A stitch in time saves nine: Bank of England moves to contain inflation with interest rate rise

ITV News Business and Economics Editor Joel Hills explains why now is not an obvious time to raise interest rates

A new and highly infectious strain of coronavirus - one of unknown potency - stalks the land. The spread of Omicron may yet necessitate the shutdown of parts of the economy in the interests of public health.Now is not an obvious time to be raising interest rates.The Bank of England is acting because it is worried about the pace at which prices are rising. A painful bout of what the Bank thought was short-lived inflation is starting to look more persistent.Last month, the Bank said it expected the headline rate of annual inflation to peak at 5% next April. It now thinks the summit in the spring will be significantly higher at “around 6%”.The Bank’s thinking remains that many of the forces which have driven up inflation over the last six months - supply chain disruption, soaring demand for goods, rising energy prices - will fade. But the domestic labour market is causing concern.

Unemployment is very low and there are a record number of vacancies. An abundance of jobs has brought with it “underlying earnings growth” which the Bank says is “above pre-pandemic rates”. It’s tight, so the Bank is tightening.High inflation hurts. The Bank worries that people are responding to the squeeze on their living standards by demanding higher pay-rises and that they are getting them. The danger here is an inflationary loop of spiralling wages and prices.By raising interest rates the Bank hopes to cool consumer demand which should, in turn, cool demand for labour, reducing the upward pressure on pay.

The Bank also wants to reassure any doubters that it is utterly devoted to getting inflation back down to the 2% target. The message: “Keep the faith, we’re on it.”But raising interest rates will also hold back economic growth at a time when Omicron already threatens to suffocate what was left of the slowing recovery. And it will compress the budgets of many households at a time when they are already feeling the pinch.The increase in Bank Rate is slight and won’t directly impact the majority of households immediately but it will be widely felt over time.There are 11 million mortgages in the UK. The majority are fixed, only 2.2 million are on tracker or standard variable rate deals.According to UK Finance, increasing Bank Rate from 0.1% to 0.25% means these borrowers will see their monthly repayments rise by between £9.58 and £15.46However if, as investors expect, this is first in a series of increases and Bank Rate reaches 1% by this time next year, the change will be between £57.46 and £92.73 a month.Savers will welcome the prospect of (slightly) better returns but money in the bank will still be losing its value because no bank will be offering savings rates which can come close to matching the official rate of inflation.Predicting what happens next with Omicron is impossible. The path of the virus could nudge inflation in either direction but the Bank has decided it can’t afford to wait and see.The hope is that by taking modest action now it will avoid the risk of having to do something more dramatic later. A stitch in time saves nine. Hopefully.