Interest Rates for buy to let

MPC rate decisions and buy to let mortgages

Over the past 6-9 months the outlook for the UK economy has improved dramatically. From a position where growth had been sub-trend for the whole of 2005, the first two quarters of 2006 have seen growth at or above trend. Moreover, the retail sector has shown dramatic improvement; retail sales volumes are now growing by 4.3% y/y (August ’06) versus growth of a meagre 1.2% y/y in Jan ‘06.CPI inflation has also turned around, with the inflation rate pushing up to 2.5% in June from 1.9% at the start of the year and then returning to 2.5% in August.

What also will worry the Bank of England is that the most recent inflation figures demonstrated a more general increase in prices (electric & electronic items, toys & games, furniture etc) rather than the fuel & energy led rises that had prompted the previous increases in inflation.The members of the UK MPC are likely to find themselves in a familiar dilemma at the November meeting. This meeting coincides with the next quarterly forecast revisions for growth and inflation from the Bank of England and recent developments in both are likely to heavily influential on the Bank’s projections for the next 2 years.

In particular, the MPC will worry that the rebound in retail sales growth and the more general rise in high street prices (high street inflation is at a 4½ year high) means a shift in the balance of power between retailers and consumers back towards the retailers. They will also be concerned by the prospect of upside risks on upcoming wage rounds in the public and private sector.Over the next 3 years, we think that there are serious risks of a succession of rate hikes, but only if the inflation data warrants it.

As a consequence we are not going to "forecast" anything other than a hike in rates at the November MPC taking the base rate to 5%. However there are significant risks that, at some indeterminate point in 2007 a further 25bps rate hike or hikes will be required especially based on the latest forecasts for growth in the UK. It is noticeable that the Chancellor, Gordon Brown, and industry lobby groups have accepted that UK interest rates will have to rise. It will also be worthwhile watching energy prices to see if the predicted and hoped for fall in oil prices occurs. Given the substantial risks (economic, geopolitical and speculative), there is a better than even chance that oil prices will resume their upward trend in 2007.

Into 2008, we think the UK labour market will improve and that could also threaten higher wage demands, and that improvement will also support stronger consumer spending growth. Moreover, import price inflation will also rise in 2008 & 2009, since the Chinese renminbi and Indian Rupee are both expected to strengthen by up to 20% against the GBP over the next 3 years. Note also that some of that strength is likely to be due to the pound losing some ground against the US dollar, which is also likely to increase prices from other Asian countries that continue to deal predominantly in dollars.

So the story unfolds in two parts. The first is that central to our interest rate forecast is the serious upside risks to rates over the next 18 months, but the acceptance that the timing of any further rate hikes will be determined by inflation and output data. The second is that eventually the strength of inflation pressures (domestic, imported and wage) coupled with the strength of economic growth.