Interest rates after the inflation figures and MPC minutes

Following yesterday’s publication of the disappointing March inflation figures, with the year-on-year Consumer Prices Index up from 3% to 3.4%, and the Retail Prices Index up to 4.4%, today the Monetary Policy Committee’s April meeting minutes and the latest unemployment figures were published.

On Friday we will get the Office for National Statistics’ first estimate of the first quarter gross domestic product.

Unemployment in the UK rose 43,000 in the three months to February to 2.5 million, the highest for 16 years and pushing the unemployment rate up to 8% of the workforce, the highest since 1996.

One positive spin which could be put on these figures is that at least our 8% unemployment rate is less bad than the 9.7% in the US and 10% in the Eurozone. However, this doesn’t alter the fact that these figures reaffirm the truism that all Labour governments have left office with unemployment higher than when they came in.

The increase in CPI, although it is still 0.1% lower than the January figure, has generated some comments on the likelihood that Bank of England base rate will start increasing earlier than previously expected.

The MPC minutes helped fuel this with a note that some members of the committee were concerned about a change in the balance of risks to inflation. However the vote was 9-0 for no change in Bank rate or the quantitative easing programme and of course when the MPC does decide it is time to tighten monetary policy it can do so either by increasing Bank rate or selling some of the £200bn of assets, mainly gilts, it bought in the QE programme, or maybe a combination of both.

The increase in CPI was mainly due to increased petrol/diesel prices, air fares and household gas bills, with transport costs now up 11.3% on the year. Sterling oil prices have increased by 20% in the last two months and following the flight disruption airlines will be able to charge premium prices in the short-term, which may well mean another increase in the air fares figure for the April CPI. Oil prices are notoriously difficult to forecast and so this makes forecasting CPI challenging.

“There are still many risks to the economy and the balance of risks still suggests Bank rate will need to remain very low for quite some time.”

Ray Boulger

Senior technical manager at John Charcol

I think the MPC will want to see what the new government’s tax policies are before making any change in Bank rate because an increase in taxation has a similar impact on the economy to an increase in Bank rate, as both reduce people’s spending power. Likewise a reduction in public spending reduces economic activity and so the more taxes are increased and/or public spending cut there less need there is for interest rates to increase to achieve the same objective.

This of course assumes the new government avoids handing control of our destiny to the markets and the International Monetary Fund, not only by making its game plan clear quickly but also producing a budget which satisfies the markets that it will be fiscally responsible.

There are still many risks to the economy and the balance of risks still suggests Bank rate will need to remain very low for quite some time. However, there is a stronger argument now than there has been for about nine months for buying a five-year fixed rate deal on the basis that the best five-year fixed rates have come down almost to the levels available a year ago.

There is also increased political and other uncertainty, specifically with inflation persisting at a higher level than the MPC expected, although it still expects the rate to fall later this year. The risk of a hung parliament is clearly greater than it was a week ago and with it the risk that Vince Cable might become chancellor, something my City contacts tell me would be perceived very negatively.

A two-year fixed rate deal on the other hand in many respects offers the worst of all worlds. If Bank rate stays low for at least two years a tracker will work out cheaper and if interest rates rise one may pay a little less over the two years but will then probably only be able to get another fixed rate at a significantly higher level in two years time.