The UK’s headline inflation rate has come in lower than expected at 6.7% but it still seems highly probable that the Bank of England will raise interest rates yet again on Thursday.
Not for the first time, central bank policymakers could end up disregarding the warnings from business groups and economists about the long-lasting damage that further fiscal tightening poses to an already weakened economy.
Minutes after the latest official data revealed August’s reading had bucked market forecasts of a rise to 7%, the Institute of Directors and the Federation of Small Businesses called on the Bank rate setters to sit on their hands rather than risk a rise in corporate bankruptcies and unemployment.
They said the continuing downward trend in inflation since February showed that the 14 consecutive interest rate rises so far were already working. The money markets agreed that a further increase may no longer be necessary, shaving their bets that a quarter-point rise to 5.5% would go ahead from about an 80% likelihood to just 47%.
Despite those improved odds for no change, the monetary policy committee is likely to ignore pleas for restraint after the body that advises central bank policymakers, the Bank for International Settlements, said this week that interest rates must be used aggressively to bring inflation down permanently.
The Organisation for Economic Co-operation and Development and the International Monetary Fund also subscribe to this view, and this international economic consensus is likely to prove decisive when Threadneedle Street decides on borrowing costs on Thursday.
Yet the Bank’s concern about the need to raise rates to tackle stubbornly high core inflation, which strips out volatile elements such as food and fuel, is looking outdated: annual core inflation was 6.2% last month, down from 6.9% in July. The key measure of domestic inflation, the all-services index, also droppedsignificantly, from 7.4% in July to 6.8% in August.
Much of the downward effect to the headline 6.7% figure came from sectors of the economy that kept inflation high for much of the year. Restaurants and hotels cut prices month on month and shops selling food and nonalcoholic beverages did the same, bringing the annual inflation rate for both down by more than expected.
Recreation and culture, and furniture and household goods also fell month on month, only partly offset by upward contributions from higher oil prices that pushed up the cost of transport.
Suren Thiru, the economics director at the Institute of Chartered Accountants in England and Wales, said further interest rate rises would be a “misstep” and that “additional tightening unnecessarily” risked aggravating the financial struggles facing households and businesses.
The worry for business leaders must be that while inflation remains much higher than the Bank’s target, further interest rate rises will not only bring prices crashing down, they will bring the rest of the economy to its knees.
Recent research by the British Chambers of Commerce found almost half of companies reported that current interest rates were having a negative impact.
Martin McTague, the national chair of the Federation of Small Businesses, spoke on behalf of many when he said: “With signs that interest rate rises are starting to bite, tomorrow’s base rate decision by the Bank of England has to be the peak for rates, one way or another. Leaving rates high for longer than needed will devastate the chances of an economic recovery.”
Regardless of the fate of interest rates, Wednesday’s inflation figure is good news for Rishi Sunak, who is on track to hit the target he set in early January of halving inflation from 10.7% by the end of this year.
Sanjay Raja, the chief UK economist at Deutsche Bank, said he expected inflation to continue the march downwards during the autumn and winter to average 4.5% in the fourth quarter.