Britain's borrowers and business leaders were handed another month's stay of execution yesterday after the Bank of England decided to keep interest rates unchanged. With the economy looking set for strong recovery many commentators feel the real questions about rate rises are not "if" but "when" and "by how much".
On the question of timing, next month is a front-runner for a number of understandable reasons. Most economists believe that with rates still close to a 50-year low and strong evidence of a marked rebound in the corporate sector and continued strength in the housing market, the Bank should be tightening monetary policy.
January is a grim month in which to announce a rate rise as households recover from the seasonal excess of Christmas and the New Year sales.
A February rate rise, by contrast, has the advantage of being accompanied by the Bank's quarterly inflation report, which is seen as a good opportunity to explain the reasoning behind its decision. This year contains an added impetus in the form of the recent change to the Bank of England's inflation target, which came into force last month.
The inflation report will include the Bank's first forecasts based on the new consumer prices index (CPI) that has replaced RPIX as the method of measuring inflation. Lastly, the Bank probably wanted to wait for official figures on the January sales as well as the closely watched quarterly surveys from the CBI and British Chambers of Commerce. Graeme Leach, the chief economist at the Institute of Directors, said: "The Bank is keeping its powder dry until next month. Consumers and business shouldn't be deceived into thinking the interest rate outlook is flat. It isn't - rates are likely to rise."
The Bank put the City on a war footing last month when the minutes of its December meeting said rates would rise "at some point", assuming the economy continued to expand in line with its forecasts.
Under the new CPI rate, inflation at 1.3 per cent is well below the 2 per cent target. But Michael Saunders, an economist at Citigroup, said the Bank's view of the state of the economy would take priority in the debate. "Although inflation currently is below target, policy in recent years has tended to respond more to swings in growth as a guide to capacity pressures and future inflation risks rather than the current inflation rate," he said.
Mr Saunders believes rates will hit 5 per cent by the end of this year - a rise in borrowing costs of a third from their current level of 3.75 per cent. He is not alone. Goldman Sachs, Fortis Bank and Investec all think rates will hit at least 5 per cent this year. Philip Shaw, the chief economist at Investec, is forecasting a peak of 5.25 per cent next year. "Overall the Bank's angst over the inflationary implications of fast economic growth, robust consumer spending exacerbating the UK's economic imbalances and a potential house price bubble all suggest that rates are set to rise again in due course," he said.
The good news for businesses and mortgagees is that they are in the minority. Out of 25 other economists polled by the Treasury, seven said rates would peak at 4 per cent, five opted for 4.25 per cent, seven thought 4.5 per cent, while six forecast 4.75 per cent.
None of these would look excessive given the UK's recent economic history, when rates rose as high as 15 per cent, but would look pretty frightening to anyone who had taken on a mountain of debt when rates plunged to 3.5 per cent.
Mortgage borrowing has risen to record levels, while unsecured borrowing - credit cards, overdrafts and bank loans - have also risen fast.
Figures from Datamonitor published today showed unsecured borrowing surged by 30 per cent last year to £175bn - equivalent to £4,326 per adult compared with £3,383 at the end of 2002. This is dwarfed by the £760bn of mortgage debt outstanding - although this, obviously, is offset by the rising value of homes. Some economists believe that as the housing market slows, tax rises hit households' pockets and interest rates start to rise, consumers will finally rein in their spending plans.
Nick Stamenkovic, an economist at RIA bond brokers, said: "Even if they do raise rates in February we don't think they will go higher than 4.25 per cent given the uncertainty over how it would affect debt-laden consumers."
John Butler, the UK economist at HSBC, agreed rate rises were inevitable but said that might not be the "end of the story. The vulnerability of the consumer, the lack of any sustainable global recovery and with underlying inflation remaining benign, the Bank is likely to switch back to cutting rates again by 2005," he said.
The high street suffered its worst Christmas for at least nine years as sales fell for the first time in nine months, the British Retail Consortium said yesterday. Bill Moyes, BRC director general, said: "The consumers' willingness to shop has slowed significantly since the summer. The Bank of England cannot rely on consumer spending continuing to grow at the levels needed by the economy."
The other brake on rate rises could be further rises in sterling's exchange rate, which could do the Bank's job for it by squeezing Britain's export and tourism industries. Roger Bootle, the chief economic adviser to accountants Deloitte & Touche, said the huge movements in currencies that began last year posed one of the largest potential threats to the UK and the Bank. He said the pound could either continue to shadow the euro and appreciate against the dollar or move with the US currency and fall against the euro - both of which could harm the economy. He said a jump to $2 would raise the UK's effective exchange rate against the rest of the world by 3 per cent. "A sharp rise would prevent the Bank raising rates and could even force it to reduce them," he said. "Alternatively a fall against the euro could push the Bank to raise rates sharply, risking a 1980s-style housing market fall."
But before one gets carried away with speculation over the timing and size of a UK rate rise, one should remember rates look set to stay on hold or even fall elsewhere in the world. The European Central Bank yesterday resisted pressure to cut rates to offset the impact of the surge in the euro against the dollar. Wolfgang Clement, the German economy minister, had led calls for a rate cut after the 40 per cent rise in the euro over the past two years. But Jean-Claude Trichet, the ECB's president, said growing global demand would partly compensate for any damage the strong euro would have on its exports. "We are not the prisoner of an equation. We take all pertinent analysis and we make a judgement," he said.
In the United States, the Federal Reserve has adopted a very dovish stance, saying monetary policy can stay on hold for "a considerable period". Interest rates look set to stay at zero in Japan and have been cut recently in Canada and Switzerland.Reuse content