UK: Economic Update - Latest issue August’s interest rate rise

Last Updated: 6 August 2004

Roger Bootle's response to the August's MPC meeting

  • This rise in interest rates to 4.75% is merely another staging post on the way to much higher interest rates.
  • The increase is readily justified by recent data. Notably, the annual growth rate of GDP rose from 3.4% in Q1 to 3.7% in Q2 – well above the economy’s estimated trend rate of around 2.7%.
  • Moreover, retail sales grew at a very robust monthly rate of 1.1% in June. And although the Bank of England’s new mortgage approvals series – which is a forward-looking indicator of activity in the housing market – fell from 124,000 in May to 114,000 in June, the Nationwide showed that house prices rose by 2.1% in July, taking the annual growth rate to a 14 month high of 20.3%.
  • Accordingly, the real decision to be taken today was not about whether interest rates should be raised but rather by how much. There will surely have been some discussion of the merits of raising interest rates by 0.5%. In my view, the Committee should have gone the whole hog today. As I argued in May, consumers need to be brought up short. Moreover, the runaway housing boom needs to be stopped before it leads to a catastrophe. If it does not do this the MPC risks having eventually to raise interest rates much higher.
  • But the Committee has stated in the past that it does not want to shock consumers and the last time it discussed raising rates by 0.5% in May, it compromised by raising interest rates by 0.25% in successive months. Although this softly, softly approach is, in my view, second best, it is nevertheless preferable to deferring a further rate rise until the next Inflation Report. Today’s interest rate hike should be seen as the first stage of a two part plan to get interest rates up to 5.0% by the end of September.
  • If there is no sign of adjustment from consumers then at some point the MPC may have to contemplate a 0.5% shock rise.
  • Nevertheless, I continue to believe that rates will probably finish the year at 5.25%.

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