Rate rise ‘will hit corporate returns’

Bank of England governor Mark Carney  Photo:  Anthony Devlin/PA Wire
Bank of England governor Mark Carney Photo: Anthony Devlin/PA Wire
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A rise in interest rates in 2016 will make borrowing less attractive for large companies and put an end to the trend of increasing profits, a leading business group has predicted.

The Institute of Directors said profitability of UK companies had reached all-time highs but it believes things will change in the coming year.

The IoD said 2015 may have been “as good as it gets” for jobs, with employment possibly falling slightly from its current record high.

The directors’ group also predicted improved productivity, which it said is likely to return to its long-term trend rate of growth in 2016.

James Sproule, chief economist at the IoD, said: “We have been living in a world of extraordinarily low interest rates for eight years, and are now at risk of seeing asset bubbles develop.

“The rate-setters on the Monetary Policy Committee have so far taken a cautious approach, but we believe they will have no choice but to start raising rates this year if they are to get monetary policy back to a position where it could be effective again if we hit another crisis.

“Ultra-low interest rates have promoted misallocation of credit, as larger businesses which can borrow have levered themselves while smaller businesses have not been able to gain a similar advantage.

“But this trend has almost certainly run its course and any interest rate rise will make borrowing less attractive and, as a consequence, corporate returns are likely to disappoint as the year progresses.”

Earlier this month, the IoD welcomed the US Federal Reserve’s decision to raise interest rates, and it called on the Bank of England to “see through this temporary period” of low inflation and begin normalising rates in the UK.

At the time, Mr Sproule said: “The Federal Reserve’s decision to start normalising interest rates is a welcome sign of the central bank’s confidence in the US economy. For Britain, higher US interest rates give the Bank of England the flexibility to start normalising rates on this side of the Atlantic as well.”

The Federal Reserve raised interest rates from record lows set at the depths of the 2008 financial crisis, a shift that heralds modestly higher rates on some loans.

The Fed coupled its first rate hike in nine years with a signal that further increases are likely to be made slowly as the economy strengthens further, and inflation rises from low levels.

The move ended an extraordinary seven-year period of near-zero borrowing rates.

But the Fed’s statement suggested that rates would remain historically low well into the future, saying it expects “only gradual increases”.

The action reflected the central bank’s belief that the US economy has finally regained enough strength, six-and-a-half years after the “Great Recession” ended, to withstand modestly higher borrowing rates.