UK interest rates set to rise as inflation remains above 10%

Economists warn base rate might end up as high as 5 per cent in a bid to tackle runaway inflation

The Bank of England in the City of London financial district. Reuters
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Experts have warned that interest rates might have to rise by more than previously feared because current measures are doing little to reduce high inflation.

The base rate, which is set by the Bank of England, might end up as high as 5 per cent as decision-makers try to keep a lid on runaway price rises, economists said on Wednesday.

The warning comes after Consumer Prices Index inflation hit 10.1 per cent in March, a fall from 10.4 per cent in February, but still much higher than the 9.8 per cent that experts had predicted.

Inflation is a measure of how fast prices are rising for shoppers across the country. The Bank of England is meant to try to keep inflation as close to 2 per cent as possible at all times.

The main tool it has to do this is interest rates. By putting up the base rate, it encourages people to save rather than borrow.

This reduces the amount of demand for products and services, therefore helping to keep prices under control.

Economists said that the base rate, which currently sits at 4.25 per cent, could be increased further by the Bank of England to curb inflation.

Last month, Deutsche Bank economists predicted rates were most likely to peak at 4.25 per cent, but following the latest smaller-than-expected drop in CPI inflation and continued wage inflation growth, they are now guiding towards a peak of 4.75 per cent for interest rates.

Meanwhile, economists at Investec said they are pricing in “75 basis points” of further increases by November, which would take rates to 5 per cent.

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The Office for National Statistics revealed food prices had increased by 19.1 per cent year-on-year, the sharpest jump since August 1977.

Bread, cereal and fruit prices increased, while the impact of vegetable shortages also continued to weigh on inflation.

Meanwhile, clothing and footwear prices rose by 7.2 per cent year on year, although this represented a slight slowdown against February’s data.

Restaurant and hotel prices also continued to rise at 11.3 per cent, but also saw inflation cool from the previous month.

Increases were partly offset by lower fuel costs, with petrol and diesel costs down 5.9 per cent against the same month last year after prices had spiked following Russia’s invasion of Ukraine.

“Inflation eased slightly in March, but remains at a high level,” ONS chief economist Grant Fitzner said.

“The main drivers of the decline were motor fuel prices and heating oil costs, both of which fell after sharp rises at the same time last year.

“Clothing, furniture and household goods prices increased, but more slowly than a year ago.”

Economists have predicted that stubborn inflation will drop more sharply from April amid a decline in energy prices, although the continued price cap at £2,500 ($3,110) annually for a typical home means households will feel little change.

The UK fiscal watchdog, the Office for Budget Responsibility, last month cut its forecasts for inflation, predicting CPI would end the year at about 2.9 per cent.

“These figures reaffirm exactly why we must continue with our efforts to drive down inflation so we can ease pressure on families and businesses,” Chancellor Jeremy Hunt said.

“We are on track to do this — with the OBR forecasting we will halve inflation this year — and we’ll continue supporting people with cost-of-living support worth an average of £3,300 per household over this year and last, funded through windfall taxes on energy profits.”

Kitty Ussher, chief economist at the Institute of Directors, said: “Business remains extremely concerned by the rate of inflation and wants to see it under control.

“While it is a relief that the headline rate of inflation is now pointing downwards again, following the surprise rise last month, the Bank of England’s job is not yet done.”

Martin Beck, chief economic adviser to the EY Item Club, said: “The club still thinks headline inflation will fall at pace this year, mainly reflecting strong base effects and falling wholesale energy prices, which should feed through into lower household bills from the summer.

“Less expensive energy will likely directly lower inflation, and by reducing businesses’ costs, should indirectly bear down on core and services inflation.

“However, the recent persistence of underlying price pressures poses a risk to just how quickly inflation will fall.”

The latest data also showed the CPI measure of inflation including housing costs dipped to 8.9 per cent for March from 9.2 per cent in February, while the Retail Prices Index slowed to 13.5 per cent from 13.8 per cent.

Updated: April 20, 2023, 3:05 AM