Bank of England hints at interest rate rises

Andrew Bailey, the governor of the Bank of England, has provided the most ominous signal yet that UK interest rates could rise imminently.

The Governor told an online panel of central bankers on Sunday that they will “have to act” to curb rising inflation. Prices are likely to climb further, he warned, in ways that would warrant action to tame “medium-term inflation.”

He did not give any indication, however, when exactly the Bank might increase rates from the current record low of 0.1% although his comments fuelled speculation that rises would come sooner than later.

The Bank has already forecast that the UK inflation rate will exceed 4% by the end of the year – more than double its target – thanks to the economic toll of Covid-19, soaring energy prices and current shortages in labour and materials.

Less than a month ago, investors were predicting that the Bank of England would not move on interest rate rises before the summer of 2022. Now, financial markets are betting that interest rates could rise by 0.15% as soon as this coming December, increasing to 1% by the end of 2022 – the highest rate in over a decade.

Back in July, Bailey insisted it was “important not to over-react to temporarily strong growth and inflation”. While sticking by his original view that climbing inflation is “temporary”, his tone has clearly shifted up a gear following his warnings that price rises could last well into next year.

As Neil Collins wrote in Reaction last week: “The idea that this is merely a passing surge in prices before stability resumes looks more fanciful by the day.”

Why are inflation woes becoming increasingly difficult to ignore?

In large part, inflation is being stoked because of the enormous surge in energy prices. Bailey is predicting these price rises could push inflation even higher and mean that the period of high inflation will last longer than previously expected.

The most recent figures show that prices rose by an average of 3.2% over the last 12 months. New inflation figures are set to be published on Wednesday.

Bailey has warned that some “unwanted price changes” could prove “very damaging” if they become “embedded” in the economy, longer term.

Hiking up interest rates isn’t a measure that central banks resort to lightly. Notably, if the Bank of England does press ahead with the decision to raise them, it will be acting ahead of its international peers; the US Federal Reserve, and the European Central Bank are both still resisting this course of action.

Bailey would undoubtedly face opposition for doing so. David Blanchflower, a Monetary Policy Committee (MPC) member from 2006 to 2009, told the BBC today that a speedy interest rate rise would be a “terrible error” and an “absolute disaster” that could even tip the UK into recession.

It’s also worth highlighting, however, that Bailey’s message last night was not entirely gloomy. A more positive takeaway was that lessons learnt by financial regulators during the global financial crisis of 2007-09 – such as the importance of regular stress tests – will help us to weather the storm.

“There are lessons that we have learned in terms of resilience,” says Bailey, “that can usefully be adapted.”