16 Feb 2011

Interest rates: ‘Don’t run ahead of yourself’, says King

The Bank of England lowers its growth forecast and signals a rise in interest rates to tame inflation – but Faisal Islam says the Monetary Policy Committee cannot agree on the way forward.

In its latest quarterly report published today, the Bank said output was likely to be weaker than expected in 2011, but a double dip recession was not expected.

Inflation is likely to continue rising this year to around 5 per cent, before falling close to the Government’s 2 per cent target in 2012 – but only if interest rates rise in the second quarter of 2011.

Higher mortgages

That would mean higher mortgage costs for those who are not on fixed-rate deals and more expensive borrowing for business. Yesterday, official figures showed that the Government’s preferred measure of inflation – the Consumer Prices Index – had risen to 4 per cent.

“It is clear that at some point bank rate will have to go up.” Bank Governor Mervyn King

It was also announced today that unemployment had risen to almost 2.5 million, with a fifth of 16 to 24-year-olds out of work.

Bank Governor Mervyn King said: “It is clear that at some point bank rate will have to go up. Anyone making long-term financial decisions should not expect bank rate to be at these low levels indefinitely.”

“But the judgment about timing and the speed at which the bank rate will rise is a difficult one, it is not at all obvious and we are certainly not going to pre-announce any judgments or decisions on that today.”

He added: “I think some people are running ahead of themselves in saying we are pre-announcing – or we are laying the ground for – a rate rise. That decision has not been taken and will not be taken until we get to the next meeting or the following meeting or that – and it may be many quarters before we do anything.”

Faisal Islam writes: So what a swerve from Merve at this morning's Inflation Report.

The Governor of the Bank of England produced an inflation report that made the case for a modest set of interest rate rises this year, confirming a hint in his letter to the Chancellor yesterday, but then pointedly opted to avoid articulating that case himself.

"Some people are running ahead of themselves and saying that we are pre-announcing or laying the ground for a rate rise," the Governor said - a pointed reference to this morning's front page splash in the FT.

Sterling plunged as he was speaking, as the currency markets had been gee'd up for a green light for rate rises from May. As Alan Clarke, economist at BNP Paribas, said: "While we didn't get a red light, at best the traffic lights on Threadneedle Street are flashing amber".

So what's going on here? The BoE doesn't know, and to the extent that it does know, it does not agree on the way forward.

Read Faisal's blog: Five reasons for Merve's swerve...

The markets are expecting base rate to double to 1 per cent by the end of the year, and the Bank warned that if action was not taken, inflation would still be above the Government’s target in two years.

Mr King said it was not clear when inflation would fall. “Both the timing and extent of that decline in inflation are uncertain.”

Lower growth

Although Britain is no longer in recession, there was an unexpected 0.5 per cent contraction in growth in the last three months of last year.

The report said the strength of the recovery would be affected by higher prices and the Government’s plans to cut the deficit with an £81bn programme of spending cuts and tax increases.

Unemployment rise

Today, the latest unemployment figures showed a rise of 44,000 in the final three months of 2010. There are almost 2.5 million people out of work, a jobless rate of 7.9 per cent. Youth unemployment has risen to a record high of 965,000, affecting more than a fifth of 16 to 24-year-olds.

Ian Brinkley, from The Work Foundation said: “This mini-recession in the labour market as a whole is turning into a major crisis for young people.”

Martina Milburn, chief executive of youth charity The Prince’s Trust, said: “There are now enough unemployed young people to fill every football stadium in the Premier League, with almost 200,000 left queuing outside.”