The Bank of England has chosen to leave rates unchanged, a cautious move that indicates policymakers will wait to see how the boost to the UK economy from easing oil prices and improving inflationary conditions unfolds. The decision arrives at a sensitive point for consumers, companies and financial markets that have been awaiting what the central bank will do next after a long period of turmoil and higher borrowing costs.
This decision is indicative of the increased optimism that inflation is beginning to ease, not least as the world’s oil markets stabilize and oil prices once again begin to fall. As one of the world’s biggest consumers of energy, cheap oil alleviates many costs of factory and transportation.
This presents some hope that the UK’s inflationary price increases can maintain their decade long decline. Interest rates are another tool used by central banks and government agencies to control inflation and inflate the economy. When interest rates are increased the cost of borrowing rises and spending should fall.
This in turn should lower prices and slow inflation.15 When interest rates are lowered spending should increase and inflation should increase.16 Finding the correct balance is the difficult part for any policymaker. By leaving rates unchanged, the Bank of England seems to be sitting on the sidelines, waiting and watching.
Policy makers probably want to see more confirmation of sustained convergence of inflation to the target before committing to policy. The markets had expected a cautious stance on this occasion, given the rather conflicting signals emanating from both home and foreign economies. The price of oil has been, and still is, something important behind the current outlook.
Energy costs are relevant across most of the economy, affecting costs in everything from distribution and logistics, to food manufacturing and other industries. Rising oil prices tend to be absorbed and passed on by companies to the customer, pushing up prices. Falling prices smooth inflationary pressures. Falling energy prices have been encouraged by both businesses and consumers.
Higher cost of living for households have been eased by lower costs of petrol while companies are somewhat relieved in their rising operating costs. It could stimulate economic activity and could result to lower inflation figures in the coming months. Just as the drop in oil prices was seen as a positive for the inflation outlook, the Bank of England remains reluctant to declare outright success on this front too early.
It is not simply short-term energy inflation readings which matter, but the more influential measures of underlying inflation, pay growth and the wider macroeconomic environment. Bankers know that inflation can be surprisingly stubborn in the face of falling energy prices, if the labor market remains robust and wage growth high. The UK economy has not been overly subdued given the difficult environment. There has been resilience in consumer expenditure, employment has remained high and some sectors have persisted in growing.
Yet, the rise in the cost of borrowing has impacted on mortgage debtors, businesses looking for credit and interest rate sensitive industries. Owners of homes are one of the key groups that are most attentive to interest rate polls. Mortgage interest rates rose sharply during periods of strong monetary tightening, adding strain to household budgets.