Can interest rate rises halt inflation?

Once again the Bank of England caught financial markets on the hop by raising interest rates today to 0.25 per cent, the first rise in more than three years.

Traders had expected the Bank’s Monetary Policy Committee to delay a rate hike because of fears that the spread of the Omicron variant is already dragging down the economy. 

If in doubt about the impact, take a look at the photographs today of a deserted Oxford Street, of the capital’s empty railway stations, of desolate centres in great cities such as Manchester and Liverpool while pictures from hundreds of other towns across the four nations tell the same story.

Such is the level of anxiety induced by the government’s health advisers warning to the public to “prioritise” their social meetings that we now have a de facto lockdown. Restaurant and bar owners country-wide are reporting that parties and dinners are being cancelled en masse. It really is a cancel culture.

Whether this was the government’s intention is unknown. But the impact is going to be horrendous for millions of small business owners who depend on this Christmas period for their livelihood and indeed, on the population’s mental well-being as families cancel their get-togethers.  

Yet in the event, the MPC’s nine-strong committee decided inflation is the greater danger than a fragile economy, and turned decidedly hawkish with eight to one of its members voting for a rate increase in an attempt to cool down inflation. 

Even the most dovish members sharpened their talons after seeing the latest inflation figure of 5.1 per cent for November, up from 4.2 per cent the month before, and its highest level since September 2011.

The BofE is the first of the world’s central banks to take the leap, a move which follows on from the US Federal Reserve’s meeting on Wednesday when it indicated at least three hikes will be on the cards for next year. 

While the Fed held rates at 0 per cent, it did accelerate the withdrawal of its stimulus programme. It’s warning of rises to come follows on from soaring inflation which reached 6.8 per cent in November, the highest since 1982.

Inflation – triggered by stratospheric energy prices as well as supply shortages – is jumping around the world. Across the Eurozone, the rate was 4.9 per cent last month while factory-gate prices in China have been growing at their fastest pace for 26 years. 

In the UK, the Bank’s economists forecast inflation will stay close to 5 per cent through the winter, peaking at around 6 per cent in April next year mainly because energy bills will catch up with wholesale gas prices. They also revised growth for the fourth quarter down to 0.6 per cent from 1 per cent.

What is evident is that all the chatter about inflation being transitory has been dumped. It’s now almost universally accepted that many of the supply chain disruptions to shipping routes, raw material supplies and other hiccups provoked by the pandemic, are here to stay for some time to come. 

But the big question is whether hiking interest rates to control prices and encourage businesses and households to save rather than spend will have any impact on curbing inflation? It’s a moot, and controversial, point. Some argue that higher rates are a greater risk, tipping the world into recession.

For now, savers will benefit by the tiniest amounts while mortgage payers will have to fork out more, which in itself could feed into inflation.

Only Sterling liked the surprise hike, bouncing up against the dollar and the euro. This is good news for those who are brave enough to travel overseas; if you are allowed to, of course.