UK inflation hits a 30-year high – but will the Bank of England raise interest rates?

UK inflation is now rising at a rate of 5.1% a year – its highest in 30 years and a lot higher than the Bank’s target of 2%. So, asks John Stepek, will the Bank of England Raise interest rates?

Andrew Bailey, governor of the Bank of England
Andrew Bailey: the Bank of England has very little room for error
(Image credit: © Chris Ratcliffe/Bloomberg via Getty Images)

The Bank of England is meeting this Thursday to decide whether or not to raise interest rates.

This morning, we learned that annual inflation is rising at well over twice the Bank’s target rate.

So the fact that a rate rise (from the current record emergency low level of 0.1%) is not a foregone conclusion, gives you some idea of just how extraordinary conditions are right now.

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Figures for last month show that the consumer price index (CPI) is now rising at a rate of 5.1% a year. That’s not only a lot higher than the Bank’s target of 2% (not to mention the upper band of 3% at which it has to start writing letters to the chancellor), but it’s also much higher than analysts had expected.

Indeed, it’s the highest it's been since September 2008, when it hit 5.2% (and prior to that one-off freak reading, you have to go back to March 1992, when CPI was rising at 7.1%).

Meanwhile, if you still pay attention to the old Bank of England target measure, now disdained as unworthy of the statistical stamp of approval, things look even worse.

Until December 2003 the Bank targeted RPIX, which is the retail price index, excluding mortgage interest payment costs. (Why do you exclude mortgage interest costs? Because if you put interest rates up to try to tackle inflation, that’ll then push up mortgage interest costs, which in turn means you actually make the inflation figures look worse if you don’t adjust for it.)

Anyway, the Bank used to use RPIX for its inflation target, and the target was a bit higher, at 2.5%. RPIX is now rising at an annual rate of 7.2%, the highest level since March 1991, and almost treble the old target rate.

This throws the latest data on wages – which showed them rising at 4.9% a year in the quarter through October – into stark relief. At this rate, you’re still not getting a pay rise in “real” terms. Meanwhile, with double-digit house price inflation, you’ve not got much luck on that front either.

The Bank of England is taking a real risk if it doesn’t act

Why might the Bank not raise rates? Omicron is the obvious excuse. The new variant (combined, a cynic might argue, with purely political woes) has catapulted the government into what can only be described as a stealth Christmas lockdown. The Bank may be very reluctant to make any move on interest rates at a time when economic activity is being crimped by a mixture of confusion, fear and frustration.

You can also argue that a rate rise does nothing. And in practical terms, that’s true. Raising rates right now won’t do much to change the things that are causing higher inflation in the immediate term. Supply chains won’t magically get unclogged because the Bank puts rates up to 0.25%.

However, when it comes to central banks, indications of intent matter. If the Bank essentially washes its hands of the idea that it can control inflation then that’s a pretty strong signal to the market that where inflation goes next could be anyone’s guess.

Much of what central banks did while the global economy was struggling to recover from the financial crisis was about confidence bolstering. For example, investors learned to assume that central banks would not let financial systems collapse, and as a result, the level of intervention required was minimised because markets panicked less.

If central banks act as though inflation is now beyond their control – even although deflation was equally beyond their control – then markets may well start to react as if it really is out of control. That risks currency sell-offs and potentially even bond market sell-offs.

That doesn’t seem likely right now, but we’re moving into a new era. The odds of mis-steps and nasty surprises are increasing. And unlike the Federal Reserve, the Bank of England doesn’t have the wiggle room for error that the world’s most important economy and global reserve currency gives the Fed.

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.