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Interest rates may go up sooner than expected

THERE are signs of a real debate within the Bank of England's Monetary Policy Committee (MPC) about the possibility of an interest rate rise sooner rather than later.

Two members of the nine-strong grouping voted for a rise when they met on August 6 and 7. Their reasons for doing so are interesting. They argue that unemployment has fallen rapidly and that, because of that, wage growth could pick up soon. Acting now might also pre-empt the need for bigger hikes later. Certainly, rates will have to rise at some point and the hawks on the MPC seem to have enough confidence in the strength of the recovery that they believe the benefits of an early rate rise outweigh the risks.

It is worth noting that since that vote, new data has come to light that might have led the two dissenters to exercise caution had they known about it. The latest inflation figures show a sharp fall to 1.6 per cent (removing pressure on the Bank to raise rates to keep it to two per cent or below), while last week, the Bank halved its forecast for average wage growth in 2014.

Even so, the direction of travel is now clear. There appears now to be a distinct possibility that interest rates could rise before the end of year, as opposed to February next year, as had previously been forecast.

The fact that this debate is taking place is, however, heartening. A rate rise would be good news for savers, who have seen their carefully marshalled reserves eroded over several years. An interest rate rise should benefit them, though it is not clear how much of it would be passed on to them by financial institutions.

The predicted quarter point boost would have a limited effect even if passed on in its entirety given that many savings rates are so woefully low, but it would be distinctly better than nothing.

There are also, naturally, dangers in acting too quickly. Some highly indebted households could suffer, since there has been a huge real terms cut to their incomes caused by years in which wages have failed to keep pace with inflation.

Because the economic recovery is still fragile, a rate rise might also risk taking some of the momentum out of it. Millions are in low-paid jobs and the housing boom in parts of the country has given an unrealistically positive impression of the strength of the economy overall. Outside the south-east of England housing hotspot, some areas have seen marked house price inflation (such as Edinburgh and Aberdeen) but others have sluggish growth, so a rate rise could stymie desirable growth in those areas.

A move that took the shine off the housing boom would have political ramifications going into next year's General Election, since it would tend to expose other weaknesses in the economy but having the independent MPC set rates means such considerations should not enter into it.

Instead, their tricky task is to announce a rise only at the moment when they think its benefits outweigh its disadvantages. That moment looks to be approaching rather more quickly than previously assumed.

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Finance

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