Five reasons why UK rates should be kept on hold

February 15, 2011

By Ian Campbell
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

LONDON — What is the Bank of England doing? Inflation at 4 percent in January is double its target. Mervyn King, the bank’s Governor, is under fire.

Something must be done, mustn’t it? Actually, no. And here are five reasons why.

First and foremost come taxes. If taxes such as VAT hadn’t been hiked, UK inflation would be 2.4 percent, according to the national statistics office. That’s still above the BoE’s target, but not by much. Moreover, a rate rise would not reverse the inflationary impact of the government’s tax rises. It would merely add to the pain suffered by UK consumers, lumping monetary pain on fiscal tightening.

Secondly, much of the inflation comes from global commodity prices. It may be true that BoE’s money printing helped heat that boiling pot. But oil price pain is intense in the UK, with fuel inflation 15.3 percent in January. “Transport” provides 1.2 points of the nasty 4 percent inflation rate. A lot of the UK inflation comes in barrels, and raising interest rates would do little or nothing to counter it.

Critics of King should remember, too, that a dose of inflation is in some respects good. Yes, it hurts those who are struggling. But with wages rising by about half the inflation rate, Britons are becoming more competitive. For a country with a trade deficit and a need for jobs that is no bad thing. Call it rebalancing.

A fourth reason centres on the pound. Its fall from a $2 exchange rate three years ago has made inflation worse, as King says. But devaluation also makes Britain cheaper and more competitive. Raising rates would drive the pound up. That would be unhelpful for growth and jobs.

The story would be different if buoyant growth in the UK money supply, or credit creation, or GDP, were pushing prices up. But the fifth and most resounding reason not to raise rates is that the UK is depressed. Annual broad money growth is negative, credit is down, the economy contracted in the fourth quarter.

Higher rates aren’t what the UK needs now — unless you want double dip recession.

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