A tale of two interest rate decisions
The Bank of England has kept interest rates on hold at 0.5% and the European Central Bank has raised interest rates in the eurozone by 0.25% to 1.5%.
In the UK, the decision to keep interest rates on hold was widely anticipated.
The decision by the Monetary Policy Committee comes despite price inflation at an annual rate of 4.5%, at more than twice the government target of 2%.
The Bank of England is more concerned about the febrile economic recovery than attempting to bring inflation under control in the short-term with a rate hike.
Inflation was the reason for higher interest rates in Europe.
The decision to increase eurozone interest rates from 1.25% to 1.5% followed an indication last month from European Central Bank chairman Jean-Claude Trichet that such an increase was likely.
Inflation across the 17-nation eurozone is currently running at 2.7%, against a eurozone target of 2%.
Whilst higher interest rates in Europe to bring inflation under control will benefit stronger economies such as Germany, it is likely to push the cost of borrowing up even higher for countries such as Greece and Portugal which are already struggling.
Higher interest rates in Europe are also likely to strengthen the Euro against Pound Sterling.
This really is a tale of two interest rate decisions.
It could be argued that the UK faces an even more urgent need than Europe to put up interest rates to control price inflation.
The remit of the Bank of England and the European Central Bank differs, with the latter solely focused on controlling inflation through interest rate decisions.
Back in the UK, the Bank of England must balance control of inflation with the weak economy. It appears that, for the time being at least, the latter objective is the primary focus on the Bank.
We will have to wait until later this month to see the Minutes of the latest Bank of England rate setting meeting, to discover whether the number of members supporting higher interest rates has changed since last month.
Until then, savers will continue to be unhappy with the impact of historically low interest rates and stubbornly high price inflation on their savings.
Borrowers who have variable or tracker rate mortgages will continue to benefit from exceptionally low monthly payments, hopefully using their spare income to both pay down debt in anticipation of higher interest rates in the future and go shopping to help boost the economy!
We believe that one risk emerging from these decisions to maintain near zero interest rates in the UK is that borrowers will start to think it is ‘normal’.
This could create big risks in the future when interest rates have to go up, if borrowers have adjusted their budgets to account for all of their income each month.
People who have put themselves in this position will need to quickly find ways to cutting their expenditure when interest rates start going up, or they will find themselves in a very tricky financial position.
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