Why is the Bank of England considering an interest rate rise?

Rising inflation and winding down of Covid likely to weigh on central bank’s decision makers

Inflation could be about to run out of control, spurring workers to demand higher wages to protect their living standards. A self-perpetuating spiral of higher wages leading to higher inflation is the fear that stalks all central banks. There is also a growing sense among some policymakers that the pandemic emergency is over, and so the emergency cut in interest rates from 0.75% in March 2020 should be reversed.

The central bank’s monetary policy committee (MPC) has the task of keeping inflation at 2% over the medium term, which means the next two to three years. It can ride out a short burst of inflation, but more persistent price rises need to be tackled. The economy is almost back to the size it was before the pandemic and most businesses are operating with backlogs of work. Whether inflation will prove short lived remains unclear.

Shortages of raw materials, manufactured components and skilled staff in some industries have pushed up prices. From a rate of almost zero at the beginning of the year, the consumer prices index has risen to 3.2%, before falling back in September to 3.1%. The Bank’s chief economist, Huw Pill, says it is heading to 5% over the next few months. Until now the MPC has considered these trends to be transitory. It is possible the committee has changed its view and thinks inflation will persist.

The government believes the emergency is over, which is why the furlough scheme has ended. But there are still plenty of measures in place to support businesses hit by the pandemic, indicating that Covid-19 is still dampening economic activity. Business investment is low, consumer confidence is declining and households are beginning to hoard savings again. Many people on middle and low incomes have suffered a financial shock from which they have not yet recovered. Some economists believe it would be a mistake that could even push the economy back into recession.