Bank of England may have to increase by 0.5 percent
At the beginning of this month the odds were pretty much 50/50 that the Bank of England would leave rates on hold as the CPI fell to 2.7 percent. Today the office of national statistics published the latest figures that show the CPI has jumped a massive 0.4 percent to 3.1 percent. This also triggers the need for the Governor of the Bank of England to write a letter to the chancellor explaining why the Bank has allowed prices within the CPI to rise so much.
With this increase it is almost certain that the Bank will be forced to raise interest rates at the beginning of next month - the question is now will it be a nominal 0.25 percent or a more meaningful 0.5 percent. We opt for the latter and the reasoning is very simple, when interest rates were down in the 3 percent area an increase of 0.25 percent represented an increase in borrowing of around 9 percent, with interest rates at the much higher rate of 5.25 percent now a similar small increase would represent about half that increase to borrowers.
The problem has been that people have got used to borrowing and any increases in the cost of borrowing have been too shallow to force people to reign back on debt. The tide may now be changing - although the CPI pretty much ignores housing costs for example, there is a knock on effect that takes place further down the road and is reflected in the RPI. So of course the other shck has been the increase in RPI to a fifteen year high of 4.8 percent.
The RPI figure is likely to be jumped on as it will be used by firms and negotiators as the means to set wages. With fewer people using collective bargaining (ie trades unions) as a means of negotiating salaries, the pressure for wage increases is spread more thinly across the year (ie trades people joining new jobs negotiate for themselves) because of this the obsession of keeping the CPI/RPI low for the winter months is old fashioned and does not reflect reality.
So what should happen? Well first the cost of borrowing needs to reflect the reality of risk, in effect this means ‘teaching’ the poor old house owner the salient lesson that house prices are a risk borne investment and that prices can go down as well as up. We’re also afraid that interest rates will need to rise fast enough to pull back on house inflation, we’re afraid that those who borrowed recklessly against the increase in values of their houses will need to learn that the party’s over.
Ironically we initially thought that Gordon Brown would do all in his power to avoid this situation as he looked set to take over the reigns of power at Number Ten, now it looks clear that he and his actions have precipitated his own epitaph.