Bank Of England

As the Bank of England duly increased interest rates, as was widely expected, some economists have become alarmed that the rate setting committee at the bank (the MPC) may be getting carried away.

The last time the Bank of England increased rates was in 2007, just a few months before the run on Northern Rock, and a year before the worst financial crisis in a life-time. Which rather begs the question why did they do it? Looking back, with the benefit of hindsight, one could be forgiven for using the word ‘incompetent’, to describe that decision.

Forward wind the clock ten years, and the UK economy is one of the worst performing economies in both Europe and the G7 – it was the worst in both areas in Q1 and the worst in the G7 in Q2 and second worst in the EU, yet, while the central bank responsible for overseeing the euro area, frets about pulling back on quantitative easing, one of the most expansionary examples of monetary policy ever, the UK’s central bank increases rates. Looking at it from that point of view, the decision makes no sense. Has the bank repeated the error of 2007?

There is a difference, of course. Interest rates have increased from 0.25 per cent to 0.5 per cent – which was, until just after the Brexit vote, the lowest interest rate ever. You can be all hyperbolic and say that the bank doubled rates, or you can be realistic and say they have returned to the what was, until recently, the lowest level since at least 1694 when the Bank of England was founded.

Much depends on what happens next.

The markets are pencilling in two more hikes in interest rates over the next two years, and today, as well as announcing the rate increase, the Bank of England released its inflation report, which in broad terms, said it thought that the markets were right to expect interest rates to hit one per cent by the end of 2019. That may seem high by recent standards, but bear in mind that before 2008, an interest rate of around five per cent was normal.

The justification for the rate increase is that inflation is at three per cent. But then it went much higher in the early years of this decade, the bank held firm, recognising that the jump in inflation was down to a one-off fall in sterling, as is the case this time around.

Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics was not impressed. He said: "Our view remains that the MPC is too upbeat on the outlook for GDP growth and will be surprised by the extent to which CPI inflation falls back in 2018. Just as the Committee was caught out by how quickly sterling’s depreciation boosted inflation, so it looks vulnerable to underestimating how quickly the import price shock will fade. We think it will be another 12 months before the bank rate rises again, about six months longer than markets expected before this meeting.”

Paul Hollingsworth, Senior UK Economist, at Capital Economics disagreed, saying: "if we are right in thinking that economic growth will actually accelerate a bit next year, to above the MPC’s estimate of the economy’s “speed limit”, then the MPC would tighten policy more rapidly than markets expect. Indeed, we envisage a further three hikes in 2018."

Paul Davies, director and turnaround specialist at accountancy firm, Menzies LLP, said: "Even though today’s rate rise was well signposted by Mark Carney, it will bring hardship for businesses that rely on consumer spending. Consumers are always wary of a rise in interest rates and we may see the retail industry experiencing a bumpy ride as UK shoppers tighten their purse strings. Businesses can defend against the effects of turbulence by ensuring cash management is a top priority, managing creditor payments and adapting to changes across the supply chain. Consumers and businesses will be hoping that after today’s announcement, any further interest rate rises will be staved off until well into the New Year.”