Bank of England freezes interest rates

Thursday, 10 July 2008 12:00 AM

The monetary policy committee (MPC) voted to maintain interest rates where they have rested since April - as the economy starts to slow.

The MPC is currently trapped between high inflation and a slowing economy.

An interest rate cut traditionally buoys an economy - making borrowing easier - but high inflation is cut back by increasing the cost of borrowing.

Trevor Williams, chief economist at Lloyds TSB Corporate Markets, said: "By holding rates, the Bank of England has made the best it can of a very difficult decision. The UK hasn't yet reached recession, but the worry is that raising rates could trigger this. Equally, not raising rates could risk even higher inflation later on.

"The best option is to wait until the inflation picture becomes clearer. Importantly, this means ensuring that inflation is past its peak - or risk further elevating inflation expectations - before considering in which direction rates should move next."

Bank of England chief Mervyn King has repeatedly stated he feels inflation is a greater ill and allowing rising prices to get out of hand would cause greater long-term damage to the economy.

The MPC's single target is to main price stability by keeping inflation - as measured on the consumer prices index (CPI) - down to two per cent.

CPI currently stands at 3.3 per cent and is expected to rise further - off the back of higher food, fuel and energy prices - even as high as four per cent, before falling back.

However, the MPC believes price rises beyond this are unlikely and inflation should fall back in 2009.

It is uncertain whether further oil and food price rises will continue and high wages deals - as workers pushed for more as the cost of living rises - could maintain upward pressure on inflation.

The low pound is also pushing up inflation as the cost of imports increase.

Analysis by capital Economics shows, after excluding the effects of the oil price, import price inflation has risen from 2.3 per cent a year ago to a 14-year high of 8.6 per cent.

While inflation is usually culled by rising interest rates - the Chartered Institute of Personnel and Development (CIPD) is warning a future rate hike could hit employment gravely.

CIPD chief economist John Philpott said: "Many employers have their finger on the redundancy trigger.

"They are not yet ready to start firing but a rise in interest rates would probably be enough to cause a substantial jobs cull come the autumn. And once this starts the economy could witness a sudden 'avalanche' of redundancies."

However, Jonathan Cornell, managing director at Hamptons International Mortgages, warned if inflation keeps rising then an interest rate rise seems a strong possibility.

He said: "If inflation at 3.3 per cent can't force the MPC into making a decision I don't know what will. While any increase in the base rate signals worries for borrowers, unstoppable inflation is not a happy compromise.

"While the MPC takes another month to weigh up its priorities, borrowers should view the time as a lull before the storm and look to arrange their finances accordingly. If inflation continues to rise, rates will increase and those who are prepared for it will fair best in the long run."

Daniel Barnes

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