Bank of England interest rate hikes could put more businesses in danger in its bid to tame the UK's double-digit inflation, an expert has warned. Economists have said the Bank's base rate could go as high as five percent as decision-makers try to keep a lid on runaway price hikes.
Consumer Prices Index (CPI) inflation hit 10.1% in March, a fall from 10.4% in February, but much higher than the 9.8% experts predicted. Susannah Streeter, Head of Money and Markets at Hargreaves Lansdown told Express.co.uk that business insolvencies could increase if rates rise. Higher borrowing costs led to a 16 percent rise in firms going bust last month.
Ms Streeter said, "more firms could go by the wayside as rates go higher. If loans like mortgages become more expensive for households, they are likely to cut back further on discretionary spending, leading to a decline in retail sales and spending across hospitality. An ensuing economic contraction is likely to see unemployment rise further and a further easing of recruitment as firms batten down the hatches. But it should also lead to more wage restraints and a loosening of sticky core inflation."
The Bank's base rate is currently 4.25%. Members of its Monetary Policy Commitee will announce any further changes on May 11.
Michael Saunders, Senior Policy Advisor at Oxford Economics, told the BBC on Thursday that the Bank will probably raise the rate again, but that we have "just about" reached a turning point in terms of inflation.
Rishi Sunak is being investigated by the House of Commons standards commissioner over paragraph six of the code of conduct, it emerged today. The paragraph relates to declaring relevant interests in proceedings of the House or its Committees, as well as communications with MPs and public officials.
Dr Bruce Morley, from the University of Bath's Department of Economics, told Express.co.uk, "there is a strong case for not raising interest rates for now. He said another rate rise increases the chances of a recession. Increased interest rates are likely to increase the chances of a recession this year. We are already beginning to see a rise in the UK unemployment rate, as it has recently increased to 3.8% up from 3.7%, although still low by historical standards. With a rise in interest rates, this upward trend is likely to continue this year. Similarly with insolvencies, a rise in interest rates will increase the number of insolvencies as for many companies the increased cost of borrowing will have an adverse impact on their business and ability to pay the interest charges on any borrowings they have. The markets appear to be predicting a rate rise in May, although given the recent turmoil in the banking sector, there is a strong case for not raising it for now.
Global banks recently saw the biggest crisis since 2008 after Silicon Valley Bank and Signature Bank collapsed in the US and Credit Suisse sought a lifeline from the Swiss government. But Dr Morley added that he expects the BoE to still raise its rate, saying, "yes, I expect it to go up, although I think you can argue that they should leave it as it is for now, waiting to see what happens in the banking sector over the coming months before raising it again. Also the Bank of England is forecasting inflation to fall back below three percent by the end of the year, so more increases may not be necessary. However, recently inflation has been higher than expected and wage growth stronger, so this could well facilitate the rise in the rate."
He warned a rise to 4.5%would increase the cost of borrowing for industry and household mortgages, especially for people with flexible rate mortgages linked to the base rate and those on fixed rate mortgages but who need to renew their mortgage this year. Dr Morley said, "house prices have stopped increasing and, currently, are fairly stable, but more interest rate rises could cause a fall in house prices. This would have a wealth effect, reducing housing wealth which would reduce spending in the economy and adversely affect the banking sector."
Ms Streeter said, "inflation has risen further and stayed higher than elsewhere as Britain grappled with the energy shock and labour shortages made worse by Brexit. The tight jobs market in particular is a real cause for concern, because as companies are forced to pay workers more money, they are passing on expensive labour costs in terms of higher prices.This spiral upwards is eroding our spending power which is also damaging for growth prospects over the longer term. Central bank policymakers know that fresh rate hikes risk tipping the stagnating economy into recession, but consider it a price potentially worth paying to stop domestically fuelled inflation becoming entrenched in the economy. The hope is that another rate hike might help release more gas from the inflation balloon which is still riding high."
