• Today’s decision by the MPC to leave interest rates on hold at 5.5% is only a temporary reprieve. There is a very good chance that interest rates will be raised to 5.75% next month, and failing that, in August. What’s more, I think that rates will eventually have to rise to 6%, or perhaps even higher, in order to secure the UK’s low inflation environment.
  • Admittedly, CPI inflation has now started to fall. The drop from 3.1% in March to 2.8% in April was the start of a move that could see inflation fall back below the 2% target by the end of the year. I think that May’s inflation figures, which the Committee will have seen ahead of today’s decision, will show a further fall in inflation to 2.6%.
  • And evidence has started to emerge that the previous increases in interest rates are starting to take their toll. Mortgage demand appears to have slowed, with the number of new mortgage approvals falling for the third month in a row in April.
  • But it is the threat of higher inflation in a few years’ time that is likely to drive interest rates up further. And the MPC may view a housing market slowdown as a price worth paying in order to keep inflation under control.
  • In particular, the MPC is concerned about the evidence that firms are gaining pricing power. May’s CBI price expectations balance showed that manufacturers intend to raise their selling prices by more than at any time in the last 12 years. And the Committee is still concerned that the rapid rates of money supply growth and the high level of asset prices forewarn a sustained rise in price pressures in the medium-term.
  • Of course, the previous rises in interest rates will eventually slow economic activity and weigh down on pricing power, money supply growth and asset prices. But if these factors have been supported by a rise in people’s price perceptions as well as strong economic activity, then interest rates will need to rise further and faster to have the desired effect. By not raising interest rates today the MPC missed an opportunity to show that it means business.
  • Overall, it seems to me that the UK’s inflationary environment is under serious threat for the first time since the early 1990s. And the consequences of leaving interest rates too low are much greater than those of raising them too high. Interest rates of 6%, or perhaps even higher, are just around the corner.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.