Hike in interest rates a step closer

June 4, 2009

menashysmall2- Edward Menashy is chief economist at Charles Stanley. The opinions expressed are his own. -

The Monetary Policy Committee of the Bank of England has kept its key lending rate at a record low of 0.5 percent, last reduced in March 2009 when it indicated that conventional policy had reached its limit and unorthodox measures such as quantitative easing were to be used.

Recent economic statistics however have been strong with the UK service sector staging a surprise return to growth in May 2009 thus raising the prospect that the country’s recession may be about to end. Also the Nationwide survey of consumer confidence hit a six month high in May 2009.

Recently the CBI indicated that the banks would tighten credit less aggressively in the next three months.  The survey indicated that only 7 percent of firms expected to be offered tougher conditions for new lending, down from 36 percent from the March 2009 survey.

So against this backdrop all these factors have raised the prospect that policy might soon change.

Hence, if recessionary forces are decelerating and credit is becoming more available the prospect for rising interest rates has moved a step nearer.  Could this explain the strength of the pound and the weakness of the gilt market?

Not surprisingly, the Bank of England is expected to stick to its target of £125bn for Quantitative Easing. Interestingly the futures market foresees interest rates taking the following shape:

Month/Year     Base Rate %
Sept 2009        1.12
Dec 2009        1.31
March 2010    1.48
June 2010        1.81
Sept 2010        2.21
Dec 2010        2.66

Conditions remain very difficult for income seekers.  Record issuance, rising inflation, slow growth, downgrades in credit ratings have left investors bewildered yet, for capital protection we suggest looking at the 2.5 percent Treasury Index-Linked 2016.

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