Kames Capital: Why rates will not rise in the UK next year

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The Bank of England’s Monetary Policy Committee (MPC) will leave the base rate at 0.5% throughout 2015 as economic growth in the UK weakens and inflation continues to undershoot, Kames Capital’s Chief Investment Officer Stephen Jones argues.

The Bank has successfully managed to help the economy recover at the expense of its inflation-focused mandate, with the Consumer Prices Index (CPI) inflation rate only matching the target level of 2% once since the financial crisis. The rhetoric from central banks continues to differ from their actions. They have had a core bias to support growth and ignore inflation since the credit crisis, and I think that will persist next year.

Our central prediction is for growth to actually come off marginally in the UK in 2015, while we do not expect inflation to become an issue, with no wage rises in the pipeline to force the MPC’s hand. Therefore, we do not expect a rate rise in the UK next year.

While the MPC is split on interest rates, with a 7-2 vote in November’s meeting in which two members called for a 0.25% hike, we expect the current voting pattern to be sustained. This split in the MPC is likely to persist for some time, with a couple of votes for a hike but the core of the MPC voting to hold. While there have been ongoing expectations the huge amount of stimulus poured into the UK economy will eventually lead to a spike in prices, inflation is likely to dip in the near term in line with Bank forecasts, it could potentially fall below 1% by the end of this year before rising marginally over the longer term.

Inflation will fall in the near term in the UK, before heading back towards the 2% target on a 2-3 year view; but it is unlikely to suddenly start shooting higher thanks to the period of strength the pound enjoyed at the start of this year, and because there continues to be little wage inflation.

The ‘growth at any cost’ mantra which has driven central bank actions since the financial crisis will not change in the near term, with only the US economy showing enough strength to be able to cope with a rate rise in 2015. The robustness of the US economy is well established. It has seen ongoing job creation, unemployment has come down, and it is a predominantly self-sufficient economy, with at least 80% of GDP internally generated.

The US Federal Reserve also has a dual mandate to achieve both full employment and prevent rising prices, and as employment continues to climb next year, I think they will begin gently raising rates at the end of 2015 to prevent inflation shooting higher.

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