Why Interest Rates were increased again to 0.25%
To the dismay of householders and industry, the Monetary Policy Committee unexpectedly increased interest rates for the third time in only 6 months. Interest rates now stand at 5.25%. Although the increase was only a quarter of 1%, it will add considerable financial burden to the UK’s overstretched borrowers. For example somebody with a mortgage of £100,000 will find themselves paying an extra £15, or £21 for an interest only mortgage.
The citizens advice bureau warned of financial disaster for some families, especially since it comes in the difficult post Christmas spending period. The CBI also expressed its regret. The CBI are worried on behalf of exporters. The rise in interest rates has further increased the value of the £ making British exports less competitive. The pound rose yesterday to nearly $2 per £1. Given the impact on borrowers and increased risk of insolvency many have questioned the banks motives.
The Monetary Policy Committee have defended their decision by saying that inflation is still above the government’s inflation target. CPI Inflation is currently 2.7%. However some argue that this is only a small divergence between their target of 2%. The key thing is the future course of inflation. Next month the MPC will produce their inflation report, this could be key to deciding whether interest rates have to rise further. The MPC also cite other inflationary pressures; such as the ever-resilient housing market. House prices rose by 3.3% in the last 3 months giving another unsustainable rise. The MPC also cited increased wage pressures. The latest wage settlements have been averaging around 4%, a figure the MPC argue could lead to further inflation; the CBI however were disputing the inflationary impact of wage rises. Perhaps the most significant justification for the interest rate rise is that this pre-emptive move will prevent future interest rate rises. If the MPC can dampen consumer spending early it will prevent a future inflationary situation. This pre-emptive inflationary strategy is exactly what Gordon Brown had in mind when the MPC were made independent in 1997.
However some economists are increasingly aware of the limitations of monetary policy. The effects of raising interest rates are not equally spread across the economy. First time buyers and usually young people with high levels of borrowing will definitely feel the financial pinch. However there is a significant proportion of the economy sitting on equity gains from rising house prices, these consumers have also usually paid off most of their mortgage. Therefore higher interest rates do not dampen their spending. In fact the elder generation are often helping out their children with equity for buying a house. This and the influx of foreigners into the housing market is maintaining healthy demand despite the increased interest rates. The effect of this is that rising interest rates may have less impact on reducing inflationary pressures. Increasing the likelihood of future inflationary pressures.
The Future of Interest Rates in UK (Nov 2006)