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A former Bank of England official says interest rates might have to rise this year to control inflation in a blow to those hoping for cheaper mortgages.
Michael Saunders, a former member of the Bank’s rate-setting Monetary Policy Committee (MPC), said lower borrowing costs look increasingly less likely due to the spiralling cost of food and fuel as a result of the Iran war.
Now a senior economic adviser to Oxford Economics, Mr Saunders warned that rising energy costs could take inflation to 4.5 per cent this year, up from 3 per cent presently.
When the MPC met last month, it voted to keep rates at 3.75 per cent.
It had indicated it wanted to cut them before the US-Israeli strikes on Iran began. The committee meets again on 30 April, when it is likely to again adopt a “wait and see” approach.
Before the Iran invasion, the Bank and City economists thought inflation would fall closer to the government’s 2 per cent target, allowing for interest rates to be cut to encourage borrowing and boost growth.
That now seems less likely given the likely rising inflation on food, fuel, transport and most other items.
It would be best for the Bank to increase rates rather than risk seeing inflation head out of control, Mr Saunders said.
“It would probably be less costly to tighten this year and then loosen if needed next year than to keep rates on hold and then – if significant second-round effects materialise – catch up with sharp tightening next year,” he said.
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Michael Saunders: ‘Lower borrowing costs look increasingly less likely due to the spiralling cost of food and fuel as a result of the Iran war’ (Getty)
The cost of a two-year fixed-rate mortgage deal has gone from around 4 per cent to well above 5 per cent, with the cheapest deals being pulled off the market by banks.
The average two-year fix rose to 5.88 per cent, and 5-year fixes to 5.77 per cent, since the conflict in Iran began.
He adds: “A decision to hike rates while CPI inflation is rising sharply also could have a better impact than unchanged rates in signalling the MPC’s commitment to the inflation target.”
If Mr Saunders is right, that will come as a blow to borrowers hoping that mortgage rates might come down.
Paul Dales, chief UK economist at Capital Economics, said: “If CPI inflation does rise to 4.5 per cent (or looks like it is on track to), then it is possible that the BoE [Bank of England] hikes interest rates.
“The reasons Saunders suggests are sensible. In our baseline scenario, CPI inflation rises to 4.0 per cent, which is probably just about a level the BoE can tolerate, especially when the economy is weak.
“After all, CPI inflation rose to 3.8 per cent last year, and the BoE carried on cutting rates. My hunch is that it is more likely that the BoE will talk tough, but won’t actually deliver a rate hike, unless inflation rises much above 4.0 per cent.”