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Interest rates likely to fall back towards pre-pandemic levels, says IMF

Samantha Partington
Written By:
Samantha Partington

Interest rates are expected to fall back towards pre-pandemic levels once inflation has been tamed, according to a forecast.

Recent interest rate rises are “likely to be temporary”, according to analysis by the International Monetary Fund (IMF).

In its report, World Economic Outlook, the IMF wrote: “When inflation is brought back under control, advanced economies’ central banks are likely to ease monetary policy and bring real interest rates back toward pre-pandemic levels.”

However, the IMF did  not predict how soon this would happen.

Since December 2021 the Bank of England has gradually and consistently increased the base rate from 0.10% to 4.25% to try and tame inflation.

Inflation, however, remains at 10.4%, way above the Bank’s target of 2%. Rising energy prices and food costs are the main drivers of high inflation.

Rising inflation and interest rate hikes have also been seen in the US, Europe and other countries.

Ageing populations, who spend less, are said to one of the factors that would be likely to lower inflation.

Mortgage rate relief

One of the widest-felt effects of the base rate rises has been the impact on mortgage rates. The average standard variable rate, the rate borrowers move onto when their mortgage deal expires, exceeded 7% in March, a level not breached since 2008 according to data firm Moneyfacts. A year ago, the average SVR stood at 4.61%.

Russ Mould, AJ Bell investment director, said: “Anyone groaning under the weight of much heftier mortgage payments may welcome the IMF’s prediction for a return to pre-Covid ultra-low interest rates in the UK.

“However, the implications for the British economy are less than favourable. A combination of falling productivity and an ageing population is expected to tame inflation but at the cost of constraining economic growth. The equivalent of someone being told they can no longer walk but at least they won’t fall over.”

Treat forecast with caution

Laith Khalaf, head of investment analysis at AJ Bell, added: “It’s important to recognise that the IMF is suggesting interest rates will head back towards pre-pandemic levels, not that there will be a wholesale return to zero interest rate policy.

“Its analysis suggests that in the UK the natural rate of interest is around 0.5% above inflation, which would mean a nominal interest rate of 2.5% assuming the central bank can hit its inflation target.”

But to do so the IMF concedes there are a range of possible outcomes around this scenario and a lot of economic projections that feed into the analysis.

“In other words, the IMF’s findings have a wide margin of error and should be treated with caution,” adds Mr Khalaf.

He continues: “It’s difficult to see how interest rates could be cut when Consumer Price Inflation still stands at around 10%, but inflation is forecast to recede rapidly over the next year, with the latest report from the Bank of England suggesting that it will fall to 1% in 2025, and just 0.4% in 2026. That gives some credence to the IMF’s claims, and also implies that current expectations of monetary policy are too tight.”