A rise in interest rates is not the answer to rising inflation warns Lawrence Galitz of ACF Consultants, after UK Chancellor George Osborne predicted in his ‘Budget for Growth’ that inflation will rise to 5% this year before dropping to 2% in two years time.
Inflation has been creeping up slowly from 3.3% in November last year, to 3.7% in December, 4.0% in January and 4.4% in February.
In December, the rise in inflation was largely due to higher fuel, utility and food costs. In January the Office for National Statistics blamed it on the increase in VAT, with the cold weather also pushing up expenses. In February, it was the spike in oil prices that drove up domestic heating costs.
This increase in inflation has been caused principally by rising oil prices. But those seeking political reform in the Arab world are unlikely to clear the streets and rush back to their homes just because Britain raises its interest rates. Raising rates has little or no impact on such externalities.
Traditional techniques should not be used to calm inflation fears – the unique reasons for the rise cannot be dealt with in the usual way.
These are unusual circumstances as none of them are demand-led. Price rises such as these are forced onto consumers and businesses alike who have no choice but to accept them and pay up.
Although rising inflation puts pressure on the Bank of England to lift interest rates, this is the last thing the Monetary Policy Committee should be considering right now.
The economy is still extremely fragile and recovery and growth are both still weak. Raising interest rates would simply be a knee-jerk reaction and pile on further woes for the country rather than boosting economic growth.
We need an environment of lower interest rates to continue for the foreseeable future until economic recovery is strong and assured. Only then should interest rates be raised.