For the past few years, the monthly meeting of the Bank of England to vote on interest rates has been a non-event. With interest rates stuck at 0.5% since March 2009, people have long got used to ignoring these meetings.
However, I think that’s about to change. I suspect that some of Mark Carney’s colleagues on the Monetary Policy Committee (MPC) will soon be pushing for a rate rise, if they haven’t started already.
This means that rates could start to creep up earlier than many expect, whether Carney wants them to or not.
Full speed ahead
As we’ve noted before, Carney was brought in for political reasons. With an election due in May 2015, George Osborne’s priority was making sure that the economy was growing as fast as possible just before the election. There was also an implicit goal of keeping house prices high, since falling prices would also hurt the government’s chances of re-election.
Since Carney was known for very loose monetary policy in his time as the governor of the Bank of Canada, it was clear he would err on the side of keeping rates low for as long as possible. At the time, it wasn’t necessarily a bad thing, with unemployment at 7.8%, and lingering talk of a ‘double dip’ recession.
The problem is that the recovery has been faster than anyone would have guessed (though it is by no means complete). This means that the need for low rates is starting to pass.
At the same time, keeping rates close to zero risks recreating the distortions which laid our financial system low in the first place.
The most obvious case is the property bubble, which in London is just as extreme now as it ever was. In essence, the risks have shifted from deflation to inflation.
It’s clear that Carney doesn’t want to slow things down. When he first took control of the Bank of England, he made it clear that as soon as unemployment fell below 7% he would start raising rates.
At the time it looked as if this would take some time to happen. However, when Carney realised that this target was going to be met a great deal quicker than most people expected, he simply ditched the target.
Since then, he has publicly given contradictory signals, one moment suggesting that rates will be hiked soon, and then appearing to go back on his words. This dithering has led one MP to compare him to an “unreliable boyfriend”.
Similarly, when Carney had a chance to force banks to cut back on mortgage lending in June, he blew it. Instead, he outlined measures that were (with one exception) essentially softer versions of the restrictions that the Financial Conduct Authority (FCA) had already put in place in the spring.
Carney’s colleagues break ranks
However, Carney may not be able to put off a decision on a rate rise for much longer.
Other members of the MPC are apparently growing increasingly worried about the effects of low rates on the economy. Indeed, there are strong rumours that several MPC members will break ranks with him at today’s meeting.
To be clear, I’m not saying that the base rate will rise tomorrow. But when the minutes of today’s meeting are published in a fortnight’s time, we may see that one or two members of the committee have voted for a rise.
As Samuel Toombs of Capital Economics points out, if this happens it will be first time that the MPC has not voted unanimously for three years. Overall, Toombs thinks that recent survey data “increases the chances that the MPC decides to raise interest rates before the end of the year”.
Similar pressures seem to be building on America’s Janet Yellen and the Federal Reserve. As my colleague John Stepek pointed out last week, we’ve just seen the first vote in favour of raising rates in the US.
All in all, it looks like tightening may be about to start in the near future.
Buy Japan and Greece
When rates start going up in Britain and the US, they are going to hit the two most frothy assets: London property and American shares.
However, the US market is particularly risky because of its expensive valuation. Indeed it trades at a cyclically-adjusted price/earnings ratio (Cape) of around 26. Out of 55 markets surveyed by Mebane Farber, only Denmark and Indonesia are more expensive on this measure.
If you want to reduce your exposure to the US, we’d suggest putting some money into Greece and Japan as alternatives. Greece is still very cheap, trading at a Cape of four. It should also benefit from quantitative easing by the European Central Bank, and can be accessed through Lyxor ETF FTSE Athex 20 (PAR: GRE).
If you want to invest in Japan, check out David C Stevenson’s recent article on the best Japanese funds. If you’re not already a subscriber, sign up for a free trial and you will be able to read the article in our archive.
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