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This week UK headline inflation remained stubbornly high at 8.7%, yet core inflation (excluding food and energy prices) rose from 6.8% to 7.1%. This no doubt led to the Bank of England surprising some of the market with a 0.5% rate rise yesterday, to take UK interest rates to 5%. Policy makers are ultimately gambling that the UK economy is strong enough to bear the highest borrowing costs in 15 years, whilst casting a deaf ear to those with mortgages that need refinancing in the latter part of the year as interest rates are now expected to peak nearer to 6%. With about a million households refinancing their home loans over the rest of this year, and a similar amount in 2024, the effect of a near five percentage-point increase in official rates will be felt acutely.
What now stands out is how much higher UK inflation is when compared to other developed markets. Our 8.7% compares poorly to the US, now at 4.05%, France at 6% and Spain at 3.19%. Our rising core inflation is mainly down to wage increases, rising air fares, food prices and costs of services as consumers continue to spend savings. Prices remain on the rise - in a London pub this week I paid almost £8 for a pint of beer (I should check before I order next time)! The May numbers did have some extraneous factors, such as a 10% rise in the minimum wage as well as a 20% jump in plane-ticket costs courtesy of three public holidays. What matters though is the longer-term trend, which is still pointing upwards. The other salient point for the Bank of England is that inflation is running above its own expectations from just last month.
With the Bank of England committee voting 7-2 in favour of the rise, it was interesting to note that the two who held off said that it was for two main reasons. Firstly, energy and food price inflation is already falling and will keep doing so, “which with some lag, would reduce associated persistence in domestic wage and price setting.” Secondly, “we have not yet seen anything like the full impact of past rate increases, and the fact that market yields had already risen so much means the market has tightened financial conditions anyway”. Some hope on the horizon possibly.
Raising rates is not just about placing pressure on those with fixed rate mortgages running out in the near future, even though these may be the current headlines. Mortgages are one. Drive up the cost of mortgages, and people will have to spend more on their monthly bills. So they can’t spend as much elsewhere. Demand falls.
Savings are another. Make savings more attractive, and people will save more and spend less. (Of course, you can also argue that the savings channel puts more money in savers’ pockets, which they then spend, which won’t in fact help).
Activity is another. We have already seen the housing market slow rapidly because the size of mortgages available to buyers has shrunk, and sellers are not keen to sell at the new, lower prices. As a result, you get fewer people moving, and therefore less home renovation spend.
Anticipation is another. If you push up debt costs today, it won't affect all debtors right away. But they can see what’s coming. So those with fixed-rate mortgages cut back now to make sure they can cope when the new rate comes through.
Businesses can also see what is coming. Even the ones that do not carry much debt might think twice about ambitious expansion plans, be more careful about hiring and generally act to slow the economy down.
What remains clear is that for now, the message from Bank of England policymakers is that the interest-rate rises will continue until inflation significantly improves and this is their only focus.
On that note, please do try to have a good weekend and a drink in the sunshine – just maybe not an inflation ravaged beer in central London!
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