Recently the inflation rate in the United Kingdom has gone up with June seeing an increase in the prices of food and clothes. The consumer price index rose to 1.9% in the month of June from 1.5% in May. The expectation of an increase in the interest rate, following the increase in inflation has also raised the pound to a record six year high against the US dollar at $1.7192.
Due to the warmer climate this year, the high street clothes retailers have delayed their sales promotions. This has resulted in a price increase between May and June, compared to the same period last year, where prices saw a decline. Food prices have also risen in the same period compared to the last year, where they saw a decline. Furniture and airfare prices also saw a comparatively higher increase than the last year. All these factors have led to inflation rates reaching a five month high in the month of June, well above forecasts; however, the inflation rise is still below the Bank of England’s 2% target and has been so for the last six months. At the same time, wage increases are expected to still lag behind inflation.
According to Chris Williamson, Chief Economist at data specialists Markit; the increase in inflation has further raised expectations that the Bank of England will raise the interest rates sooner rather than later. This has also pressurized the Bank of England to decide when to increase interest rates.
However, the economists remain divided as to when the increase in interest rate will come about. There is a speculation that there might be an increase in November or early 2015. However, investors are betting on an interest rate rise before the end of 2014. At the same time, markets have priced a rate increase from 0.5% by the end of the year. Markets becoming more confident that the Bank of England may raise interest rates before the end of the year, has led to the British Government’s bond prices tumbling following the rise in data and sterling.
Given the positive economic outlook of UK, Rob Wood, the chief UK economist at Berenberg, predicts a 60% chance that the Bank of England will begin increasing interest rates in November this year.
Important to note is that since last year, the consumer price index had been falling, which has helped the Bank of England to hold off on raising interest rates, despite UK’s strong economic recovery. However, now the stage is completely set for an increase in interest rates, as the UK economy along with an increase in inflation is growing strongly, there is also a boom in the housing market with house prices increasing and unemployment is also going down.
According to former Bank of England Policy maker, Andrew Sentence, this raise in inflation also points to the fact that the economy is strong enough to withstand a rise in interest rates. He further said that the rate rise should take place later this year rather than in 2015, because in 2015, MPC could be “tempted to postpone a rise beyond the general election, which would be too late”.
On the other hand, Mark Carney (Governor of the Bank of England) has rebuffed the Bank for International Settlements’ call to raise interest rates faster, commenting that the recommendation was “outside political and economic reality”. According to Carney, the timing of the first rise in interest rates would be “driven by data”. He further added: “The only guidance that the new Monetary Policy Committee is now giving is around the expected medium-term path of interest rates, not the timing of the first rate rise.”
According to Mark Carney, the biggest risk to the economic recovery is over-heating in the housing market. Particularly, the high levels of mortgage debt taken on by households. This is because when debt levels get too high, British people “economize” everything else in order to pay their mortgages. This leads to a major macroeconomic impact, if many people are highly indebted. Thus, leading the economy back in to recession.
Since the recent rise in inflation was due to retailers’ decision of postponing sales, according to Samuel Tombs of Capital Economics, the inflation will ease again by the end of this year, which shall remove the pressure to raise interest rates immediately.