bank of england base rateInterest rates are the main tool of central bank monetary policy. Whether interest rates are increasing or decreasing affects many aspects of our lives.  What does the future hold for central bank interest rates?  For lay people it’s any ones guess.  For people who don’t want to rely what they are told in newspapers and financial media this post is for you.  Let’s Compare Bets.com loves uncertainty because ‘ Life’s a Gamble ‘, so let’s have a look on where we think interest rates are going.

Why is this important?

Governments, private individuals, private companies, institutions around the world have all come to rely on debt.  Europe (including the United Kingdom), USA, Japan, and China all fall into this category.  That fact is not necessarily a bad thing as these countries are all in the same boat relatively speaking, but, some of the numbers are still staggering.  Since the financial crisis global debt has gone up by nearly $40 trillion dollars, and rising.  That’s the number forty followed by twelve zeros.

Interest rates affect interest received from bank accounts, mortgage payments and hence house prices, commercial loans payments, how much lenders are able to lend, and the income that pensioners get.  In the UK and USA interest rates are at historic lows.

UK finances rely on the kindness of strangers to keep the wheels on the economy.  Foreign central banks, institutions, companies and private individuals invest in the UK because it is a good place to do business and they get a return on their capital.  This inflow of money plugs the UK Government’s current account deficit.  Interest rates play a central role in ensuring the UK government can keep foreign investors happy.

If something happens that makes a central bank rate rise necessary there would be negative consequences for certain types of asset.  Most notably property prices.  Property is the UK’s favourite asset.  Value of the housing stock drives large swathes of the economy, so, anything that effects it is worth watching. Owning a second property, is an implicit bet on house prices and interest rates to some extent.

A perfect storm for seriously bad implications for the UK economy would be something that forces the Bank of England to increase interest rates without their being a corresponding pick up in economic activity.  Rising interest rates are no problem for business when they have pricing power and can increase prices.  Increasing prices is difficult if peoples wages are not rising.  UK wages are not increasing enough to cause underlying inflation required for rates to rise.  So any rate rise would just make debt more expensive and leave everyone with less disposable income (or less net profit for companies).  More importantly it gives the Government a big head ache over how they will service their IOUs (gilts).   What could cause this to happen?  If the UK leaves the EU the value of pound sterling would likely drop (like it did after the UK left the European Exchange Rate mechanism in 1992).  A sudden drop in the currency could force the Bank of England to raise rates in order to protect it’s value to keep holders of Government IOUs happy.

Are we asking the wrong question?

Instead it could read will interest rates ever go up?  Economic dead lock may result if Governments are forced to do something called Helicopter Money.  Name by Milton Friedman’s metaphor of dropping dollar bills from helicopters for people to spend.  Japan is country expected to try this technique.

In reality it means Governments and central banks adding zero’s to their capital investment accounts with no intention of it being paid back to anyone.  Permanently increasing money in the system.  Which is basically what has already been happening for years.  The difference is that gilt maturities have just pushed back farther and farther, thus giving the illusion that it will be repaid.

Helicopter money is when money is created to directly finance public spending for things like infrastructure with no intention of paying it back.  High speed rail, schools, hospitals, motorways or nuclear power stations.

Low interest rates are a massive part of central bank policy around the world to keep debt under control.  Low rates are needed to help create the inflation required to erode the value of the debt as it is not possible to pay it back.

UK interest rates may not rise to normal levels for a generation.  Not going above 2% for some time.  It’s unlikely that rates will rise at all until Banks in the UK and Europe are fixed.   Experts believe that UK Banks will not have repaired their balance sheets until 2019 at which time they will be more willing to lend to business (which seems strange considering all the debt already out there).  However, lending to business should promote capital expenditure for expansion and new projects, as well as replacing assets.  This should help increase wage inflation.

European banks on the other hand only started realising the losses they hide in (or off) their balance sheets in 2014 / 2105 which is when the European Central Bank started quantitative easing.

The consequences of low interest rates include;

  • asset price bubbles in property and bond markets
  • the phenomenon of companies, especially in the USA, of borrowing to buy back their own shares to ensure their earnings per share go up. This help prop up stock market valuations.
  • reducing the incentives for people to save making the situation self full filling

Where would an informed investor consider putting money to get a good return now, taking into account the situation with interest rates?

For a bit of fun readers might want to check out our featured review. Fast, fun, and easy money my friends. Go to the review.

Infrastructure is a good theme because it should benefit directly from central back policy.  HICL Infrastructure Company Limited (HICL) is a long term investor in infrastructure projects in education, health and transport. It is an investment trust and can be bought through a stockbroker.  There is a good dividend history and momentum in the stock price.

Costain(COST) is an engineering solutions provider to the energy,water and transport sectors.  Among other things Costain is involved in the Government’s £15 billion road improvement strategy with funding secured for the next five years, and is a joint venture partner for delivering ‘smart motorways’.  Morgan Sindall (MGNS) is another company in a similar field more involved in construction, like social housing.

For how to deal with the coming interest rate and economic environment just follow the helicopters.  Life’s not so much of a gamble after all.