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7 Reasons why the Bank of England should not raise interest rates any higher

7 Reasons why the Bank of England should not raise interest rates any higher

Examining the Bank of England’s Recent Policy Shift and Its Potential Consequences

In a remarkable turnaround, the Bank of England has raised its base interest rates from historical lows of close to zero to five percent in just 18 months, with more increases expected soon. This significant shift comes after an economy that became accustomed to 13 years of ultra-low interest rates. However, despite the bank’s intentions to curb inflation, there are growing concerns that the rapid increase in interest rates might do more harm than good to the economy. In this blog post, we will explore seven reasons why further interest rate increases may have undesirable consequences.

**1. Time Lag and Delayed Impact**

Changing interest rates is akin to driving a car while looking only through the rear window. It takes considerable time for interest rate adjustments to affect the economy. Even though interest rates have risen, many mortgage holders have not yet experienced the full impact, as they have not remortgaged. It is estimated that over 1 million households in the UK will soon face an additional £500 in monthly mortgage payments. This will create strong deflationary pressures on the economy, affecting consumer spending, business investments, and even renters indirectly.

**2. Falling Inflation and Global Trends**

Inflation is finally starting to decline and is expected to continue doing so over the next 12 months, regardless of the Bank of England’s actions. Some reasons for cautious optimism include falling food prices, a decline in oil and gas prices, and rapid decreases in inflation across Europe, the US, and China. Though the UK’s inflation performance has been challenging, it generally tracks global trends. The current interest rate hikes could exacerbate deflationary pressures, leading to slower economic growth or even a recession.

**3. Impact on Mortgage Holders**

The sharp increase in interest rates has a more potent effect due to soaring house prices. Small changes in interest rates can have a significant impact on disposable income. For instance, a six percent interest rate now is equivalent to around 12-13 percent in the 1990s. As a result, many mortgage holders are facing financial stress, impacting their spending capacity and overall economic growth.

**4. Risk of Recession**

The UK economy has been stagnating for a few years, with below-average growth rates. The sudden interest rate hikes further deter business investment, potentially leading to a severe recession with rising unemployment. While controlling inflation is essential, targeting a specific two percent rate might not be the best approach, especially when facing external shocks.

**5. Unequal Impact**

Interest rate hikes disproportionately affect the young and low-to-mid-income earners, who are burdened with higher mortgage payments, student loans, and credit card debt. On the other hand, those who have already paid off their mortgages benefit from higher nominal interest income. This inequality adds complexity to monetary policy’s effectiveness.

**6. Credibility Concerns**

The motivation behind the rapid interest rate increases has raised concerns about the Bank of England’s attempt to restore its credibility. After consistently underestimating inflation, there is a fear that they might now overcompensate and prioritize reducing inflation without considering the wider economic impact.

**7. Falling House Prices**

While falling house prices might benefit affordability in the long run, in the short term, they contribute to reduced spending as people worry about declining wealth and equity withdrawal. This added deflationary effect could further slow down the economy.

In conclusion, the Bank of England faces a challenging task in balancing inflation control and economic growth. While the intention to control inflation is valid, the rapid interest rate increases come with substantial risks. It might be wiser for the bank to wait and assess the impact of previous rate adjustments before implementing further increases. A more measured approach can avoid unnecessarily deepening a recession and causing long-lasting economic and social consequences.

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