Interest rates could be frozen in February

23 January 2008

The head of the Bank of England has warned that further interest ratecuts are not a given because of fears that inflation may rise beyond 3%.

In a speech, the Bank’s governor, Mervyn King, said higher energy and food prices, as well as the lower exchange rate, could push inflation “significantly” beyond its 2% target this year – potentially even exceeding the 3% mark. If inflation does exceed the 2% target by more than 1%, then King is required to write an open letter to the chancellor explaining the reasons for this.

Last year, for the first time since the Bank was given independence in 1997, King wrote such a letter and last night he warned that he may have to put pen to paper again in 2008.

King added: “We are determined to keep inflation on track to meet the 2% target in the medium term.”

This morning the Bank revealed that the decision to freeze rates in January was nearly unanimous, with just one member of its Monetary Policy Committee voting for a cut.

Economists, mortgage lenders and other pundits were widely predicting a cut in January. This was despite the fact that rates were cut in December and that it is unusual for rates to change in the month before an inflation report is due.

The minutes from January’s vote show Bank of England governor Mervyn King proposed rates should be frozen at 5.5%. Eight members of the MPC agreed while just one, David Blanchflower, voted for a reduction.

The Bank of England says that it decided not to cut rates in January because of the worsening prospects of short-run inflation. It also wanted to see February’s inflation report before taking action.

Simon Denham, managing director of Capital Spreads, says: “Mervyn King continues to try and show his vigilance in the face of inflation even though he spends most of his time reminding us that 2008 will be the toughest year the UK has faced in a decade.

“With the likelihood of a recession ever increasing, this should be enough to persuade our rate setters here that it is time for a similar move in interest rates.”

He adds: “Who is the irresponsible one? The tenacious American, who risked the possibility of stagflation in order to reignite growth, or the cautious Brit, who tackled inflation at the expense of lowering borrowing costs and the economy?”

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