Higher inflation should not lead to an increase in interest rates

Consumer price inflation rose more than expected in April, reaching 4.5% - up from 4.0% in March - according to figures released earlier today by the ONS.

George Osborne

Consumer price inflation rose more than expected in April, reaching 4.5% – up from 4.0% in March – according to figures released earlier today by the Office for National Statistics.

The jump was due mainly to higher air and sea fares, reflecting the timing of Easter this year, and to higher tobacco and alcohol prices following increases in duties announced in the March budget.

Meanwhile, retail price inflation fell from 5.3% to 5.2%. Air and sea fares have a significantly lower weight in the calculation of retail price inflation than in consumer price inflation. In addition, retail price inflation includes council tax payments and housing depreciation, which had a downward impact on inflation, whereas council tax and depreciation are excluded from consumer price inflation.

One worry is that consumer price inflation excluding energy, food, alcohol and tobacco – which some economists believe is the best representation of underlying inflation pressure in the economy – rose to 3.7% in April, from 3.2% in March. It is now at its highest level since records began in January 1997. This will add weight to the fears of those members of the Monetary Policy Committee who are voting for an immediate increase in interest rates in the belief that there is a danger of higher inflation becoming permanently locked into the UK economy.

On the other hand, unless wage inflation picks up (and there is little to suggest that it will), higher price inflation adds to the squeeze on households’ spending power. The Bank of England thinks inflation will reach 5% by the autumn. Already, we have seen the effect of this squeeze on the retail sector – sales volumes have not increased for the last eight months – and on the broader economy, since it explains, in part, the stagnation of real GDP over the last two quarters. An increase in interest rates, and the higher mortgage rates that would follow, would add to this squeeze and might even risk tipping the economy back into recession.

For this reason, the majority on the Monetary Policy Committee, who oppose higher interest rates, are right. The pressure for an increase in interest rates will mount if inflation does rise to 5% in coming months. It should be firmly resisted.

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7 Responses to “Higher inflation should not lead to an increase in interest rates”

  1. Mike McGregor

    RT @leftfootfwd: Higher inflation should not lead to an increase in interest rates: http://bit.ly/iyRtv3 writes @ippr's Tony Dolphin

  2. Michael

    Higher inflation should not lead to an increase in interest rates I Left Foot Forward – http://j.mp/jatXU9

  3. William

    The MPC has continually failed to hit its SOLE target of inflation,by setting interest rates at a level that has caused a 20 percent currency devaluation, and robbed savers of any meaningful return.Rates should be increased now, accompanied by a fiscal stimulus to prevent a double dip recession.

  4. MDHelp

    I agree that the base rate should be held. There is an inbalance between the base rate and SVRs of lenders. Any increase will push up the SVRs and severely effect the housing market and economy. We should hold tight unless wage inceases have a significant impact.

  5. matthew fox

    According to Mervyn King, the Vat increase is partly responsible for the high inflation rate.

  6. Hal

    The idea that the MPC has only one target is a myth. The remit reads as follows:

    a) to maintain price stability; and

    b) subject to that, to support the economic policy of Her Majestsy’s Government, including its objectives for growth and unemployment.

    So the MPC is giving consideration to part b) of its remit. As it should.

  7. John77

    “some economists” believe that CPI excluding food, fuel, alcohol and tobacco (a measure already excluding housing costs) is the best measure of inflation. For whom?!? Food, warmth, housing and three basic needs for all of us (alcohol and tobacco taxes are the two most regressive ones, hitting the poor harder than the rich).
    They need to get back to real life where real people need to eat, to live (and sleep) somewhere, travel to work etc.
    A rise in base rate will gradually reduce inflation and any lender that handed out a mortgage that was unaffordable with zero real interest rates (currently they are negative) should be sacked because the FSA will come down like a ton of bricks on his/her employer.
    A rise in interest (including variable but not fixed mortgage) rates will encourage a reduction in over-spending, but a recession means a reduction in *production* which is a different thing. The UK is not a closed economy.

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