Will interest rates rise this week?

10 February 2011

This Thursday the Monetary Policy Committee will issue its latest interest rate decision.

As inflationary pressures mount it is under increasing pressure to raise rates. However, a small but vocal minority claim this would have a detrimental effect on our fragile economy. Here we look at the arguments for and against a rate rise.

Will interest rates rise in 2011?


Monetary Policy Committee member Dr Andrew Sentance has been arguing the need for a rate rise since last June but at the last MPC meeting in January he was not alone in his views. Fellow member Martin Weale also voted for a 0.25% rise. But why?

The main issue is inflation.

When interest rates rise it incentivises people to save and discourages them from borrowing because they get a better rate of return of their savings and their borrowing costs more.

This has the effect of taking money out of the economy, as people spend less. This reduces demand in the economy which should push down the cost of goods.

Consumer price inflation rose to an annual rate of 3.7% in December, up from 3.3% in November. The figure was higher than the 3.4% expected and way above the target of 2%.

Read: Rising inflation: What does it mean for you?

Sentance has said higher interest rates would help to protect savers from the effects of higher inflation by raising the return on their savings deposits.

His views have been backed by Charles Bean, deputy governor of the Bank of England. Bean says the increase in the cost of fuel and food could cause inflation to rise further and argues this would need to be curbed using monetary policy.

"It is one of the risks that continuing strong growth in emerging markets may mean a tendency for commodity prices to continue to rise relative to the general prices of goods and services," he says.

Ros Altman, director general at Saga, has also commented on the detrinmental effect this has on pensions.

"Even though the state pension is linked to the retail price index at the moment, many pensioners are seeing the real value of their savings or their annuities being eroded by inflation," she says.

"It is time to step up the pressure on the Bank of England to call for rates to rise from the current excessively low 'emergency' levels. The dangers of not raising rates are actually greater than the dangers or increasing them."


But not everyone is hoping for a rate rise. David Kern, chief economist at the British Chambers of Commerce, argues the economy is still too fragile to handle a rate rise.

Read: Interest rates must not rise in 2011, warns think tank

He says while figures from the Purchasing Managers' Index showed businesses rebounded well following the disruption caused by the snow in December, the MPC should not be too hasty.

"We are concerned that recent positive figures could heighten pressure on the MPC to raise interest rates too early," he says.

"The UK recovery is still fragile and the more forceful implementation of the government’s austerity plan will inevitably have negative effects on business cashflows and consumer disposable incomes.

"While we support the Government’s continued deficit cutting programme, we believe it is important to ensure that the recovery continues and there are no setbacks."

His opinion is echoed by the Ernst and Young ITEM Club, the only non-governmental economic forecasting group to use the HM Treasury model of the UK economy.

In its winter four-year forecast, the ITEM Club warns that an increase in Bank base rate could endanger the economic recovery in what is going to be a tough 2011.

ITEM says the current high level of the CPI index is largely due to the VAT increases and commodity price rises, and it expects the CPI to fall back to the 2% target when these temporary pressures fall out of the index.

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