Will rising interest rates crash the market?

The UK’s Daily Telegraph reports comments by MPC member Paul Fisher that homeowners should steel themselves for an increase in interest rates, with an ultimate target of 5% (currently the Bank of England’s lending rate is 0.5%).

This would be a two-edged sword. It would combat inflation and begin to reward savers; but it would also worsen conditions for business, by reducing the consumer’s disposable income and raising the cost of commercial finance (which is already hard to get, particularly for smaller businesses).

The effect on the stockmarket would be negative, as higher costs and lower turnover would squeeze profits; and debt-fuelled share speculation would become more expensive and so riskier for the investment banks, who might give up looking for a bigger fool and race for the emergency exit.

However, there is no timescale given for this process and the article says that the market expectation is that the rate will rise to only 2% within the next two years.

I think Mr Fisher’s statement, ostensibly warning borrowers to tighten their belts, is actually intended to be overheard by the bond market, trying to reassure the latter that it won’t be ripped-off by inflation.

I also think it’s a tactic characteristic of the previous government, namely to make a tentative policy announcement in order to gauge reactions and trim sails accordingly. It’s come from a source that can later be spun as having been a personal view or at most, merely a long-term aspiration of the Monetary Policy Committee.

There are dangers in this type of news management. To me, it’s a sign of the real weakness of our current economic position. And if the bond market thinks it’s being bluffed because the government hasn’t a clue how to proceed, it may decide to call for a show of the cards.

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