International pressures make MPC

International pressures make MPC

Views BlogsLiverpool BlogsCommentLettersSend a Story Video or PictureIT been 21 months since the UK bank interest rate was last changed from its present level of 0.5%. As we move into the New Year, the question is how much longer can this record low rate continue?

The question is becoming all the more urgent because inflation remains surprisingly and stubbornly high. Rises in fuel, food and raw material costs show no sign of easing any time soon.

When setting interest rates each month, the principal concern of the Bank of England Monetary Policy Committee MPC is to keep inflation beneath 2% in order to help create the conditions necessary for sustainable economic growth. With consumer price inflation now at 3.3%, there is a clear case for a rise in the bank rate sooner, rather than later, during 2011.

However, irrespective of the duties of the MPC, there is more to determining interest rates than just inflation. Interest rates represent the price of money paid by borrowers to lenders and will, therefore, be determined by demand and supply in lending markets. According to data published by the Bank of England earlier this week, lending conditions in the UK remain extremely weak, as weak as they ever have been during the credit crunch. Such data argues against the wisdom of an increase in interest rates. Furthermore, it can even be used to suggest that an early rise in interest rates may dampen UK economic prospects next year, about which there appears to be little consensus among economists.

Last week, the Confederation of British Industry CBI published a downbeat assessment for 2011. It downgraded its forecast for UK growth to 0.2% for the first quarter of 2011.

The employers group predicted the Bank of England would begin to monetary policy in the spring as inflation picks up. It said that would be followed by a slightly faster stimulus withdrawal over the second half, taking the bank rate from a record low of 0.5% to 2.75% by the fourth quarter of 2012.

The CBI concerns focus on rising unemployment and the imminent New Year VAT increase, as well as higher than expected inflation.

The group said the economy would expand by 2.4% over the year as a whole, which it said was subdued for this stage of the recovery. This reflects the tenuous nature of our economic recovery and the possibility that any early rise in interest rates could jeopardise growth.

Higher than expected inflation has been a recurring feature of UK economic management for several years now, since well before the recession started. This has remained true even during the lowest points of the recession, which is not something that economists would have traditionally expected to see happen.

Given the global origins of the inflationary pressures, it is possible that the MPC may have to admit that it is not as much in control of matters as might be hoped. The prices of fuels and other commodities, for example, are set by international market forces. The price British householders pay for gas is in part determined by gas supply conditions in Russia, Ukraine and Germany. A couple of decades ago, the principal inflationary pressure was more likely to be rising incomes or too much government stimulus.

If so, it may be time to review the remit of the MPC to allow it to focus more on factors that are within its control. We also need greater international cooperation to create the low inflationary environment needed for sustainable economic growth.