Interest rates on hold for 22nd straight month
The Bank of England confirmed expectations today as it announced the base rate would stay the same at 0.5% and no changes would be made to quantitative easing.
For the 22nd consecutive month, Mervyn King's MPC deferred making a decision that might hinder the strength of the recovery, but analysts think the time to act is edging nearer.
"It will be interesting to see whether some members changed into Andrew Sentence's camp, who has been voting in favour of a rate hike for some time," said analysts at Commerzbank. But the breakdown of votes will not be available until the meeting minutes are released on 26 January.
Inflationary concerns in the UK are currently rising and there is mounting pressure on the Bank of England to confront this, according to Howard Archer, chief European and UK economist for IHS Global Insight.
However, the fiscal squeeze – most recently demonstrated by the hike in VAT to 20% – was probably fresh in the committee's minds when it chose not to shake up policy.
"We suspect most MPC members will have favoured keeping monetary policy unchanged while they look to see how much the economy is being affected by the fiscal squeeze currently kicking in. The problem facing the MPC is that economic data for late 2010 and early 2011 are likely to be distorted by December's severe weather and some catch-up effect on lost business," added Archer.
This article was written for Interactive Investor
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.