Will 5.1% inflation nudge Bank of England to raise interest rates?

·5-min read
LONDON, UNITED KINGDOM - 2021/12/14: General view of the Bank of England, the Royal Exchange and the streets outside Bank station in the City of London, the capital's financial district. (Photo by Vuk Valcic/SOPA Images/LightRocket via Getty Images)
The MPC will now have to weigh up the surge in price rises, and the International Monetary Fund (IMF) discouraging it from delaying any further, against the threat of the Omicron variant. Photo: Vuk Valcic/SOPA Images/LightRocket via Getty Images

UK inflation soared to its highest level in more than a decade last month, climbing to 5.1%, according to the Office for National Statistics.

This is significantly more than the Bank of England’s (BoE) 2% target and well above the expectations of 4.5%, thanks to the rising cost of clothing, fuel and second-hand cars.

It comes just a day before the Bank’s Monetary Policy Committee (MPC) meets on Thursday to decide on UK interest rates, spurring debate as to whether the reading will be enough pressure for the bank to take action.

Read more: FTSE heads lower as UK inflation soars to decade high of 5.1%

In November, Threadneedle Street voted to keep rates at their current historic low of 0.1%, voting by a majority of 7-2 despite widespread anticipation it would increase the rate to 0.25%.

The UK's main interest rate has been at 0.1% since the pandemic began, having been set at 0.75% pre-pandemic. A rise to 0.25% would have been the second lowest the bank has ever set.

Analysts have said that they expect the rate to be hiked to pre-pandemic levels in the next 18 months as the economy resumes a more steady course.

Since the last meeting, however, there has been a rapid spread of the new Omicron coronavirus variant, which could delay policymakers from hiking rates. Doubts about coronavirus restrictions and their impact on the jobs market have already dashed predictions of a pre-Christmas rise.

Watch: What is inflation and why is it important?

Earlier this month Michael Saunders, one of the more hawkish officials who voted to increase rates, said it was best to wait for more information on the new strain before making a decision on UK interest rates.

He said he wanted to assess the data on the impact on the economy, before deciding how to vote on 16 December.

“At present, given the new Omicron COVID variant has only been detected quite recently, there could be particular advantages in waiting to see more evidence on its possible effects on public health outcomes and hence on the economy,” he said at the time.

The MPC will now have to weigh up the surge in price rises, and the International Monetary Fund (IMF) discouraging it from delaying any further, against the threat of the Omicron variant.

“A rise in rates, combined with the risk of the Omicron variant, could jeopardise the UK’s economic recovery. The Bank will need to balance these considerations against the tightening in the labour market and rising expectations of inflation,” Hannah Audino, economist at PwC UK, said on Wednesday.

Read more: Food and fuel prices push UK inflation to 10-year high

Elsewhere, Yael Selfin, chief economist at KPMG, said: “Despite today’s inflation figures, we expect the Bank of England to adopt a wait-and-see approach at this week’s meeting, allowing for more time to assess the net impact of the variant on growth and inflation.”

Paul Dales, chief UK economist at Capital Economics, also echoed this point.

“This gives the Bank enough ammunition to raise interest rates tomorrow, but we still think it is more likely [it will choose] to keep its powder dry until it knows more about the Omicron situation,” he said.

“Inflation may stay around 5% for about six months and may even nudge up a bit further in April 2022. But we still think it will start to fall sharply from June 2022, perhaps to quite close to 2% by the end of 2022.

“So while the Bank of England won’t be able to ignore the inflation backdrop for long (we wouldn’t completely rule out a hike tomorrow), we doubt it will raise interest rates next year as far as the 1% level priced into the markets.”

On the other hand, Michael Hewson of CMC Markets took to Twitter to say that a hike should have happened in November. “The Bank of England is now in a hole of their own making,” he said. “Should have gone in November.”

Brian Coulton, chief economist at Fitch Ratings said: "We don’t think it will take much to persuade another three members of the MPC to vote for a very modest rate hike tomorrow to 25bps, particularly as the groundwork has already been laid.

"There will be more confidence now that the end of the furlough scheme has not resulted in a major unemployment shock, core inflation has surprised on the upside and the Omicron variant threatens to intensify shortages of goods and labour.”

Also Derrick Dunne, chief executive of YOU Asset Management said: “A change to the base rate is by no means off the table. With that in mind, investors would do well to prepare for all eventualities, and selecting investments which track the inflation rate will help to maintain a resilient portfolio.”

Traders have recently cut their bets that the MPC will increase the Bank Rate to 0.25% at the next meeting, instead pricing in that a raise will not take place until the following meeting in February.

The currency market position now implies around a 30% chance of an increase, having been as high as 60% previously.

Watch: Will interest rates stay low forever?