Why Did The MPC Increase Interest Rates In UK - January
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To the dismay of householders and industry, the Monetary Policy Committee
unexpectedly increased interest rates for the third time in only 6 months.
Interest rates now stand at 5.25%. Although the increase was only a quarter of
1%, it will add considerable financial burden to the UK’s overstretched
borrowers. For example somebody with a mortgage of £100,000 will find themselves
paying an extra £15, or £21 for an interest only mortgage.
The citizens advice bureau warned of financial disaster for some families,
especially since it comes in the difficult post Christmas spending period. The
CBI also expressed its regret. The CBI are worried on behalf of exporters. The
rise in interest rates has further increased the value of the £ making British
exports less competitive. The pound rose yesterday to nearly $2 per £1. Given
the impact on borrowers and increased risk of insolvency many have questioned
the banks motives.
The Monetary Policy Committee have defended their decision by saying that
inflation is still above the government’s inflation target. CPI Inflation is
currently 2.7%. However some argue that this is only a small divergence between
their target of 2%. The key thing is the future course of inflation. Next month
the MPC will produce their inflation report, this could be key to deciding
whether interest rates have to rise further. The MPC also cite other
inflationary pressures; such as the ever-resilient housing market. House prices
rose by 3.3% in the last 3 months giving another unsustainable rise. The MPC
also cited increased wage pressures. The latest wage settlements have been
averaging around 4%, a figure the MPC argue could lead to further inflation; the
CBI however were disputing the inflationary impact of wage rises. Perhaps the
most significant justification for the interest rate rise is that this
pre-emptive move will prevent future interest rate rises. If the MPC can dampen
consumer spending early it will prevent a future inflationary situation. This
pre-emptive inflationary strategy is exactly what Gordon Brown had in mind when
the MPC were made independent in 1997.
However some economists are increasingly aware of the limitations of monetary
policy. The effects of raising interest rates are not equally spread across the
economy. First time buyers and usually young people with high levels of
borrowing will definitely feel the financial pinch. However there is a
significant proportion of the economy sitting on equity gains from rising house
prices, these consumers have also usually paid off most of their mortgage.
Therefore higher interest rates do not dampen their spending. In fact the elder
generation are often helping out their children with equity for buying a house.
This and the influx of foreigners into the housing market is maintaining healthy
demand despite the increased interest rates. The effect of this is that rising
interest rates may have less impact on reducing inflationary pressures.
Increasing the likelihood of future inflationary pressures.
About the Author
R.Pettinger is an Economics teacher at Oxford and writes frequently on the UK
economy and mortgages. He edits a site about Mortgages including a guide to
different types of mortgages.
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Article Published/Sorted/Amended on Scopulus 2007-03-25 20:09:30 in Economic Articles