Brace yourself - Interest Rates set to rise further to purge economy of rampant inflation

'The pound in your pocket is buying less and less' - ITV News Business and Economics Editor Joel Hills reports on the soaring rate of inflation

We are living in difficult and dangerous times.

The price of food rose at its fastest pace in 42 years in September, driving the headline annual rate of inflation to 10.1%.

Inflation at this level kills spending power. Every household and business in the UK will be feeling poorer but those on the lowest incomes in society will be suffering unimaginable distress.

In theory, the September’s inflation rate should mean that benefits and the state pension also rise by 10.1% from next April but we know that the new chancellor is looking for savings.

Even if the uprating were to go ahead, as currently planned, The Institute for Fiscal Studies calculates that the “real” value of working-age benefits will be 6% below their pre-pandemic level.

We are, I’m afraid, in the foothills of something terribly serious because despite the weakening outlook for the economy - as a result of spiralling prices and enforced belt-tightening all-round - the evidence suggests the Bank of England will feel it has no choice but to hike interest rates further.

Consumer Price Inflation - which the Bank is tasked with keeping anchored at 2% - will probably clear 10.5% in October as the Ofgem energy cap rises to £2500. The government is currently subsiding energy bills for everyone but we know it plans to stop doing this from April and, as it stands, the average bill will increase again. 

The market price, in dollars, of oil and a host of agricultural commodities has fallen significantly in recent months but the steady decline in the value of Sterling means the UK not feeling the full benefit.

Price rises in past 12 months. Credit: ONS

The price of petrol and diesel looks like it is has peaked but prices, more broadly, continue to rise.

What’s known as “core” inflation, which strips out volatile movements in food and energy prices, is running at 6.5% - that’s much higher than the Bank will feel comfortable with.

Equally concerning, UK “Services” inflation rose to 6.1% in June. This is an unmistakable sign that wages are picking-up domestically (the UK doesn’t import many services) which many employees will feel is a very good thing but which most economists would consider to be troubling evidence that inflation is feeding itself.

The new chancellor, Jeremy Hunt, has ditched much of the Truss/Kwarteng Growth Plan - which bizarrely sought to hit the fiscal accelerator as monetary policy applied the break - but markets are betting that the Bank will still hike interest rates by 0.75% next month and that Bank Rate (currently 2.25%) will need to peak at 5.25% next May to purge the economy.

Martin Weale, a former member of the Bank’s Monetary Policy Committee, says he’d be voting for a hike of between 0.75 to 1%.

Martin Weale. Credit: Getty Images

“The inflation surge has gone on for well over a year now and there’s every sign of it intensifying rather than easing,” Weale said.

“People are staring to make wages arrangements and companies are starting to adjust prices on the assumption that underlying inflation is going to be higher than the Bank’s 2% target. Anyone my age remembers the 1970s and how we got up to inflation of 25%. Without an adequate policy response that would happen again.”

Investors don’t have perfect foresight but the direction of travel seems clear enough. Weale says he “wouldn’t be at all surprised” if Bank Rate does reach 5% next year. Many households and businesses would struggle to absorb a jump in borrowing costs of that magnitude.

According to the ONS, the price of the average house increased between July and August. Incredibly, annual house price inflation ran at 13.6%. Not for long.

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