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Why interest rates increases are not necessarily bad news

The Bank have announced that interest rates are going up. Credit: PA

Interest rates are heading up and are likely to rise faster than the governor of the Bank of England indicated three months ago.

What’s changed? An global economic upswing is underway and the benefits are reaching British shores. This morning the Bank said it believes the prospects for economic growth look a little brighter.

The uncertainty about Britain’s future relationship with the European Union continues to restrict business investment, the squeeze on household income continues, but neither situation is severe enough to be causing alarm.

The Bank’s Monetary Policy Committee has voted unanimously to keep Bank Rate at 0.5% and maintain the stock of UK government bond purchases (aka as quantitative easing) at £435 billion but it is clearly signalling that, all things being equal, that level of unprecedented economic support will need to be withdrawn earlier than previously indicated.

Credit: Joel Hills

With economic growth stable the Bank has turned its attention to inflation. Prices are rising at a pace that it well above the Bank’s 2% target and, although the impact of the slump in the pound is diminishing, domestic inflationary pressure is picking up.

The Bank expects pay-rises to become more generous - which is of course is welcome news - and the price of oil has risen significantly. The Bank has decided it needs to respond.

Three months ago Mark Carney told ITV News that we should probably expect two 0.25% interest rate increases over the next three years. The financial markets are now betting on there being three over the same period.

Higher interest rates are not a bad thing, as long as they don’t cause havoc. Indeed they signal a return to more normal economic times.

Brexit is cause for concern. Credit: PA

The Bank’s analysis of the impact of the 0.25% increase in November shows that companies and households took it in their stride. Savings rates rose slightly and effective mortgage rates are lower now than they were in mid-2016.

It is the job of a central bank to worry intelligently about what might go wrong and Brexit remains the clearest cause for concern. The Bank is banking on a “smooth adjustment” which may not be possible.

But leave aside future risks for a moment and the here and now looks healthy. The economy is growing modestly, unemployment is low and predicted to fall, the squeeze on living standards looks like it is coming to an end.

The Bank of England’s guidance about interest rates remains the same: changes will be “gradual” and “limited”, although what the Bank means by this has altered slightly.