HOW HIGH WILL UK INTEREST RATES GO?

30.06.2022 With annual inflation looking set to peak at around 11 percent later on in the year below we look at the outlook for UK interest rates.

Over the last year UK CPI inflation has risen steadily with May registering an annual rate of 9.1 percent. However, it is important to note that currently the vast majority of inflation has been generated externally (mainly caused by higher energy prices and rising prices of overseas manufactured goods). In contrast, the domestic service sector is only contributing around two percentage points to the UK annual inflation rate. This is why the Bank of England has, so far, been cautious about raising interest rates.

At present the main focus is on preventing inflation becoming embedded in the economy via higher wage settlements. Currently a number of groups of workers, such as the rail workers and local government employees, are agitating for significant pay increases. So, in order to manage the expectations of wage setters the Bank of England will have to keep raising rates until there are clear signs that inflation has peaked.

The Monetary Policy Committee will also be wary of causing a lot of permanent economic damage as domestically generated inflation is currently modest. It should be noted that consumers’ disposable income, adjusted for inflation, will fall this year. While surveys suggest that the dominant service sector is starting to struggle.

This points to a half percentage point increase in August, to demonstrate to worker groups that the Bank of England is serious about controlling inflation, followed up by two further quarter point increases before the end of the year.

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This post was written by Robin