Friday, 6 June 2008

Interest rates going up?

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.


Anonymous said...

Hopefully the BoE learned from the Fed: You can lower interest rates as much as you like but that big slosh of new liquidity won't be going into housing


aSteve said...

As I understand (reading between the lines) King's strategy, it is to accept that we will have inflation running high - averaging maybe 3%+ for a year... but not worry about that. The view, I think, is that a major recession is inevitable and that alone will dampen inflation. I'm certainly seeing anecdotal signs that the economy is slowing rapidly and that unemployment will rise.

I can certainly see the logic in this... and consider it far preferable to the US approach. Conversely, I can't help wonder if it is going to be a combination of commodity prices and taxation that cause the recession this time around... coupled, of course, with the abrupt curtailing of both portfolio and direct investment which are essential to fund new projects.

If anything is going to force central banks' hands it will be the price of oil. Suddenly, 118p/l for unleaded doesn't seem such a high price to pay.

VADO said...

oil up to $139, definitely time for a global interest rate hike.

CityUnslicker said...

How does the BOE raising interest rates help reduce the price of oil or wheat?

Inflation is a following measure, not a leading one. When the economy crashes high interest rates will kill us. Inflation will collapse anyway as people have no money to buy anything.

The real measure of inflation is RPIX and that is steady and about to fall.

powerman said...

Raising interest rates tends to increase the value of the currency in question, so it therefore takes less pounds to buy a given amount of oil or wheat, all other things being equal.

Of course, monetary considerations are only part of the picture, along with demand/supply fundamentals like population growth and oil production, and speculative activity by people fleeing the equity markets.