Was the Base Rate increase an overreaction?Make Text Bigger
Was the Bank of England’s decision to increase the Base Rate from 0.25% to 0.5% and overreaction to artificially high inflation figures or can we anticipate potential future adjustments upwards?
One of they key factors expressed several times by Mark Carney and his team for the increase in Base Rate is the erosion of slack within the economy with unemployment falling to a 42 year low and global growth at a much higher overall level than the UK’s. This then raises concerns of wage lead inflation adding to the external price lead inflation caused mainly by the fall in the exchange rate since the Brexit vote.
However, this is against the backdrop of very weak productivity growth in the UK which is a problem for many Western economies, but our output per worker is particularly low compared to the US and the bigger European countries.
The Bank of England November inflation report said: “The increase in inflation to above the MPC’s 2% target over the past year reflects the effects of the continued rise in import prices following sterling’s depreciation. Over this period, inflation has picked up most in those components that tend to have the greatest imported content, such as food, energy and other goods . The rise in global oil prices in recent months has added somewhat to external cost pressures and is likely to feed through to retail fuel prices, and therefore to CPI inflation, relatively quickly.”
This does tend to indicate that inflation is lead by external cost factors that are very difficult to influence with domestic interest rates dampening demand.
Even worse you would normally expect any increase in interest rates to strengthen Sterling by attracting more money into the UK, but the Foreign Exchange markets instantly reacted badly and the pound fell against the Dollar and the Euro thus adding to even more inflationary pressure on prices.
Analysts have speculated that the easily justifiable rate increase considering a 3% inflation figure is more of an attempt to give the bank some wiggle room up or down depending on the outcome of Brexit negotiations. Mark Carny did indeed stress in his press conference that there could be adjustments either way depending on future negotiations and that this would not reflect on the current decision or mean that it was a mistake.
The Chart 1.6 shows for interest the future projected rise in interest rates for the UK against other countries, but predicted future rises have been pushed out almost every quarter for the last five years and do show only small predicted increases. Therefore there is definitely nothing in the figures for mortgage borrowers to panic over yet.
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