- Mark Bolsom is the Head of the UK Trading Desk at Travelex, the world’s largest non-bank FX payments specialist. The opinions expressed are his own.-
One of the Bank of England’s Monetary Policy Committee members, Andrew Sentance, was quoted this morning suggesting that the Bank of England will need to consider raising interest rates this year if a “recovering economy poses a threat to inflation.”
Sentance’s view that inflation will rise is consistent with our forecast and is also backed up by the recent upwards trend in the UK’s CPI Manufacturing data. A rise in inflation is unsurprising, given the Bank of England's asset purchasing scheme, which aims to boost liquidity through printing more money. Inflation has also been bolstered by a weak pound, rising oil and commodity prices, as well as the return of VAT to 17.5 percent.
However, whether rising inflation can be controlled by raising interest rates, as Sentance suggests, is debatable. Historically, central banks have used interest rates to combat inflation, as they act as a brake on credit consumption – as rates become higher, credit becomes more expensive. Hiking up rates therefore offers the consumer an incentive to save, and reduces liquidity in the economy.
However, the current problem faced by the Bank of England is that raising rates above their current level of 0.5 percent will not have a positive impact on liquidity, because credit remains relatively tight. Although billions have been injected into the financial system, it seems that, thus far, this is still being used to build up balance sheets and asset prices. Relatively little has filtered through to consumers, and borrowing remains both restricted and difficult.