Interest rate rises will demand tough choices of treasurers

Council treasurers face tough investment decisions following this week’s inflation statement by Bank of England governor Mark Carney, according to a leading fund manager.
Carney effectively dropped his policy of linking future interest rate rises with unemployment levels, following a sharper-than-expected drop in the latter figure.
In the wake of the announcement, Steven Bell, director, global macro at F&C Asset Management told Room151 that councils could expect the official interest rate to rise as early as the end of this year.
Bell said: “The world has changed. The story of the past few years has been that rates are going to go lower than you think and stay there longer than you think.”
“There was really one strategy for treasurers, which was to tie their money up for a long period.
“While returns have been relatively low, investment decisions have been fairly easy. These decisions are going to get a lot harder.”
John Hawksworth, chief economist at PwC told Room151: “The assumption that rates would remain for a couple of years has been safe. It is no longer a reasonable assumption.” However, he said that the expectation that rates are likely to rise relatively soon has been around for some time.
Bell said that in coming months councils would have to balance their desire for safety with the possibility that they could be trapped into long-term investments at low rates only to see interest rates rise.
He said: “In the next six months it will be very easy to get caught out. The governor has to make a very finely balanced decision about when to increase rates. Too early and inflation could rise. Too late and the recovery could stall.”
Last summer, Carney unveiled the “forward guidance” policy, which would see the bank reviewing interest rate levels if unemployment fell below 7 per cent.
At the time, the UK was in danger of a so-called triple dip recession, with the bank expecting the threshold to be reached in 2016. However, the economy has recovered strongly since, with the bank expecting the next set of unemployment figures to show unemployment fell to 7 per cent in January.
This week Carney announced that instead of unemployment figures, a much wider range of indicators would be used to judge when interest rates should rise.
In addition, Carney emphasised that any future rises would be small ones. Hawksworth said: “The announcement gives some basis for planning. The interest rate is not going to quickly return to pre-crisis levels.”
But he warned that it was worth councils planning for different scenarios where rates might change again or could remaining on hold further to any negative shocks from the Eurozone.
Bell said that the introduction of new indicators, although they would be more transparent, was essentially “a return to normal business” for the Bank of England.
And he was critical about the introduction of forward guidance in the first place.
He said: “After its introduction, lots of resources were poured into examining the unemployment statistics and people discovered its flaws.
“The statistics are a rolling three month average, so lag behind the real economy. It is as if your car’s speedometer told you your speed from five seconds ago.”
Hawksworth agreed, saying that “in many ways, the unemployment was an unfortunate metric to choose”.
However, Bell said, despite its lack of effectiveness in the long-term, forward guidance had helped perform its short-term task of steering the economy away from a triple dip recession.