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Could interest rates be on the way up?
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Could interest rates be on the way up?

19th June 2008

The announcement this week that inflation was above the Government’s 2% target has led many to re-think their predictions for interest rates this year.

Official figures from the Office for National Statistics said the Consumer Prices Index (CPI) rose by 3.3% in May, up from 3% in April. This is on the back of the announcement in May that the wider Retail Prices Index (RPI) measure of inflation rose to 4.3% from 4.2% the previous month.

As inflation according to the Consumer Price Index is 1% above the government's 2% target, the Bank of England governor Mervyn King has had to write a letter to the government to explain what action the Bank is taking to get inflation back within the government’s target.

In his letter the governor blamed sharp rises in the prices of food and energy for the increase in the rate of inflation. The governor predicts that “inflation is likely to rise sharply in the second half of the year to above 4%". The governor also stated that there were "considerable uncertainties…and any such projection is particularly sensitive to changes in domestic gas and electricity prices," Should the UK avoid severe external shocks, then the rate of inflation will begin to fall back towards the 2% target next year the governor said.

In the past 12 months, events on the world stage have combined to drive world agricultural prices up by 60% and retail food prices by 8%. Oil prices have nearly doubled over the past year and on Monday the price hit a fresh high of almost $140 a barrel. Wholesale gas prices are up by about 160% in the past year and UK household energy bills have risen by about 10%.

The chancellors comments and the higher than expected rise in consumer price inflation has meant most industry figures have reversed expectations for interest rates over the next 12 months with predictions of a cut replaced with predictions that rates will be held at 5% or even increased, as it is felt that the Bank are unlikely to cut any interest rate until they are convinced that the inflation is back under control.