On Thursday, we saw the decision by the Bank of England to raise interest rates again, the tenth such increase since December 2021.
Given its previous timidity in dealing with inflationary pressures, it was of little surprise that the Bank’s Monetary Policy Committee took decisive action with the expectation that prices will finally stabilise and may even start to fall over the next few months.
Yet, with inflation only decreasing slightly at the end of the year after last October’s high-water mark of 11.1%, economists remain worried whether the Bank of England will be on track to achieve a significant decrease in the rate of inflation by the end of the year.
This is because of two main reasons. First, inflation has increased in many economies due to a combination of global factors. These include the continuing war in Ukraine which has led to a surge in gas and food prices, the slow recovery in the world economy following the Covid pandemic, and the recent shutdown in China that has affected manufacturing supply chains across the world. All of these are factors that may make inflation more stubborn to reduce quickly.
Secondly, there remain concerns over the labour market situation here in the UK with data showing that, unlike most of the major economies, the workforce has not returned to its pre-pandemic size. This is not only because many over 50s have left the workforce after the Covid pandemic, but also the UK’s exit from the European Union which has resulted in an exodus of workers from a range of key sectors.
These factors have led to a tightening of the labour market, and businesses are having to pay above average wages to attract staff, thus compounding higher inflation.
While some will welcome this increase in interest rates to curb inflation, this will still have an impact on those homeowners who are not on a fixed-term mortgage and will see increases to their monthly bill adding more pressure to the cost-of-living crisis. This may also affect the housing market as demand for mortgages will fall and there has recently been a further decline in house prices across the country.
For those businesses that are currently borrowing to grow, the cost of servicing the debt may increase to the point where they may find it difficult to survive, particularly if those firms have already been forced to borrow from the UK Government to survive the Covid pandemic.
This may also have an impact on the business investment that is so vital to economic recovery as firms may hoard cash to hedge against a worsening economic situation rather than using it to grow. And whilst savers may welcome the potential to earn more interest on their deposit accounts, the reluctance of banks to pass on the benefits of interest rate increases may not have the beneficial effect that many expected.
Yet there is no other option available to policymakers currently. Inflation can be the killer of any economy especially one that is looking to recover from the biggest economic decline in over three centuries. Despite the short-term pain of higher rates of interest, the main priority of both the Bank of England and the UK Government must be to use every monetary and fiscal instrument possible to reduce inflation over the next twelve months.
Inflation is having a catastrophic impact on the way people live their everyday lives by increasing the cost of food and heating, is adding substantial and often unsustainable costs to many businesses and, as we have seen from the continuing strikes this week, is leading to those working in the public sector to demand higher wage increases to be able to cope with the higher cost of living.
So what is the prognosis for the next few months? Given that no-one would have predicted the current situation a year ago (not least the Bank of England) it is difficult to be certain about what will happen now.
There are optimistic signs that with gas prices falling considerably over the last few months, there will be a direct and beneficial effect on both inflation and costs to households across the UK, although prices are still expected to remain higher than when the energy crisis began well into 2024.
Yet the cost of food remains high with prices increasing by 14% last month and while there are some signs that global food prices are beginning to reduce, it may take some time for this to impact on supermarket prices and the costs to the British consumer.
Despite this, the Bank of England is confident that inflation is finally being managed and has suggested that the current interest rate rise may be the last needed by policymakers to deal with rising inflation.
On a wider canvas, it is unlikely that we will see interest rates fall back to the extremely low levels we had for thirteen years after the financial meltdown of 2009. Whilst I am sure there may be pressures to drop them again to stimulate the economy, it is doubtful we will again see the low of cost of borrowing that many young people and businesses will have taken for granted in the last decade as the norm, contrary to the experience of the rest of us who grew up in a very different period of higher interest rates.
But what is certain that after being disregarded for so long, managing inflation and the wider monetary policy of the political parties will be as important as anything else in terms of the future of the UK’s economy and society.
As a result, everything we have taken for granted in terms of managing our everyday lives since the last recession of 2008 will have to change and whether that will be good news for both households and businesses and the future of this nation is undoubtedly something that will be widely debated over the next twelve months and in the run-up to the next general election.
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