Is the Bank of England ready to increase base rates? -
UK bank interest

Is the Bank of England ready to increase base rates?

As we look towards the next Monetary Policy Committee (MPC) meeting, scheduled for 21st September, money markets are primed for an increase in base rates. Yesterday’s Treasury Committee meeting, in which MPC members were grilled on their strategy for interest rates, offered an interesting insight into the current situation. Is the Bank of England on the verge of a base rate policy U-turn?

Bank of England policymakers split

Andrew Bailey, the Governor of the Bank of England, confirmed that policymakers had been split on forward guidance for base rates. The August meeting saw several issues discussed but no change in policy. Even though inflation is expected to peak around 4% later this year and then fall back towards the MPC target of 2%, it is proving stubbornly strong.

Some of the more prominent members of the MPC, Bailey and David Ramsden, have been talking of base rate rises in recent weeks. There is now a consensus that movement on Bank of England interest rate thresholds will tip the balance, favouring a rate rise at the next meeting. So, while there is always the caveat that a new strain of Covid-19 may emerge, it seems as though we are moving towards a significant policy change.

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Skills shortage and supply chain issues

In recent weeks we have seen issues regarding supply chains and a significant increase in raw material costs. For example, cleaning company McBride reported a 50% increase in the price of cardboard and a 300% rise in the cost of some solvents. These cost increases will eventually be passed onto consumers, further fuelling inflation. An increase in base rates would make borrowing more expensive and reduce short-term consumer demand.

At the same time, there has been an enormous increase in wage inflation, which currently stands at 8.8%. Higher base rates will reduce competition in the workplace and hopefully bring wage inflation back under control. There is no doubt that MPC members have several vital matters to consider ahead of the September meeting.

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Savers continue to suffer in silence

Even after a recent increase in savings rates, savers in the UK continue to suffer in silence. The current inflation rate has made a difficult situation more challenging. Even after a surprising short-term dip to 2% in July, inflation is still expected to head towards 4% by year end. Instant access interest rates are currently below 0.2%. This represents a relative reduction in spending power of 1.8% per annum, even in a best-case scenario. In a worst-case scenario, this relative reduction in spending power would be 3.8% if inflation hit 4%!

For those who have been careful and saved money in the past, this constant erosion of spending power is causing unrest. Moreover, even in a best-case scenario, we will only see several small interest rate rises in the short to medium term. Consequently, it will be some time before savers are even able to maintain their relative spending power, let alone increase it.

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Bank of England ready to increase base rates

Despite resisting the money markets in recent months, the Bank of England seems ready to increase base rates for the first time in more than a decade. The UK economy is in danger of overheating, with supply issues, growing demand and a sharp spike in wage inflation likely to prove troublesome. It seems almost certain that base rates will rise after the September MPC meeting, but nothing is set in stone during the pandemic!

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