Interest Rates and Saving Rates

A reader asked a question about forecasts for interest rates over the next few years.

I looked at some of the factors affecting interest rates over the next few months. Overall, rates are likely to remain low. This is because:

• Spare capacity in economy
• Inflation still below governments target of CPI 2%
• Rise in unemployment
• Possible tax rises and spending cuts to deal with budget deficit.

However, the further in the future we go, the more difficult it will be to predict interest rates. At the moment, it is hard to see any evidence of inflationary pressure in the economy. But, that could change if the economy recovers and the impact of quantitative easing and low interest rates start to take effect.

• Another factor that may  keep interest rates low is the predicted rise in the savings rate. The savings rate is predicted to keep rising because
• Decline in consumer wealth encourages people to save.
• Fear of unemployment encourages people to save for precautionary measures.
• Banks not keen to lend but trying to encourage savings to rebuild battered balance sheets.

If consumers continue to increase their savings, against a backdrop of stagnant incomes, it means consumer spending will remain subdued over the next few months leading to a slow economic recovery.

• The problem with savings