Mervyn King is right to be cautious on interest rates

If I were Mervyn King, would I vote to raise interest rates? I suspect I wouldn't be quite brave enough. With the rate as measured by the Consumer Price Index at 4% and the Retail Price Index rate at 5.1%, there is no doubt inflation is uncomfortably high. But that doesn't mean we can, or should, try to do much about it.

Anyone in doubt as to the fragility of the UK economy need only look back at the most recent economic data. GDP growth is flat at best. Unemployment is still rising, with youth unemployment at a record high somewhere over 20%. Our productivity is collapsing. And the fact that the base rate is low doesn't mean for a second that the credit environment is particularly easy. Rates on personal loans and credit cards regularly hit new highs; getting a mortgage remains a distant dream for the average would-be first-time home buyer; and as John Stepek pointed out in MoneyMorning this week, as the year goes on, things will get much worse.

Why? Because since the start of the financial crisis our banks have been supported by the Bank of England via the likes of the Special Liquidity Scheme and the Credit Guarantee Scheme, both of which allowed them to get their hands on cheap funding. They are about to lose that support. The result? By the end of this year the banks will have to find £110bn or so on the open market and by the end of 2012 they'll have to refinance something in the region of £400bn-£500bn.

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Where will the money come from? Some will come from retail deposits the savings you and I hold at the banks. But the rest will have to come from the wholesale market, which, as Northern Rock found out in 2007, is not always an easy place to do business. It also isn't quite as big as the big banks need it to be. As analysts at Capital Economics point out, the £400bn-£500bn "that banks need to refinance far outweighs the £130bn of term debt raised in the markets last year".

All this means it will cost the banks more to get hold of funds over the next few years than it has over the last few. As they pass the costs on, it will cost the rest of us more to borrow too. Regardless of what the Bank of England does, the rates that actually affect us are already high and likely to rise. So why would the Monetary Policy Committee (MPC) want to make matters worse with a rise of its own? Beyond calming saver pressure groups, it is hard to see how a rate rise could help.

Let's not forget that MPC's conversations can't stop the minimum wage in China rising, can't stop Ben Bernanke printing money and can't do much about the global price of oil. Add it all up and it's no wonder King says it could be "many quarters" before rates start to rise: he clearly prefers accepting the risk of ongoing stagflation to that of creating economic disaster. It might well end up being the wrong call particularly given how nervous I am about inflation but for now I would probably do the same.