Inflation figures for December were worse than expected, with the consumer prices index (CPI) rising to 3.7% from November’s 3.3%. Meanwhile, the retail prices index (RPI) is running at 4.8%.
These numbers don’t even take into account the VAT hike, which will be reflected in the January figures. Clearly, inflation will rise above 4% in coming months, more than double the government’s 2% target, and is likely to stay there for some time.
Unsurprisingly, there is growing pressure on the Bank of England to raise rates to keep inflation in check. And yet, is that really what the Bank should do? It is easy to see why savers are fed up with effectively losing money each month, while borrowers with hefty mortgages rejoice in another month of rock-bottom rates.
Last week, the Monetary Policy Committee announced that interest rates would remain at 0.5% for the 22nd month. But, while inflation is far higher than the government’s target, interest rates shouldn’t rise before the second half of this year because of the tentative economic recovery.
The Bank of England must hold its nerve, despite pressure from influential sources to increase interest rates.
There is talk of the Bank becoming a laughing stock for carrying on its single-minded pursuit of low rates. Mervyn King, governor of the Bank of England, may have written four letters to the Chancellor last year explaining why inflation was so high, but the weak economic recovery could be severely hampered by a premature rate rise.
Rates clearly do need to rise at some point, nobody is disputing that. But this should only start happening once the recovery is well underway. The full effect of fiscal tightening, necessary to bring the budget deficit under control, has not yet been felt. In other words, things will get worse before they get better, and rising interest rates at the same time could make a bad situation almost unbearable.
Borrowers should brace themselves for a rise in interest rates. They will rise at some point, even if it’s not next month, so it’s important to be prepared, rather than complacent.
Swap rates – the rate which lenders pay to borrow from each other – have steadily risen since last October, and several lenders have been busy raising their fixed rates in response. Those lenders which haven’t done so are likely to follow suit in coming days and weeks.
Borrowers who need the security of a fix should take advice, see what is out there and take action.
Melanie Bien is director of Private Finance
