When will UK interest rates rise?

With Britain's economic recovery faltering, the Bank of England's decision to keep interest rates at 0.5% comes as no surprise. But how long can rates remain at their record low level? James McKeigue looks at when interest rates might turn back up again.

So, the decision is made. And it's what everyone expected. The Bank of England's Monetary Policy Committee (MPC) has left its key interest rate unchanged at its current record low of 0.5%. Recent economic news made it pretty likely that BoE governor Mervyn King and the 'low-rate majority' in the MPC would stick to their guns.

King has made it clear he sees the weak economic recovery as a more serious concern than rising inflation, which he has consistently described as being a short-term problem.

To be fair to King, he is caught between a rock and a hard place. On the one hand, loose monetary policy and rising global commodity and labour prices mean that Britain is importing inflation. On the other, the weak recovery seems unable to pull the economy away from the threat of a double-dip recession so raising interest rates would just hurt the consumer even more, when they're already under pressure.

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King's views aren't held uniformly. Indeed, three of the nine-member MPC voted for a rise last month (though that may have changed this time). His opponents, led by Dr Andrew Sentance, argue that rising inflation needs to be brought under control.

Their biggest fear is that a stronger-than-realised recovery leads to a wage-price spiral that sees inflation shoot up as workers and retailers demand more money to compensate rises elsewhere. They also argue that imported inflation could be helped by raising interest rates to boost the value of sterling, which would ease some of the pressure from high commodity prices. And when the EU decided to raise rates last month many assumed the BOE would be forced to follow.

Yet a surprise drop in the rate of consumer price inflation (still very high at 4%) last month allows King to claim that his much derided 'output gap' isn't as theoretical as it seems. King believes that a lot of productive capacity unemployed workers and closed factories is unused since the recession. He believes the employment of these resources will eventually push down wages and prices.

King's hand was also strengthened by a less welcome piece of news. The unexpected fall in GDP in the last quarter of 2010 and measly 0.5% growth in the first quarter of this year also supports the idea that the economy isn't strong enough to take a rate rise at the moment. With the full force of public-sector spending cuts yet to be felt and the recent VAT rise still hitting consumer spending it looks unlikely that the economy will seem strong enough anytime soon.

That, coupled with Sentence's departure from the MPC this month, means that a rate rise could be some way off. Indeed, traders on the interest rate futures market are now betting there won't be a rise until 2012.

It also means that the biggest threat facing Britain right now is likely to be stagflation low growth, and stubbornly sticky inflation. You can read about what this means for your investments in my colleague David Stevenson's recent MoneyWeek magazine cover story: How to invest in austerity Britain

James graduated from Keele University with a BA (Hons) in English literature and history, and has a NCTJ certificate in journalism.


After working as a freelance journalist in various Latin American countries, and a spell at ITV, James wrote for Television Business International and covered the European equity markets for the Forbes.com London bureau. 


James has travelled extensively in emerging markets, reporting for international energy magazines such as Oil and Gas Investor, and institutional publications such as the Commonwealth Business Environment Report. 


He is currently the managing editor of LatAm INVESTOR, the UK's only Latin American finance magazine.