‘Bank of England has bared its teeth with price pressures moving in wrong direction’

Interest rates rise piles more pressure on households and businesses – Rob Morgan, Chief Investment Analyst at Charles Stanley Direct, part of Raymond James

The Bank of England has bared its teeth and showed its determination to fight inflation. With price pressures moving in the wrong direction and the Fed and ECB having already hiked, the spotlight was on the MPC to deliver.

Why have interest rates increased?

Economic data alone is not strong enough to justify higher rates, but inflation moving further above target and concerns about energy-driven price pressures has tipped the balance.

The MPC is trying to head inflation off at the pass and prevent a temporary inflation shock becoming a lasting problem. Wait too long to raise rates and there’s a risk inflation expectations become embedded, which would mean that the BoE might ultimately need to raise rates further and keep them higher for longer.

Is this a policy mistake?

The key risk is that the Bank ends up tightening policy just as the economy weakens. Consumer finances remain under pressure, large parts of the economy remain sluggish, and business confidence is fragile. An interest rate increase only intensifies those worrying trends.

Although overall growth remains reasonably solid and the labour market has proven more resilient than expected, economic activity is at risk of stalling from higher borrowing costs.

The impact of a rate hike on inflation is also questionable. The recent resurgence is driven by energy, fuel and other supply factors, and higher rates do not produce barrels of oil or bushels of grain. There’s a plausible scenario where the bank will need to pivot quite quickly to cutting rates if energy markets fall back into line.

What does it mean for households and businesses?

In the short term, households and businesses may experience a dual squeeze of elevated prices and higher borrowing costs. Households with tracker mortgages or coming off a fix will be facing the full force of the storm. Those with more cash than borrowing are in a better position to weather this difficult period. Interest rates on competitive savings accounts can offer a slender margin above current inflation – at least before any tax.