The Telegraph reports today that interest rates could very well increase in June, following the surprising inflation figures.
A rate rise would end a two-year period of stability, when interest rates lay at a record low of 0.5 per cent. A move upwards could add hundreds of pounds to many homeowner's mortgages but offer relief to Britain's 38 million savers, who have suffered from pitiful returns in since the financial crisis started.
The warning about a rise in interest rates came after figures from the Office for National Statistics indicated that so-called factory-gate inflation – the prices that manufacturers have to pay for raw materials – jumped far more than expected during December as a result of the spike in global commodity prices.
The rate of inflation jumped from 9.2 per cent in November to 12.5 per cent in December, as the cost of wheat and sugar pushed up the price of ingredients for food manufacturers and the price of metal, oil and chemicals shot up for other factories.
The gilt market, where the Government goes to raise money by selling bonds, immediately reacted with yields rising. These yields are the closest the City comes to a forecast for what interest rates will be in the future. The yield on a two-year Treasury was up almost 6 basis points at 1.37 per cent, having earlier struck a 12-month high of 1.39 per cent. The gilt market is now pricing in an interest rate rise in June, said analysts. Stephen Lewis, chief economist at Monument Securities, said: "The market movement suggests that investors are thinking that rates are going to rise before June. "David Page, at Lloyds TSB Corporate Markets, said the factory inflation figures “continue to feed the ongoing background concerns that inflation is a growing problem in the UK, and it feeds the fear that the Bank of England will react to that.”
Interest rates last rose in Britain during 2007 in an attempt to cool the over-heating housing market, before being drastically cut during the financial crisis of 2008. They hit a low of 0.5 per cent in March 2009 and stayed at that level since then, in an attempt to help the flagging economy.
Philip Shaw, economist at Investec, said: "The recovery in the global economy is welcome but it does have a side effect: pushing up the cost of raw materials, pushing up inflation, as these factory gate figures show. "We were originally forecasting that interest rates wouldn't rise until the back end of 2011 but there is a real risk the Bank of England's monetary policy committee will have to raise rates sooner rather than later to protect its credibility."
The Bank of England has a target to keep inflation at 2 per cent, with raising interest rates its main weapon to keep inflation under control. David Kern, chief economist at the British Chambers of Commerce, said: “These figures reinforce our expectations that during the next few months annual consumer price inflation will rise towards 4pc per cent and possibly higher. “This will create an uncomfortable background for the (Bank’s) Monetary Policy Committee, and will add to the pressure it is now facing for an early increase in interest rates.”
Next week the ONS will publish its Consumer Prices Index, the cost of living measure that is meant to stay at the Government target of 2 per cent. In November it was at 3.3 per cent and the December figure is expected to have climbed higher because of the rising price of petrol and utility bills. Mr Shaw said it could rise to 4 per cent with a few months, as the full force of factory inflation starts to feed through to the price of good on shop shelves.
Ruth Lea, economic adviser to the Arbuthnot Banking Group, said: "Of course most British families are already feeling the force of these global commodity price rises and the effects inflation. You only have to fill up a car with petrol, or visit a shop or open a utility bill to feel inflation." Already people have reason to feel squeezed, which will only get worse when the employee's rate of National Insurance goes up in April."
David Cameron, the Prime Minister, hinted yesterday that he would try to ease the inflationary pressures on families, especially the price of filling a family car. "We have to look at this idea that, when the oil price goes up, and the price at the pumps goes up, the Treasury gets some extra money, we should share some of that benefit with the hard-pressed motorist who is filling up his car," he said.
A quarter point rise in interest rates from 0.5 per cent to 0.75 per cent would add £375 to the annual interest on a typical £150,000 mortgage. There are fears that mortgage companies are already pulling their best deals in recent weeks in anticipation of a move by the Bank of England, and the best five-year fixed rate mortgage has risen from 3.69 per cent at the end of last year to 3.99 per cent this week. Savings rates, however, should receive a kick start if the Bank moved up rates. Though a 0.25 percentage point increase in savings rates would only add £25 to a savings account with £10,000 in it.
Many experts are hopeful, however, that the Bank will not succumb to pressure to raise interest rates, especially if job losses continue to climb to three million.
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