Sean O'Grady: So does this mean interest rates are about to go up?

British inflation always seems to end up higher for longer than anyone thinks
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The Independent Online

Whether you think your mortgage bills are going to rise pretty much boils down to whether you believe Mervyn King, the Governor of the Bank of England, that inflation will come down soon, and dramatically – to about 1 per cent by the end of this year. If that is the case, then we might see no rise in mortgage rates until next year, and then not much – a useful bonus for households facing minimal pay settlements and higher taxes.

However, there are reasons why inflation will be higher than expected and that rates may need to rise sooner and faster than many assume. First, the Chinese economy is bidding up world commodity prices again, which are notoriously volatile. Second, the weakness in sterling offers us no protection from those, and may get worse. Third, British inflation always seems to end up higher for longer than anyone thinks. And if you look at underlying inflation – which takes out the special factors the Governor talks about – it is still relatively high compared with Europe, America and Japan.

But all bets will be off if there is a Greek-style UK debt crisis, or a credit-rating downgrade of our gilts. If the interest rates we have to offer investors to take on British government debt soar, so will mortgage rates. Where they could go is anyone's guess.

So where interest rates end up is as much a matter for the next Chancellor (and the voters) as it is for the Bank of England. Longer term, few believe that current rates of interest can be sustained in any case. Bank rate is abnormally low at 0.5 per cent – the lowest in the bank's 316-year history, lower than during world wars or previous depressions. The Bank has also said it won't extend its special liquidity scheme when it expires over the next couple of years – leaving the banks with a near-£200bn funding gap and further upward pressure on rates. There is certainly a chance, perhaps a sizeable one, that your mortgage bill by the end of next year could be hundreds of pounds more than it is now, adding to the agony of higher taxes, soaring petrol prices and pay freezes or even cuts. The anguish of middle England has only just begun.

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