Interest rates and inflation: Misery for British households in grip of cost-of-living crisis: Ian McConnell

During an online panel discussion organised by the Group of Thirty Consultative Group on International Economic and Monetary Affairs, Mr Bailey declared: “Monetary policy cannot solve supply-side problems – but it will have to act and must do so if we see a risk, particularly to medium-term inflation and to medium-term inflation expectations.

“And that’s why we at the Bank of England have signalled, and this is another such signal, that we will have to act. But of course that action comes in our monetary policy meetings.”

He sent this message even as he highlighted his continuing belief that higher inflation will be temporary. Mr Bailey flagged his expectation that higher energy prices would push inflation up further. He also underlined his view that the energy price story meant higher inflation would last longer.

Mr Bailey’s remarks, and other signals emanating from the Bank of England’s Monetary Policy Committee (MPC), have fuelled talk in financial markets that a rise in UK base rates could come as early as next month. The MPC is due to announce its next decision on rates on November 4.

MPC member Michael Saunders, regarded as a hawk, said earlier this month: “I’m not in favour of using code words or stating our intentions in advance of the meeting too precisely. The decisions get taken at the proper time.

“But markets have priced in over the last few months an earlier rise in Bank Rate than previously and I think that’s appropriate.”

It obviously remains to be seen what is announced on November 4. At the MPC’s last meeting in late September, the nine-strong committee voted unanimously to keep base rates on hold.

There have been some big upside surprises on the inflation front in recent months.

Annual UK consumer prices index inflation has climbed from 0.4% in February – way below the 2% target set for the Bank of England by the Treasury – to more than 3%.

And there is a firm expectation that it will go significantly higher, so news of a slight dip in annual CPI inflation last month did nothing to change the broad picture.

Figures published on Wednesday by the Office for National Statistics showed annual CPI inflation eased from 3.2% in August to 3.1% in September, remaining well above the Old Lady of Threadneedle Street’s target.

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However, there was a large downward effect on annual inflation last month from the base-year impact of a recovery of restaurant and cafe prices in September 2020 following Chancellor Rishi Sunak’s Eat Out to Help Out discount scheme the previous month.

And the key point about the surge in inflation since February, and expectations of worse to come, is the pressure on already-straitened household finances.

Obviously, a rise in base rates would put further pressure on households and on businesses with borrowings, just when it is least-needed.

However, if the MPC takes no action and higher inflation expectations do become embedded, the ultimate cost could become greater still if benchmark interest rates need to be raised more sharply than in a scenario where earlier moves were made.

It is an extremely difficult juggling act for the MPC, especially against a backdrop of myriad uncertainties.

The effects of Mr Sunak’s ending of the coronavirus job retention scheme on the labour market are yet to be seen.

And we should not be fooled into thinking acute and hugely damaging skills and labour shortages in key sectors such as logistics and hospitality, fuelled in large part by Brexit, point to a strong overall labour market.

A worse-than-expected outturn on unemployment could of course dampen inflation.

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On the other hand, we have had a raft of economic surveys underlining inflationary pressures all the way through the supply chain.

And, while Brexit is of course not the only factor fuelling inflation as can be seen from global rises in the price of oil and other commodities, its effects certainly do seem to be adding very significantly to the challenges facing monetary policymakers and households.

It is also worth bearing in mind the longer-term context on the UK interest-rate front, and just how long benchmark borrowing costs have been at levels that would have been inconceivable to most before the global financial crisis more than a decade ago.

UK base rates were cut from five per cent to 4.5% in October 2008, after the global financial crisis took a lurch for the worse. They were then cut to 3% in November 2008, 2% the following month and 1.5% in January 2009. They then dropped to 1% in February 2009 and to 0.5% in March 2009.

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Base rates remained at 0.5% all the way through to August 2016, when they were cut to 0.25% in the wake of the Brexit vote.

They rose to 0.5% in November 2017 and to 0.75% in August 2018 but then, as the coronavirus crisis developed, the MPC implemented a half-point cut on March 11 last year to take them to 0.25%. Rates were reduced to their current all-time low of 0.1% on March 19, 2020, and have stayed there since.

One by-product of the ultra-low interest rates needed to support the economy has been huge strength in house prices. While it has been positive for the overall economy that the housing market has remained much stronger amid the current tumult than it did in the wake of the global financial crisis, further rises in property prices have not been good news for the likes of young people trying to buy their own home.

What is noteworthy, when contemplating the effect of any future interest-rate rises on households, businesses and the overall economy, is the fact that even before the coronavirus crisis struck base rates were only 0.25 percentage points above the 0.5% level to which they were reduced amid the global financial crisis.

It says much about the state of the UK economy during the Conservatives’ period in power that base rates stayed at 0.5% all the way from March 2009 to August 2016, and that the move then was a cut amid economic fall-out from the Brexit vote.

So it is worth keeping in mind, while the economic focus must be on recovery from the coronavirus crisis and mitigation of the detrimental impacts of Brexit, just how long we have been living in times that are very far from normal.

In terms of the immediate challenges, the financial pressures on households are writ large again in this week’s inflation figures.

The ONS noted average petrol prices stood at 134.9 pence per litre in September. This is up from 113.3 pence per litre a year earlier, and last month’s price is the highest recorded since September 2013.

Used car prices increased 2.9% month-on-month in September, meaning there has been a cumulative increase of 21.8% since April 2021.

These are just a couple of examples.

Ed Monk, investment director for personal investing at fund management giant Fidelity International, said in the wake of this week’s inflation figures: “The slight easing back of inflation…doesn’t change the cost-of-living crisis facing households.”

The Bank of England last month predicted inflation is likely in the fourth quarter to rise above the 4% peak it had forecast back in August.

And it said: “The material rise in spot and forward wholesale gas prices since the August report represents an upside risk to the MPC’s inflation projection from April 2022.”

The Bank added: “Most other indicators of cost pressures have remained elevated.”

There might be headlines of big pay rises in some sectors but, in many situations and particularly in this uncertain labour market, all the power will be with employers and workers will see their real-terms income eroded significantly by high inflation.

And this cost-of-living crisis is the last thing anyone needs right now, given the UK economic malaise in the decade leading up to the coronavirus crisis and what households have had to endure over the last 19 months. Not to mention the great uncertainty ahead.