UK Interest Rates to Rise to 5.50% on May 10th , What's Next ?

By: Nadeem_Walayat

The money markets have now priced in a rise in interest rates to 5.50% at the May meeting of the Bank of England's Monetary Policy Committee.

In my previous article I discussed the reasons why interest rates have been on the rise during 2007 towards the target of 5.75% (British Pound Finally Awakens to Inflation feeding Rising UK Interest Rates 18th April 07)

The question now to ponder is what happens after interest rates hit 5.50%. The answer to this will become apparent with the release of next inflation figures in May and June 07, as any signs of inflation accelerating away, would signal to the money markets that inflation is now out of control, and it would mean at some point the Bank of England will need to deploy panic measures of raising interest rates by more than 0.25%. Since the baby steps have had little effect and therefore larger increases may be enacted.

However at the moment, the Governor of the Bank of England is continuing to adopt a nothing is wrong attitude, despite the fact that the Bank has FAILED to keep inflation as measured by the CPI from breaching the upper boundary of 3%. The Bank of England is still firm in its forecast for inflation to move back to 2% by the end of this year.

In this regard, the May and June inflation statistics are important, any further sharp rise in inflation as we witnessed this week, could be followed by a 0.5% rise in UK Interest rates at the following MPC meeting, as the Bank attempts to bring inflation back under control. Any further rise in the CPI index, say to 3.2% (from 3.1%) would likely result in a 0.25% rise at the following MPC Meeting.

The Bank is hoping that falling gas and electricity bills will cut inflation in the coming months to back below 3%. However with earnings growth appears on target to hit 5% this year, and the growing demand for raw materials from emerging markets such as India and China means weakness in energy prices may be temporary. Thus it looks increasingly likely that Mervyn King will be writing many more letters to the 'New' Chancellor later this year.

By Nadeem Walayat
(c) MarketOracle.co.uk 2007

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