HOW FAR WILL UK INTEREST RATES NEED TO RISE?

22.03.2022   This month has seen the Bank of England raise interest rates to 0.75%. Monetary policy is now focused on bringing headline inflation back down to 2 percent. How far will interest rates have to rise?

High headline inflation has been driven by sharp increases in energy prices, supply chain disruptions, capacity constraints in some industries and strong consumer demand as lockdown savings have been spent. In the UK the current annual CPI inflation rate is 5.5 percent.

Prior to the invasion of Ukraine by Russia inflation had been expected to peak at around 7 percent in the Spring.  However higher food and energy prices are now expected to push the peak out to later in the year and raise it to close to 9 percent.

However, the Ukrainian conflict will also slow growth. This could make it harder for companies to pass on future cost increases. The extent of the growth slowdown is difficult to judge, but major geo-political events can exert a significant influence on economies. For example, post 9/11, western economies just ground to a halt as corporate hiring and investment decisions were put on hold.

The other key variable for interest rates in the UK will be the extent to which wages are raised to compensate workers for the higher costs of living. Expectations are currently that total pay will increase by around 5% in 2022 – still well below the expected peak in inflation. If this is the case the pace of consumer spending could slow as the year wears on.

The Bank of England can be expected to raise interest rates to 1 percent in the next couple of months. However, at that point it is likely to pause to assess the growth slowdown from the war in Ukraine and the magnitude of wage rises awarded to employees. The lower the increase in wages and the bigger the growth slowdown from the war in Ukraine the more modest future interest rate increases will be.

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This post was written by Robin