The good and bad in low UK interest rates


June 23, 2017

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Wind companies in the UK might have welcomed the statement from Bank of England governor Mark Carney last Tuesday that the interest rate will stay low for the rest of this decade. It should mean onshore and offshore wind stays attractive for investors.

However, we also see a warning in his words.

In January we said that the Bank of England was likely to raise its interest rate this year and, this month, the BoE was close to doing so: at its meeting on 15 June, three out of eight policymakers called for an interest rate hike from its current record low of 0.25%. It was the tightest call since 2011.

The prospect of an interest rate rise was seen as good news by financial markets. While the main reason for a rise would be to avoid inflation overshooting the BoE’s 2% target, the markets also see it as a sign that the central bank considers the UK economy strong enough to manage a slightly higher interest rate.

Carney has moved to cool the enthusiasm of the markets. He said on Tuesday that it was “not yet the time” to raise the rate as he wants to see how the economy reacts to the reality of Brexit negotiations. This view was not supported on Wednesday as the BoE’s chief economist Andy Haldane said he would consider voting to raise the rate next time as “the risks of leaving policy tightening too late are rising”.

The pair want to react in different ways to the same issue: increased economic and political uncertainty. So what does this divergence of opinion mean for wind?

We see good news and bad news. The good news is that if the interest rate is kept at its record-low level, as Carney wants to, wind firms in the UK should keep benefiting. It makes it cheaper for developers to build and enables manufacturers to cut the cost of their products, and hence help the sector to reduce prices.

Also, if returns in government bonds stay low then wind farms remain an interesting choice for investors seeking better returns for reasonably low risk.

Now comes the bad news. At the beginning of this year, an interest rate hike by the BoE looked possible because the UK economy seemed to be reacting well to Brexit, and so it could raise interest rates without hurting the economy.

That sentiment has weakened. In the first quarter of 2017 the UK economy grew just 0.3%, slowing more than expected compared to 0.7% growth in the last quarter of 2016. This particularly reflects slower activity in services and manufacturing.

And that sentiment has worsened since Prime Minister Theresa May called the snap election that plunged the UK into a fresh political crisis. Four of the BoE’s eight policymakers want to raise the interest rate now to give the BoE more room for manoeuvre and support the UK economy if Brexit negotiations don’t go well.

In addition, a poll of 700 business leaders by the UK’s Institute of Directors right after the election has shown that 65% of businesses questioned believed uncertainty over the future of the government was “a significant concern” for the UK economy. This is not just a reflection of the weakness of the Conservative government, but also the prospect it could be replaced by a Labour party headed by far-left Jeremy Corbyn.

Continued low interest rates can be good for wind, but they also show there is a weak economic outlook and political uncertainty that could discourage investors.

We remain relatively upbeat about the prospects for wind in the UK. Growth in the offshore sector is set to continue under the Contracts for Difference regime, while those in onshore wind know the rules within which they have to work.

In the short term, UK wind companies should keep benefitting from loose monetary policy, but caution will be the watchword as Brexit really starts to take shape.

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