For the first time in over 10 years, the Bank of England’s Monetary Policy Committee (MPC) has voted to increase interest rates. On 2 November the MPC increased Bank Rate from 0.25% to 0.5%. Bank Rate is the official interest rate set by the MPC and influences other interest rates charged by banks and building societies and paid on deposits.
During my conversations with businesses, I have already been asked to explain the MPC decision.
Parliament has given the MPC responsibility to keep inflation – the pace of increases in prices of goods and services – at 2% a year. CPI inflation is currently around 3%. To ensure that inflation comes back down to the target, a majority of MPC members agreed that Bank Rate should increase a little, starting with a rise of a quarter of one percent. What was that judgement based on?
One positive aspect of the UK economy is that unemployment is at its lowest since 1975. One million more people are in work than two years ago. More jobs mean more people have money to spend, which will support consumer demand.
But very low unemployment is also likely to mean that wages will increase more quickly as companies compete to take on new staff and keep existing workers.
In my conversations with employers in London, examples where the next pay rises are going to be a little higher than in recent years are becoming more frequent.
If wages increase more quickly, prices in shops will also begin to rise more quickly, as companies pass on higher staff costs. And, with so few people out of work, there is little scope for the economy to grow by increasing the workforce.
The main factor determining how quickly our economy can grow, its ‘speed limit’, will be how much more we can produce with the resources we have.
The MPC thinks the UK economy is growing at around its speed limit. If it grew any faster, that would push up on inflation. So a small rise in interest rates now is necessary to control inflation in future.
While this will increase borrowing costs for some – for instance, via higher mortgage repayments – we expect the impact to be modest. Many more people are on fixed-rate mortgages than the last time interest rates rose. And higher rates are better for savers.
The MPC expects that any further rises in interest rates will happen at a gradual pace and to a limited extent. It currently expects that perhaps a couple of additional 1/4 percent increases in Bank Rate are likely to be needed over the next three years.
My colleagues and I in the Greater London Agency will continue to act as ‘the eyes and ears’ of the Bank.
We speak to diverse organisations here in London and feed what we learn into the policymakers. You can read the latest summary of our findings here.
Peter Andrews is Agent for the Bank of England in Greater London. You can read more about the interest rate decision at www.inflationreport.co.uk.
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