King hints of 1.25% Base Rate before year end

The Telegraph reports today that the Governor of the Bank of England has given his clearest indication yet that the Base Rate will need to rise by up to three quarters of one percent before the end of the year.


Any rise in interest rates would end nearly two years of stability with record low interest rates of 0.5 per cent, hitting the majority of mortgage holders, but giving some hope to hard-pressed savers.

Leading economists seized on a key passage in the governor's letter to George Osborne, the Chancellor, explaining why inflation was above target for the 13th consecutive month. They said Mr King's words were a clear signal that interest rates could rise three times before the end of the year, to hit 1.25 per cent.

The official data revealed that inflation, as measured by the Consumer Prices Index, climbed from 3.7 per cent in December last year to 4 per cent in January, the highest level for over two years. The surging price of oil, petrol and the increase in the rate of VAT, which pushed up the price of alcohol and restaurant meals, were the main reasons for the jump.

Mr King warned that the immediate outlook was one of continuing rise in prices, because of the high price of oil, wheat, copper and other commodities on the global markets.

Mr King said: "Inflation is likely to continue to pick up to somewhere between 4 per cent and 5 per cent over the next few months, appreciably higher than when I last wrote to you. That primarily reflects further pass through from recent increases in world commodity and energy prices."

However, he then explained that inflation was equally likely to be above or below the target two or three years away, crucially, “under the assumption that Bank Rate increases in line with market expectations”.

Economists said this key phrase meant that Mr King had backed market predictions that interest rates would rise on three occasions before the end of the year.

Philip Rush, economist at Nomura. He said Mr King’s letter saw the governor “come as close as he can to support market rate expectations” without explicitly giving away the Bank's plans.

Michael Saunders, the respected economist at Citigroup, said: "This in effect is an endorsement of the market rate profile – which projects three hikes by year end– as a roughly appropriate path for policy."

An increase in interest rates would cause further problems for the already slow mortgage market. An increase to 1.25 per cent would add £54 to the average first time buyer's monthly mortgage payments, taking them up to £722 per month, according to Capital Economics, the think tank. It said: "For new borrowers who are already being asked to stump up historically high deposits, that is not a trivial amount."

High inflation is bad news too for most families, whose average wages are not keeping track with the increases in the cost of living. The Office for Budget Responsibility has forecast that average earnings this year will increase by just 2.2 per cent, followed by an increase of 2.4 per cent in 2012, raising the prospect that workers will suffer from effective wage cuts for the next two years.

Ann Robinson, the director of Consumer Policy at uSwitch.com, a price comparison site, said: “Consumers are facing a perfect storm that could see household finances knocked for six this year. When salaries fail to keep up with inflation it spells misery for consumers. These figures could be a cruel and costly combination for households, many of whom are already struggling to stay afloat in these stormy economic times."

The Retail Prices Index, a measure of inflation that many believe more accurately reflects the true cost of living because it contains housing costs, increased from 4.8 per cent to 5.1 per cent. The RPI is often used by companies and trade unions to negotiate salaries. At 5.1 per cent it is now 3 percentage points higher than national average wage increases.

Many households have already felt the full effects of inflation when they come to fill up their cars at the petrol pumps, with the price of petrol hitting a fresh high almost every day in January, because of the rising price of oil and higher fuel duty.Beer, too, has shot higher in price, with the average pint of lager climbing the £3 barrier for the first time. Publicans warned it would increase even more after the Budget next month when an inflation-busting duty increase is expected to add a further 10p to the price for pint.

Many claimed that elderly people, especially those who relied on their savings as a key source of income, were the hardest hit.Basic rate taxpayer with £10,000 in instant access savings account, which now pays an average of just 0.67 per cent, earns £53.60 a year net, but effectively loses £400 once inflation is taken into account. It produces a total net loss of £346.40 in a year in real terms.For a higher rate taxpayer, the net loss in real terms is equivalent to £359.80, according to the calculations by personal finance website Moneynet.

Ros Altmann, director general of Saga, said: "This latest surge in the CPI is a further kick in teeth for older people who often live on fixed incomes and who rely on their savings for additional income. If the Bank of England needed further evidence of the need to increase interest rates sooner rather than later, it surely now has it."The retired population spends more of its income on food and transportation costs, which has been a big contributor to the inflation increase and their spending power is being severely squeezed."