Increasing interest rates usually tackles inflation by increasing the cost of borrowing to quell consumer demand.
Recent reports from February minutes of the Monetary Policy Committee (MPC) state three of the nine members voted in favour of an increase in base rate. This has sparked some suggestions that interest rates will soon increase. I’m not convinced.
Firstly, inflation is broadly in line with the Bank of England’s predicted peak of 4%. Possibly even 5% before falling back.
A driving force of current inflation is cost increase on many foodstuffs, raw materials and fuel on worldwide markets. Increasing interest rates usually tackles inflation by increasing the cost of borrowing to quell consumer demand. It also makes the return on investment by businesses less attractive if borrowing costs are higher. But current borrowing levels (always assuming you can find a bank willing to lend) bear little relationship to bank rate. The days when professionals such as doctors could borrow at 1% above bank rate are long gone. There was a time when if you were an SME paying 4% ABR for your overdraft you felt you were being ripped off. Now 10% and 11% are not uncommon coupled with regular review fees.
But the writing is on the wall in the longer term for businesses which are heavily reliant on borrowing funds. Inevitably rates will increase at some point but I suspect it will be a gentle rise. Unlike the explosive increases seen in the 1980’s when rates doubled over a number of months to around 15%. Nevertheless a gradual increase can still put vulnerable businesses at risk.