Bank must hold its nerve and not risk country's recovery

24 January 2011 | By MELANIE BIEN

The reaction to the news that inflation soared to 3.7% in December should have come as no surprise.

With the base rate held at 0.5% for the best part of two years, the subject has become exceedingly dull, with little to say. But widespread speculation that a base rate rise was imminent sent the media into overdrive.

’Soaring interest rate on the way’, the front page of the London Evening Standard screamed last week. Lenders pinged emails to brokers citing the ’expected imminent increase’ in interest rates, advising that customers wanting secure rates should act now.

Swap rates inevitably rose on the inflation data but by the next day they fell back considerably, particularly on one and two-year money.

While all this scaremongering is predictable, it is not helpful. Although borrowers shouldn’t be complacent about rates because there is only one way in which they can move - and they will at some point - panic buying is never a good option.

What’s more, although rates are headed upwards, nobody knows when.

The inflation figures don’t make for pretty reading and are likely to get worse, moving above 4% once the January VAT hike is taken into account.

Unsurprisingly, there is growing pressure on the Bank of England to raise rates to rein in inflation but is that what the Bank should do?

While inflation is far higher than the government’s target, interest rates shouldn’t rise until later this year because of the tentative economic recovery.

The Bank must hold its nerve, despite pressure from influential sources to increase interest rates. There is a risk it may become a laughing stock but the weak economic recovery could be severely hampered by a premature rise.

Rates need to rise at some point but it is too risky to impose it before the recovery is well under way. The full effect of fiscal tightening, necessary to bring the budget deficit under control, has not yet been felt.

In other words, things will get worse before they get better and rising interest rates running alongside spending cuts could make a bad situation almost unbearable.

For those home owners already overstretched by expensive food, petrol and energy prices, who may also be in danger of losing their jobs, the last thing they need is borrowing rates shooting up.

There are fears the number of properties repossessed will rise dramatically along with interest rates - something the government will want to avoid at all costs.

Maybe what needs to be discussed is the 2% inflation target. Is the target still relevant or helpful? If there were a revised target, the Bank wouldn’t get the same stick it is getting now, which would be far more helpful.

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