Yesterday, the MPC decided to keep rates steady, but for how long? Over at the ECB, concerns about inflation are rising. Yesterday, Jean Claude Trichet warned of higher interest rates in the Eurozone. If the ECB start hiking, the Bank of England would almost certainly have to follow.
Regardless of the ECB's future decisions, the case for higher rates here is very strong. Inflation is well above target, and it has remained so for at least two years. Looking forward, the BoE project even higher inflation. In the near term, the CPI will exceed 3 percent, and might even reach 4 percent within a few months. The more accurate RPI measure is already at 4 percent and rising.
There are only two things that stop the BoE from raising rates; bank balance sheets and the housing market. Banking sector health is undoubtedly a problem, higher rates could generate serious difficulties for some smaller banks. The BoE now face a trade off - regaining control over prices but at the cost of pushing the banking sector into further difficulties.
As for the housing market, nothing can prevent a massive correction. Prices are already crashing. Even if the BoE cut rates dramatically, a recovery is extremely unlikely.
Sooner or later, the BoE will have to confront inflation. It can do it now, and risk further banking sector difficulties. Or it can delay and act when inflation has really taken off and interest rates have to go through the roof.