Inflation has hit 3.7%, considerably higher than the target of 2% that the government and Exchequer set during the previous administration and carried on by the current Coalition Government. This has led to a debate amongst economists about the interest rate – to raise or not – that is the question. Inflation eats into the value of incomes and savings, and can lead to demands for higher pay, simply to stay put in real terms. A little inflation is a good thing...but over the target and it starts to become the dominant economic factor.
Here are a few of the pros and cons...
If the rate is raised...
· Savers will get a better return on their investment, and may spend more of that money, but they need to have a lot put away to see their disposable income rise from a ¼ % interest rate rise.
· It will be a signal to the markets that the government is doing something about the threat of inflation
· Mortgages will increase – reducing the amount that home buyers can spend on other things – food, clothes, going out...all the things that keep the High Street ticking over
· The banks will benefit. They make money on the interest from the loans that they make, more interest – more money.
· But – it might make them more enthusiastic about lending, for mortgages, for business, for personal use.
· Inflation leads to industrial unrest, the unions want to protect their members, and demand pay rises to keep up with inflation. The current pay freeze in the public sector hits harder when inflation is higher, and becomes a pay cut. A change can slow down inflation and reduce the need for higher pay. Higher pay can lead to higher prices – and then – more inflation...
In the property market, which is currently stagnant, an increase in interest rates will not be helpful, unless there is more lending. People want their mortgages to stay the same, and to arrange new ones that they can rely on the payments staying steady.
The only saving grace is that the numbers are still manageable, and inflation is not spiralling like it did in the 1970s, hitting double figures. The British economy is growing at 2.7% so things are looking up in certain sectors and the impact of inflation may be countered by a buoyant outlook.