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Will Higher Inflation Trigger Interest Rate Increase?

Earlier this week figures were released which showed that the UK inflation rate had risen in August. The Consumer Prices Index (CPI) 12 month rate in August stood at 2.9% - up from 2.6% in July.

Much of the early discussion around the jump in inflation has focussed, not unreasonably, on the 1% pay cap on workers in the public sector. The cost of common consumer goods is rising faster than wages and this has led to pressure from some quarters for the government to revisit the pay cap.

Rising inflation has also caused some to speculate that the Bank of England’s Monetary Policy Committee (MPC) may be forced to increase interest rates sooner than had been expected.

We looked at the question of whether interest rates were likely to rise as recently as last month. At the time we concluded that it was unlikely that interest rates were going to rise before the end of the year. Indeed an average of market analysts was, prior to these latest inflation figures, projecting that rates would not rise until August 2018. So, do these latest figures mean that we need to revisit this projection?

On the face of it, the short answer would appear to be 'no'. The MPC had previously stated that it expected inflation to plateau at 3% or thereabouts before falling back again. The August inflation figure of 2.9% is, of course, still below that level. 

On closer inspection however, the minutes from this month's MPC meeting reveal that "headline and core CPI inflation in August were slightly higher than anticipated" and that "CPI inflation is now expected to rise to above 3% in October".

The Bank of England's target figure for inflation is 2% and, on the back of the new inflation data, Governor Mark Carney said that "some adjustment of interest rates in the coming months" may be necessary.

Now, before anyone worries about their mortgage rate shooting up, it's worth putting these remarks in context. The MPC has long shown an unwillingness to overreact to short-term fluctuations in market data. The Bank Rate has not changed from its current level of 0.25% since August 2016 and prior to that I had sat at 0.50% since March 2009.

It is therefore vanishingly unlikely that a decision will be taken to increase rates based on one or two months' inflation data. Were inflation to remain above projected levels for a number of months that would be a different story of course but as yet this has not happened.

Additionally, the Bank has consistently indicated that if and when interest rates do increase they will do so gradually, and over a period of time. In short, while the prospect of an interest rate rise before the end of the year is more likely than it appeared last month it remains far from certain and, even if rates do rise, any increase is likely to be fractional.

While the prospect of a significant increase in interest rates any time soon is remote, it is still something that you should be aware of, especially if you are considering taking out or renewing a mortgage. The low interest rates we have seen since the 'credit crunch' in 2008 are the exception, not the rule. Even if it takes us several years to get there, it is prudent to ensure that your mortgage repayments will remain affordable even when rates return to more ‘normal’ levels.

If you are thinking of buying a property and have any questions, get in touch with Warners today on 0131 667 0232 or by emailing and one of our team will be delighted to help you.

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