She added, "that the Bank has a "hugely tricky" balancing act to perform as "bubbling in the background" are concerns credit conditions will tighten and loans will be harder to come by in the wake of the banking crisis. This has led to expectations that the US will dip into a mild recession and the Bank of England has already noted that in the run-up to the crisis in March, lenders were already becoming more risk averse. The interest free loan periods available for credit cards decreased in the first quarter of the year and are expected to narrow further. Although the markets have been pricing in three potential rate hikes, with chances of the base rate heading as high as five percent rising, it is "far from certain" that it will reach that level. This is because wholesale food prices have largely dropped back to 2021 levels and, despite a long lag, these should start to filter through. Last year's eye-wateringly high energy costs will also drop out of the figures from Julu and as the headline rate starts to come down more rapidly in the second half of this year, pressure on policymakers for further rate hikes will ease. This will likely lead them to adopt more of a "wait and see" mood during the summer months and into the Autumn."
Interest rate rises are meant to bring down inflation - they haven't. So why are we all paying more on our mortgages?
Bank rate is expected to rise from the current 4.25% to 4.5% in what would be the twelfth consecutive increase since the MPC began tightening monetary policy in December 2021. It will take Bank rate to a level last seen in October 2008. Many people, chiefly small business owners and homeowners with mortgages, will have been hoping the Bank might hold fire next month.
But two pieces of data last week have given the MPC little choice. Tuesday brought news that average pay, including bonuses, grew at an annualised rate of 5.9% during the three months to the end of February. That was the same as in the three months to the end of January and ahead of market expectations. Forecasters had been expecting the rate of wage inflation to ease by now and yet it remains at elevated levels.
Then, on Wednesday, brought news that the headline rate of consumer price inflation fell from 10.4% in February to 10.1% in March. That, again, was ahead of market expectations. The MPC said at its last rate rise, in March, that "if there were to be evidence of more persistent [price] pressures, then further tightening in monetary policy would be required".
It now has that evidence.
A European and G7 outlier. Given the extent to which interest rates have been rising, many people will be puzzled as to why inflation has not begun to fall more rapidly, particularly with the UK now having the highest headline rate of inflation not only in the G7 but also in most of Europe. Only a handful of European countries, mainly those in close proximity to Russia and Ukraine such as Hungary, Latvia, Lithuania, Estonia and Poland, now have higher inflation than the UK. People may also, then, be wondering about the effectiveness of interest rate rises in dampening inflation.
There are several reasons why rate hikes are less effective in tackling inflation that was once the case.
Why interest rates aren't effective as they used to be?
The first is that the UK is emerging from a period, unparalleled in its modern history, during which interest rates have been set at close to zero and during which the Bank - like peers such as the US Federal Reserve and the European Central Bank (ECB) - engaged in asset purchases to stimulate economic activity (Quantitative Easing in the jargon). It amounted to a gigantic economic experiment that created all kinds of distortions in the economy and fuelled inflation in any number of assets, most notably residential housing. Unwinding that policy was always going to lead to unusual effects that were harder to predict. Those, it has turned out, included interest rate rises not having the impact on inflation that they have had in the past.
Pandemic impacts
Added to that, it can be argued, is the fact that, when inflation did begin to show up in economies around the world in 2021, central banks like the Bank, the Fed and the ECB insisted that it was "transitory" - a short term consequence of demand returning rapidly as economies emerged from Covid lockdowns and supply failing to keep up due to bottlenecks created by those lockdowns.
It is now very clear that this was not the case.
Central banks everywhere were slow to respond to the incipient threat of inflation and have had to over-compensate since with interest rates higher than would have been necessary had they responded sooner. The Bank can argue, in its defence, that it was actually the first major central bank in the world to begin raising interest rates in the current cycle. Some central banks, such as the Reserve Bank of Australia, were significantly slower to move - even though some, like the Fed and the Reserve Bank of New Zealand have since tightened more aggressively. That, though, does not explain why inflation in the UK remains elevated compared with countries, such as many of those in the Eurozone, with lower interest rates and lower inflation.
The savings buffer
Another factor may be what has been happening to household indebtedness since the pandemic. During the year from the start of the pandemic in March 2020, according to Bank of England data, British households accumulated some £192bn worth of enforced savings. Much of that was used to pay down unsecured debts, such as personal loans and credit cards, or simply kept to one side.
