By: Dr. Mike Campbell
Despite significant speculation that rising inflation, buoyed by higher fuel costs, would force the Bank of England’s Monetary Policy Committee (MPC) to increase the bank’s lending rate, the decision has been taken to leave the main rate at 0.5%. Details of MPC meetings emerge when the minutes are released and it has been clear for some time that the MPC is divided on the conflicting needs of reining in inflation and nurturing the still fragile UK recovery. The rate has now been held at this historic low level for two years.
The logic of those who wish to maintain the rate at its current low level is that inflation in the UK economy will moderate, in any event, towards the end of this year. This is because measures that the Government has taken to reduce the UK sovereign debt will cause a reduction in spending.
Equally, the increase of VAT (sales tax) to 20% from the start of the year will also rein in spending to some extent. Indeed, it could be argued that the 2.5% increase in VAT is already ten times larger than any likely increase in the lending rate which would surely be increased in small, incremental steps.
An increase in the rate may also lead to a strengthening of Sterling on international currency markets. Were this to happen, it would put increased pressure on UK exports as they would become comparatively more expensive than their competitors. The UK has little that it can do to counter higher crude oil costs which, on the one hand, may drive inflation higher, but, on the other are likely to put more pressure on an already weak recovery. If the Bank raises rates, businesses would have to deal with increased borrowing costs into the bargain.