Was the Bank of England right to keep interest rates on hold?

Following the five interest rate rises that took place between August 2006 and July 2007 the whole country seemed to breathe a sigh if relief when in December of last year the base rate was cut for the first time in two years. Another base rate cut quickly followed in February, and a further one in April. By this time many analysts and economists were wildly enthusing over how quickly and by how much interest rate were likely to come down, with some predicting that rates would fall to below 4% by the end of the year.

However, for the past couple of months the Bank of England has left the base rate on hold at 5%, and predictions from these analysts and economists are becoming more and more bleak. The reason behind the decision to keep rates on hold is inflation. The government’s CPI inflation target stands at 2%, but this has been rocketing out of control and now stands at 3%. The Monetary Policy Committee, which sets the rates, has the difficult job of trying to keep a lid on inflation whilst trying to boost the economy, and this is proving very problematic at present.

So, was the Bank of England right to keep rates on hold again? Well, expert views vary, with some officials agreeing that the central bank had no other choice but to keep rates on hold due to spiralling inflation levels, and others claiming that the central bank needs to focus more on the flagging economy by cutting rates in order to avoid a recession. This has certainly been a challenging year so far for the MPC members and the Bank of England, and things could continue to get tougher. If inflation levels rise to above 3% the governor of the Bank of England will have to explain why in a letter to the chancellor, Alistair Darling.

Some industry officials have expressed concerns because they feel that keeping rates on hold will not help inflation levels because these have been raised due to prices that are determined internationally, such as the cost of food and fuel. However, others have supported the bank’s decision.

Ian McCafferty, chief economic adviser to the employers’ group, the CBI, said: “The Bank had little option this month other than to leave interest rates on hold. Oil and commodity prices are still of great concern and businesses are having to raise prices as profit margins get squeezed further.”

However, officials from the British Chambers of Commerce took a different view, stating: “We understand the critical need for the MPC to maintain credibility, but the MPC cannot disregard the worsening threats to growth. The necessity to write a letter to the chancellor should not be the overriding consideration for the MPC.”

The central bank did receive support, however, from the British Retail Consortium in its decision, with officials stating: “Struggling customers and retailers certainly need a boost but, with rising oil and commodity prices stoking inflation to well above the 2% target, leaving rates unchanged was the wise option.”

Tags: CBI, bank of england, British Retail Consortium, interest rates, British Chambers of Commerce