The Bank of England, which is responsible for maintaining monetary stability in the United Kingdom by adjusting its base interest rate in order to meet inflation targets, has kept the rate at a record low of 0.5% since the height of the global financial crisis in 2008.
The markets had been expecting the United Kingdom to follow the example of the US Federal Reserve, which increased its interest rates in December 2015 for the first time in nearly a decade.
Contrary to expectations, the UK has chosen to stick with low interest rates for now. At a meeting on January 13, the Bank’s Monetary Policy Committee voted to maintain the current rate.
The Bank’s governor Mark Carney pointed out that growth in the UK was still too weak, and it faced “a powerful set of forces” – including declining oil prices, and economic slowdown in China – which were likely to keep inflation in the UK near zero.
This decision resulted in the pound declining against the US dollar. After the announcement, the value of the pound fell by nearly 5% compared to a month ago. Currency traders were selling the pound at $1.42 – the weakest result since 2009.
However, the current mood in the markets suggests that the Fed itself may have been too hasty in raising the base interest rate in the United States, and there is even a chance that it will be forced to reverse this decision. A similar blunder was made by the European Central Bank when it raised rates in 2011, only to quickly reduce them again as the eurozone economy tanked.
Therefore, the caution of the UK’s central bank is well understandable. Unless the global economy shows strong growth later in 2016 – which does not seem particularly likely at this time – we can expect any increase of borrowing costs to be delayed at least until 2017. The Bank does not have a specific timetable in this regard, and Carney has noted that “monetary policy will continue to depend on economic prospects and not the calendar”.
Critics have pointed out some issues associated with this stance: continuously low interest rates support a house price bubble (housing prices in London have long been out of reach of most first-time buyers), as well as fail to encourage people to make savings for retirement.
In addition, if there is another major global financial crisis, the Bank’s options for using monetary policy to counteract its effects will be very limited – as the interest rate is already close to zero, there is almost no room for manoeuvre. Balancing these risks with the need to maintain inflation at a reasonable level should be one of the Bank of England’s main tasks in 2016.