it will tip the balance at the meeting on Thursday week. But we will see.

Of course in the broader scheme of things the precise timing of the cuts is much less important than the general features of the interest rate cycle. It’s a question of how much it will cost to roll over a mortgage in two years’ time, not whether the Bank cuts the interest rates this month or in early August.

Here, we are going on a journey into the unknown, but we can say some things that will help guide us. One is that interest rates will generally reflect inflation. In the 1970s and 1980s when there was double-digit inflation there were double-digit interest rates.

Another is that the near-zero rates of recent years never happened before and, given what they did to inflation, will not happen again. A third is there will still be some inflation in the future, and keeping it under control will be an ongoing battle. Expect it to keep perking up again.

Finally, governments everywhere are hugely indebted, so will be competing against the rest of us for funds. That will put a floor under long-term interest rates.

It is pretty clear that the world is now set on a downward path for short-term interest rates that will last for another couple of years. They don’t need to be as high as they are now to maintain downward pressure on inflation, so they will be a bit lower in a year or two’s time. What is less sure is how high bond yields need to be to persuade people to fund national governments.

You can see how sentiment has swung violently over the past year by looking at ten-year gilt yields. A year ago they were about 4.2 per cent, pretty much exactly where they are now.

However, since then they peaked at nearly 4.75 per cent in the autumn, before sliding to below 3.5 per cent at the end of December. That is a huge movement for a market of that size.

The similar swings in the five-year rate were reflected in the way the cost of five-year fixed rate mortgages also flipped.

What the Government has to pay affects what everyone else has to pay and, though we may feel we should have a better credit rating than His Majesty’s Government, that is not the way the world works.

But that experience is a very crude guide for home-buyers. Gilt – or UK Government bond – yields don’t need to go much higher than 5 per cent, and they probably won’t go much below 3 per cent.

So if they are at the top end of that range, it is not a great time to get a fixed-rate mortgage.

And if they are towards the bottom of that range, grab one while stocks last.