David Prosser: Higher interest rates will be with us sooner than you might think

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The Independent Online

Outlook Will the nine members of the Bank of England's monetary policy committee return to the fray today with a New Year resolution to be tougher on inflation? There is certainly a palpable sense of nervousness in the City and beyond that this week's MPC meeting, the first of 2011, might see the Bank finally begin to raise interest rates from the present low of 0.5 per cent.

Certainly, the performance of the MPC last year, on the straightforward test of hitting its inflation target, was poor. Only in a single month was inflation, as measured by the consumer prices index, within a percentage point of the Bank's mandated 2 per cent target. And while the Bank stuck to its line that short-term inflationary factors would give way to deflationary pressures in the medium term, it also had to keep pushing back its assessment of when the turning point would come.

With inflation appearing to pick up pace over the final quarter of last year and, crucially, people's expectations about inflation in the future now beginning to rise appreciably, there are fears the MPC might choose this month to send out a message that it remains committed to tackling inflation.

The announcement tomorrow of no change to policy is still the more likely option, but there is an outside chance of a base rate increase – to 0.75 per cent, say. Interest rate expectations, as measured by City expectations of overnight and three-month Libor rates, have risen sharply in recent weeks.

The question is whether an increase now would have the desired effect. Capital Economics, for example, warns that rather than suggesting the MPC is serious about inflation, an interest rate rise might make people think it is running scared of the problem, which could prompt expectations of higher price rises to come.

Even more worryingly, would an interest rate rise, coming just as fiscal austerity is really beginning to kick in, do real damage to the economic recovery?

While a base rate of 0.75 per cent would still be remarkably low by historic standards, the recovery is so fragile that it would not take much to shatter it, particularly since one increase in borrowing costs would prompt expectations of further rises to come. The housing market, particularly sensitive to interest rate movements, looks especially poorly placed to cope with increases.

For these reasons, the consensus view that the MPC will hold fire for now is probably going to be proved right. But there is a danger of complacency for mortgageborrowers, many of whom, according to a survey published earlier this week, now assume the cost of homeloans will stay at currentlevels for good.

Make no mistake: interest rate rises are coming – and probably sooner than you expect.

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