It’s been eight years since the Bank of England slashed interest rates to 0.5%, as the fallout from the financial crisis rocked global markets. The UK’s now become used to cheap borrowing, but this week the Monetary Policy Committee (MPC) came one step closer to lifting rates, under pressure from accelerating inflation.
On the face of it, this month’s MPC meeting wasn’t too exciting, with the bank rate sticking at 0.25%. But it was hard to ignore the shift in underlying sentiment of the committee members.
Three of the eight-strong committee now reckon it’s time to raise interest rates, worried that accelerating inflation could be more harmful to the economy.
But, with the government struggling to pull itself together following the general election fall-out and Brexit negotiations still set to begin next week, is now the time?
Inflation jumps to 2.9%
Inflation has been running ahead of the Bank of England’s 2% target, with the weak pound pushing it to 2.9% year-on-year in May. Sterling’s low value increases the costs of imports, which feeds into prices at the till. I’ve noticed everything get a bit pricier, from the weekly shop to buying this year’s holiday clothes for the children.
The Bank of England reckons inflation will reach 3% by Autumn. When it does, governor Mark Carney will have to pen an open letter to the Chancellor explaining why price growth is ahead of target, and what he plans to do about it. Find out how inflation impacts your wealth.
Not only is inflation reducing the purchasing power of our money, but wage growth is also failing to keep up. Unemployment may have fallen to its lowest rate in 40 years¹, but wage growth continues to grind slower. This squeeze is straining the economy; uncertainty and weaker real earnings has caused retail sales growth to slow.
So, we’ve got an economy that’s slowing, despite accelerating inflation. That isn’t too pretty and the Bank of England now has a tough decision ahead of it; does it hike interest rates to try and slow the economy even though it already seems to be weakening?
Case for interest rate rise?
As inflation is being driven by the weak pound, an increase in rates could help support the exchange rate and reduce imported inflation. But the Bank of England has warned that a rise could hit employment levels and lower income growth further. It could also cause a lot of pain for unprepared borrowers who are still giddy on cheap borrowing rates.
It’s unlikely we’ll see any change in interest rates change this year, but the Bank is probably preparing itself to get on the path of monetary policy normalisation.
It’s important we prepare ourselves too. We’ve got a tough few years ahead of us as the UK negotiates Brexit and shakes hands on new trading agreements. It’s been drilled into us that we’re living in uncertain times, but we need to ensure our finances reflect this.
Whether it’s putting a little bit more away each month, or diversifying our portfolios to balance out specific risks in the UK, it’s worth being more prudent now to prevent any painful decisions later down the line.