Analysis of the Week: Holding Interest?​

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By Alison Catchpole​


The Story
On 4 November 2021, the Bank of England’s Monetary Policy Committee (MPC) was expected to announce a rise in interest rates. Instead, at the interest rate meeting on 2 November 2021, the vote was 7-2 to keep rates on hold at 0.1%, rather than raise to 0.25%. The Bank of England (BoE) held, but suggested that “it will be necessary over the coming months” to raise rates (The Guardian).

BoE Governor Andrew Bailey called the decision a “close call” after many hours of discussion, with MPC members allegedly wanting to see more evidence of how the economy recovers (BBC), though he apparently apologised for “the damage higher prices would do to household real incomes” (Financial Times). The final interest rate announcement for 2021 will be on 16 December 2021.

The Background

The nine members of the MPC meet eight times a year, equivalent to around every six weeks. Their current remit is to keep inflation (the rise in prices for goods and services) at 2% over the medium term, meaning the next two to three years.

If interest rates rise, borrowing – particularly for mortgages – becomes more expensive, potentially causing difficulties in the housing market. However, returns on savings also rise.

After the 2008 financial crash, the Bank of England (BoE) cut the Bank Rate, the base rate at which interest is charged by the BoE on loans and advances, to 0.5%. Since then, it has reduced the Bank Rate two further times to bolster the economy when facing uncertainty: once in the wake of the 2016 EU referendum, and again in 2020 when the coronavirus pandemic caused the biggest worldwide economic slowdown for centuries. In March 2020 the rates were decreased twice in a week, bringing them down from 0.25% to a historic low of 0.1%.

Historically, between 1932 and 1951, the only time interest rates went above 2% was immediately after the outbreak of World War II. This can be contrasted with the Thatcher administration policy of 17% interest, seen in 1979 as a key weapon in combating inflation.

In 2021, weaker than expected consumer spending coupled with supply chain bottlenecks have caused a drop in the predicted growth. The MPC is predicting that the economy will regain the ground lost during the Covid-19 pandemic in the first quarter of 2022, but this is later than expected.

BoE policymaker Silvana Tenreyo was amongst the seven who voted to keep the rates at 0.1%, reportedly citing the need for a trade-off between supporting growth and fighting potentially persistent inflation pressures (Reuters). In line with other policymakers, she wanted a clearer indication of the impact on the economy of the end of the furlough scheme, which only finished at the end of September 2021.

What It Means For Businesses And Law Firms
A little more than two weeks after Bailey said that the BoE would have to act to contain inflation, markets were caught off-guard. The pound plummeted, falling 1.5% against the dollar. The 10-year gilt yield fell to a six-week low of 0.85%, and the UK’s two-year bond yield fell to 0.4% from a high of almost double that earlier in the week (Financial Times). Ongoing global issues, such as the energy crisis and supply chain disruption, look to continue to push inflation for some time.

The legal industry too is waiting to see what the exact shape of the global recovery looks like. Many clients of leading law firms using a substantial amount of debt to fund their investments. Will higher interest rates impact the volume of leveraged buyouts as they drive up the cost of financing? How should parties reflect this in their terms? (White & Case)