Scale of rate hike is shock therapy for UK's inflation problem

Blimey.

The Bank of England was always going to increase its Bank rate this month. But every economist had expected only a quarter percentage point increase.

There was good reason for this.

Although inflation data had been higher than expected this week, the bank had been slowing down the rate at which it was lifting borrowing costs. So too had its counterpart central banks around the world, most notably the Federal Reserve in the US and the European Central Bank.

Typically a quarter percentage point increase is considered a “normal” increase. And while some investors had begun to bet on a bigger rate increase this month, most people expected another normal increase.

Well, the bank’s monetary policy committee (MPC) has surprised them with a bigger increase.

It’s a sign, if any were needed, of just how worried it is about inflation, which looks like it is becoming dangerously sticky.

The stickier it gets, the harder inflation is to bring down, hence why the bank is taking this more radical step.

It is a form of shock therapy that it hopes will send out a clear message: when it comes to inflation-fighting, it’s not messing around.

The problem is that some will depict it as a form of panic.

The bank has been roundly criticised for failing to forecast the sharp increase in inflation in the last couple of years. It has been criticised for being too slow to respond. Now it is responding far more quickly, but some will argue that this is a problem of its own making.

And an increase like this will have a bearing on households. For as economic tools go, interest rates are a particularly blunt instrument.

Cutting them encourages all sorts of economic activity – some good, some bad. It incentivises people to borrow more, sometimes to excess. But it also encourages investment in important parts of the economy.

Indeed, you could make the case that the pretty pass we’re in at the moment, with so many households so sensitive to even a relatively small increase in rates – with the upshot that 6% mortgage rates actually feel a lot like 15% rates did in the early 1990s.

In much the same way, raising interest rates is a little like bludgeoning the economy. It helps to reduce inflation, by making it considerably less attractive to borrow and splurge. But by the same token it also causes severe damage to many households. It creates collateral damage.

That is the dilemma facing the Bank of England right now. It knows that this will be grisly. It knows many blameless households who were simply following the best mainstream advice of the time will suffer a serious financial blow as mortgage rates rise.

Yet since its main task is to try to reduce inflation and get it down from its current 8.7% level to its target of 2%, it feels duty-bound to wield the bludgeon.

This article was originally published by Sky.com. Read the original article here.

Articles You May Like