Interest rate rises may be doing more harm than good

There is growing concern that the policy of monthly interest rates rises may be causing more problems than it resolves. With the Bank of England Monetary Policy Committee (MPC) due to meet today (Thursday) to announce whether rates rise or stay the same their actions are being scrutinised more than ever before.

As I have mentioned before interest rates are a fairly crude means of controlling inflation. They are a bit like using a hammer to crack a nut and the risk is that by continuing with this policy month on month you risk devaluing the credibility of the MPC and harming the property market.

There has been evidence of this in the last week with public confidence in the Bank of England’s ability to control inflation falling to a record low which is a blow to the authority of the governor Andrew Bailey. At issue is the balancing act that needs to be judged where you reduce inflation without inducing behaviour which actually increases inflation.

If the public thinks inflation will continue to rise, they may be more likely to boost their spending in the short term and ask for pay rises, helping to push up demand and prices.

With consumer price inflation falling from 10.1% to 8.7% in March there are clear signs that the interest rate policy, along with other factors, is working. The concern is that not enough time is being left between each rate rise to precisely see the impact that these constant rate increases are having on inflation.

Interest rates are not the only lever which will impact on inflation, and we can already see that reduced fuel costs are producing a marked decrease in food prices with many of the supermarket chains already acting to drop the cost of essential foods. However, this will take time to filter through to the level of inflation and the very real risk is that too heavy a burden is being placed upon homeowners when a broader based approach would achieve the aim of reducing inflation substantially without harming the housing market which is a key element of the UK economy.

It also needs to be recognised that this is a global inflation problem caused by the war in Ukraine impacting upon oil and gas prices. The unusual nature of the current circumstances may be a partial explanation of why the MPC has chosen to increase rates each month without waiting to see what impact these rises were having on inflation. Nobody has had any experience of dealing with war related inflationary pressures so there may be uncertainties in the data being utilised to make the rate raising decisions.

There is little doubt that defeating inflation is a vitally important action to strengthen the economy, but all indications are that the rate rises have worked, and the headline rate is starting to fall at a rapid rate. The risk is that with falling utility costs, reduced food prices, and higher interest rates, we apply too strong a brake on the economy which will subsequently require a correction to encourage the economy once more. 

Traditionally the MPC waits a few months to see the impact of each rise on inflation, but this policy seems to have been foregone in a rush to rapidly control the market. With each increase there is a real concern that there may need to be an equally rapid reversal come the Autumn and start of the next year.

What the MPC needs to consider at this stage is that what harm would be done in keeping interest rates at their current level and waiting a few months to see if inflation has already been sufficiently impacted by the various actions currently in play. I think that this would help homeowners, stabilise the housing market, and ease peoples’ finances at a time when it would be beneficial.