Interest rates after the inflation figures and MPC Minutes
Posted on 21 April 2010 by
Following yesterday's publication of the disappointing March inflation figures, with year on year CPI up from 3% to 3.4%, and RPI up to 4.4%, today the MPC April meeting minutes and the latest unemployment figures were published. On Friday we will get the ONS's 1st estimate of the first quarter GDP.
Unemployment in the UK rose 43,000 in the three months to February to 2.5m, the highest for 16 years, pushing the unemployment rate up to 8% of the workforce, the highest since 1996. One positive spin which could be put on these figures is that at least our 8% unemployment rate is less bad than the 9.7% in the US and 10% in the Eurozone. However, this doesn’t alter the fact that these figures re-affirm the truism that all Labour Governments have left office with unemployment higher than when they came in.
The increase in CPI, although it is still 0.1% lower than the January figure, has generated some comments on the likelihood that Bank Rate will start increasing earlier than previously expected. The MPC minutes helped fuel this with a note that some members of the committee were concerned about a change in the balance of risks to inflation. However the vote was 9-0 for no change in Bank Rate or the Quantitative Easing (QE) programme and of course when the MPC does decide it is time to tighten monetary policy it can do so either by increasing Bank Rate or selling some of the £200bn of assets, mainly gilts, it bought in the QE programme, or maybe a combination of both.
The increase in CPI was mainly due to increased petrol/diesel prices, air fares and household gas bills, with transport costs now up 11.3% on the year. Sterling oil prices have increased by 20% in the last 2 months and following the flight disruption airlines will be able to charge premium prices in the short term, which may well mean another increase in the air fares figure for the April CPI. Oil prices are notoriously difficult to forecast and so this makes forecasting CPI challenging.
I think the MPC will want to see what the new Government's tax policies are before making any change in Bank Rate because an increase in taxation has a similar impact on the economy to an increase in Bank Rate, as both reduce people's spending power. Likewise a reduction in public spending reduces economic activity and so the more taxes are increased and/or public spending cut there less need there is for interest rates to increase to achieve the same objective. This of course assumes the new government avoids handing control of our destiny to the markets and the IMF, not only by making its game plan clear quickly but also producing a budget which satisfies the markets that it will be fiscally responsible.
There are still many risks to the economy and the balance of risks still suggests Bank Rate will need to remain very low for quite some time. However, there is a stronger argument now than there has been for about 9 months for buying a 5 year fixed rate on the basis that the best 5 year fixed rates have come down almost to the levels available a year ago and there is increased political and other uncertainty, specifically with inflation persisting at a higher level than the MPC expected, although it still expects the rate to fall later this year. The risk of a hung parliament is clearly greater than it was a week ago and with it the risk that Vince Cable might become Chancellor, something my City contacts tell me would be perceived very negatively.
A 2 year fixed rate on the other hand in many respects offers the worst of all worlds. If bank rate stays low for at least 2 years a tracker will work out cheaper and if interest rates rise one may pay a little less over the two years but will then probably only be able to get another fixed rate at a significantly higher level in 2 years time.
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