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Interest rates hit post-pandemic high

Laith Khalaf, Head of Investment Analysis, AJ Bell

Laith Khalaf, head of investment analysis at AJ Bell, comments on the latest MPC interest rate decision:

“The Bank of England has now raised interest rates to their highest level since the pandemic struck, but the pound sunk back on currency markets, as the vote and commentary were not as hawkish as anticipated. Having initially led the US and Europe in tightening policy, the Bank of England now appears to be striking a more nuanced tone, with no members voting to increase base rate by more than 0.25%, and a judgement that only modest tightening would be necessary in the coming months.

“Nonetheless, rates are now the highest they have been since February 2009, apart from a period between August 2018 and March 2020, when base rate also sat at 0.75%. What’s different this time is that there are further rate rises waiting in the wings. Unless you want egg on your face, it’s best not to count your chickens before they’re hatched when it comes to monetary policy, but it looks pretty clear that central banks are intent on several further rate hikes as we move through 2022, to help stave off the real and present danger of sustained inflation.

“One thing that is left in little doubt is that inflation is on the rise, with the Bank of England expecting CPI to hit 8% in spring. April might not be the cruellest month either, with the Bank now reckoning we may get a double spike, and inflation potentially peaking in October. If current energy prices are sustained, the Bank calculates that the Ofgem price cap could rise by another 35% in October. The Ukraine crisis has clearly given fresh impetus to some of the inflationary forces that had already been unleashed, but it has also heightened the risk to global economic growth. Central banks are now walking a tightrope, because raising rates too aggressively could tip the world into a recession, particularly when combined with higher energy costs that are likely to wreak their own damage on the economy.

“UK consumers now face an annus horribilis, as rising borrowing costs will be compounded by higher food and energy bills, and tax rises to boot. Interest rates will mean savers getting a bit more return on cash held in the bank, but elevated inflation means they will actually be worse off. The Bank of England is honest in stating that it has limited ability to deflect the economic shock of higher food and energy prices, but that just means UK households are going to have to grin and bear it.

“It remains to be seen whether Rishi Sunak will proffer any support for household budgets in the forthcoming Spring Statement. The Chancellor can expect an inflation windfall from freezing tax allowances, and the IFS estimates this policy could now be yielding £21 billion for the Exchequer in 2026, compared to an initial forecast of £8 billion, thanks to higher inflation. But on the other hand, government borrowing is already eye-wateringly high, and rising interest rates only serve to increase the cost of servicing that debt, especially seeing as £847 billion of gilt payments are effectively pegged to base rate by the QE scheme. Rising interest rates could well quash the tax windfall the Treasury can expect from higher inflation, which leaves less budget for the Chancellor to ride to the rescue of UK households.”

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