To hike or not to hike 8211 that is the question

The UK’s Central Bank has kept rates at 0.5% for almost two years and is under intense pressure to fight off spiralling inflation that recently hit double the BoE’s 2% target. City Index Market Strategist Joshua Raymond analyses the interest-rate situation in the UK.

The Bank of England meets today to discuss whether or not to increase benchmark interest rates in the UK. The Central Bank has kept rates at 0.5% for almost two years now but is under intense pressure to fight off spiralling inflation that recently hit double the 2% level targeted by policymakers.

Last month saw one more committee member, Spencer Dale, join the ranks of Andrew Sentence and Martin Weale in calling for a rate hike, although Mr Dale and Mr Weale both called for a 0.25% increase in the base rate, as opposed to Mr Sentence’s more aggressive 0.50% hike. On the complete opposite side to these three stands Andrew Posen, who has continued to call for an extension to the quantitative easing programme, whilst five members voted to keep everything the same. Clearly there remains a significant split within the nine member camp, 5-2-1-1.

It is unlikely that this split within the committee is likely to be resolved today however, and most market participants are expecting no change to interest rates this month. The momentum within the committee certainly seems to be on ‘the hawkish team’, but with Bank of England Governor Mervyn King stating only a few weeks ago that there was little sign  that inflationary pressures are starting to become entrenched yet, we are none the wiser to second guessing who may join Mr Sentence’s team. Governor King’s thinking of course is yet to include any long lasting effect that may occur from the recent spikes in crude oil prices. Should these remain above $100 per barrel for both Brent and Nymex for any longer, this may force Governor King to reconsider this perspective.

There are of course arguments for and against a hike. Mr Posen argues that rate hikes could destabilise the anemic economic recovery currently enjoyed by the UK, particularly in the context of broader public spending cuts that are yet to bite and a fourth-quarter contraction in growth of 0.6%. Mr Sentence has however argued since last summer that inflationary pressures must be controlled and that for tightening to be effective, it must be gradual and must start now.

We are unlikely to get any closer to being able to guess in today’s decision when rates will actually rise, which they must at some point of course. For this, we must rely on the minutes of the meeting which are issued on March 23, 2011. But then again, the Bank of England has surprised the market before and so whilst I would expect no change in today’s decision, the amount staked may not be as high as you may think.

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