It is very clear that not all of those enforced savings have yet been spent - and, accordingly, some consumers may be less responsive to higher prices than was once the case. It certainly helps explain why consumer spending has been somewhat more resilient than might have been expected during the last 12-18 months or so in spite of inflation taking off. A lot of consumers seem content to pay the higher prices demanded by businesses selling them goods and services.
However, that again is a factor not unique to the UK, as it has been seen elsewhere. So we have to look at other reasons why inflation does not appear to be responding to the Bank's rate hikes so far. One reason commonly offered for inflation being stickier in the UK than elsewhere is that the UK runs persistently high trade deficits - it consistently imports more goods and services than it exports.
A weak pound and importing more than exporting
That makes the country exposed to price increases around the rest of the world and especially given the weakness of sterling since the war in Ukraine began. When Vladimir Putin attacked his neighbour, the pound bought $1.36, whereas today it will buy you $1.24. Similarly, when the war began, the pound bought €1.2037. It now buys just €1.1344. So the trade deficit and sterling weakness is undeniably a factor.
Brexit and the labour market
Another factor unique to the UK is Brexit. The tight labour market has contributed to domestically-generated inflation, as opposed to externally-generated inflation, of the kind seen in the prices of oil, grain and fertiliser as a result of the war. Now, it is worth noting that Brexit has not ended migration to the UK (indeed, during the year to June 2022, net immigration to the UK hit a record high of 504,000), but it has changed the composition of the labour market.
Many skilled workers from the EU have returned home during the last six years, particularly around the time of the pandemic, which has created labour shortages and helped push up prices. Another factor, which has again affected the UK more than many of its peers, is the contraction in the labour force since the pandemic. This is due to a combination of factors, including more over-50s opting for early retirement and an increase in the number of people dropping out of the jobs market due to long term sickness, but the impact is the same - it creates skills shortages.
That is going to particularly hurt an economy, like the UK, which is more heavily skewed towards services than many of its peers. As the MPC member Catherine Mann has pointed out, the current combination of high vacancy levels and low unemployment rates is one that has not been seen in the UK labour market before. It may help explain why inflation has not responded to interest rate rises as it did on occasions, such as the early 1980s, when unemployment was high and the number of job vacancies was low.
Fewer people impacted by rate rises
Another difference from the past is the changed nature of home ownership. Many more Britons own their homes outright now than during previous periods during which interest rates rose - indeed, more Britons now own their homes outright than those who either have a mortgage or rent. That means fewer homeowners, proportionately, are affected by interest rate rises than in the past.
At the same time, the majority of homeowners who still have a mortgage now have a fixed rate home loan, rather than a variable one. In 2005, the last significant period of interest rate increases in the UK, some 70% of borrowers had a variable mortgage rate. That is down to 14% now.
Now it is true that, as people come off their previous fixed rate deals, they will see a rise in their mortgage payments. But it is undeniable that the changed nature of home ownership and of mortgages themselves means interest rate rises are not being transmitted through the economy as once was the case.
There has always been a time lag in how interest rates rises impact inflation. It seems that lag is now longer. And that, in turn, raises the danger for the MPC of over-tightening. Whether the MPC has over-tightened, though, will only become clear over time.
Interest rates could spike to 5% in shock for Britons - but there may be a ‘silver lining'
Interest rates hikes have been enacted by the Bank of England in attempts to get high inflation under control - specifically, back to the central bank's target of two percent. However, the market is now anticipating three further interest rate increases this year, a move which would take the base rate to five percent. This is a considerable shift from expectations before the latest announcement from the Office for National Statistics (ONS), which recorded inflation in March 2023 at 10.1%.
What do high interest rates mean for mortgages?
The news of higher interest rates is likely to make homeowners wince, particularly with the existing pressure on household budgets. With millions of people set to come to the end of their fixed-rate deals, the prospect of sky-high rates is frightening. Laith Khalaf, head of investment analysis at AJ Bell, explained, "these individuals will face a much more punishing rate of interest when they come to re-mortgage. Interest rates themselves don't have to rise - simply the expectations of higher rates can push fixed rate deals up - and we may start to see a bit of upward pressure in the mortgage market as a result of this latest inflation data."