MARKETS ARE expecting interest rates to start rising in the UK during the summer after soaring energy and food prices helped push up inflation much more than expected in December.
Inflation jumped from 3.3 per cent to 3.7 per cent last month, prompting investors to bet that the Bank of England will be forced to increase rates as early as July – well before the effects of the government’s austerity plans on the economy become clear.
The unexpectedly sharp rise in prices leaves the bank with a dilemma because inflation looks set to rise above 4 per cent in the next few months – more than double its 2 per cent target – while the nascent economic recovery remains fragile.
“Any increase in rates at this stage would risk putting the recovery at risk, ” said Philip Shaw, an economist at Investec.
Most of the rise in inflation last month came from higher petrol prices, long-planned increases in gas bills and rising food prices, all of which are volatile and have been driven up by a surge in global commodity prices.
A lift in VAT to 20 per cent in January is likely to provide another push to inflation next month, as retailers are expected to pass on more of the tax increase than they did for a similar increase at the start of 2010.
The bank has argued that such price increases are temporary and inflation will fall below target next year as underlying weak domestic demand, low wage growth and public sector cuts take effect.
Paul Fisher, head of markets at the bank and a member of its rate-setting monetary policy committee, said: “We have to look through those short-term things, despite whatever unpopularity comes our way.”
Markets are now pricing in at least a 0.25 percentage point rise in interest rates to 0.75 per cent by July, with rates expected to reach 1 per cent this year.
– (Copyright The Financial Times Limited 2011)
