OBR warns 'wage spiral' could force interest rates to 3.5 PER CENT

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OBR warns 'wage spiral' could force interest rates to 3.5 PER CENT
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The government’s watchdog today warned that a ‘wage spiral’ or energy shock could drive inflation to a three-decade high of  5.4 per cent next year and force the Bank of England to take drastic action.

In a stark assessment alongside the Budget, the Office for Budget Responsibility (OBR) said its central forecast is for headline CPI to peak at 4.4 per cent in the second quarter of year.

That is far above the current 3.1 per cent, and more than double the Bank’s 2 per cent target. 

But it warned that data since the document was prepared suggests that a figure of 5 per cent could be more realistic.

The watchdog put forward two scenarios where the situation could get dramatically worse – with either a ‘mild wage spiral’ developing or continuing pressure on energy and product prices. 

In both, CPI inflation could go up to 5.4 per cent, with the OBR saying that the Bank of England base rate would need to soar to 3.5 per cent from the low of 0.1 per cent now. 

OBR warns 'wage spiral' could force interest rates to 3.5 PER CENT
OBR warns 'wage spiral' could force interest rates to 3.5 PER CENT
OBR warns 'wage spiral' could force interest rates to 3.5 PER CENT
OBR warns 'wage spiral' could force interest rates to 3.5 PER CENT
OBR warns 'wage spiral' could force interest rates to 3.5 PER CENT
Andrew Bailey Rishi Sunak In both scenarios, CPI inflation could go up to 5.4 per cent, with the OBR saying that the Bank of England base rate would need to soar to 3.5 per cent from the low of 0.1 per cent now n a stark assessment alongside the Budget, the Office for Budget Responsibility (OBR) said its central forecast is for headline CPI to peak at 4.4 per cent in the second quarter of year Public sector net borrowing will be lower than had been expected in March, thanks to the improved overall economic picture

Such a shift would cause huge pain for homeowners who would face massive mortgage costs.

But there would also be ‘fiscal consequences’ for the government as the bill for servicing the £2.2trillion debt mountiain would rise. 

The OBR said: ‘In both scenarios, a further sharp and persistent increase in costs means inflation peaks at 5.4 per cent (1 percentage point above our central forecast and the highest rate in three decades) and then falls back more slowly than in our central forecast. 

‘Based on a simple monetary policy rule, Bank Rate in our scenario reaches 3.5 per cent (its highest since November 2008), thereby suppressing demand and moderating inflationary pressures, but even so it still takes a year longer for inflation to return to the target than in our central forecast. 

‘At its peak, the impact of this vigorous monetary tightening prevents a further 2 to 3 percentage point rise in inflation, and without it the price level would be some 6 to 8 per cent higher at the scenario horizon.’ 

The OBR’s central forecast upgraded growth for this year from the 4 per cent it suggested in March to 6.5 per cent – less than some had hoped but still enough to return to pre-Covid levels of activity. 

Next year GDP is expected to be 6 per cent, lower than the 7.3 per cent at the last set of figures. 

Critically the ‘scarring’ – long-term damage to the economy – is now only thought to be 2 per cent rather than 3 per cent.   

The watchdog also now forecasts that unemployment will peak at 5.2 per cent, a fraction of what had been anticipated at the height of the crisis. 

‘Today’s Budget does not draw a line under Covid. We have challenging months ahead,’ Mr Sunak said.

‘But today’s Budget does begin the work of preparing a new economy post-Covid.’ 

OBR warns 'wage spiral' could force interest rates to 3.5 PER CENT
OBR warns 'wage spiral' could force interest rates to 3.5 PER CENT
OBR warns 'wage spiral' could force interest rates to 3.5 PER CENT
OBR warns 'wage spiral' could force interest rates to 3.5 PER CENT
Public sector debt does not rise as high under the latest OBR projections The tax burden is going to its highest level since the Second World War, despite Rishi Sunak’s promise that he wants to cut it Government spending is going to continue higher than it was before the pandemic as a proportion of GDP The scenarios with a huge spike in inflation would have knock-on effects for the wider economy, the OBR said

WHAT DOES A RATE RISE MEAN? 

What is the bank rate?

Also known as the base rate, this is the Bank of England’s benchmark interest rate that banks and other financial institutions use to price their loans and savings rates.

Where is it now?

The bank rate is still at an all-time low of 0.1 per cent, where it was cut to in March 2020, in order to help ward off pandemic-induced economic crisis. It has been at or below 0.75 per cent ever since the aftermath of the financial crisis in February 2009.

Is it about to go up and why?

Markets and economists think so. The Bank of England is supposed to set the bank rate to control inflation, and prevent it going above 2 per cent. However, as the economy has been in the doldrums for many years, inflation has not been a threat. 

This year however, with the sudden economic recovery from lockdown, the surging oil price and the various supply chain blockages it has returned with a vengeance. Inflation is now at 3.1 per cent and set to go higher. 

Money markets and economists say there is a good chance that the BoE could raise rates in November and almost certainly in December.

What changed today?

Accompanying the Autumn Budget, the Office for Budget Responsibility forecasts showed inflation peaking at 4.4 per cent in the second quarter next year and to average 4 per cent over 2022. 

Rishi Sunak also said he had written to BoE Governor Andrew Bailey to remind him of the importance of controlling inflation!

So rates are going up?

Yes it is just a question of when and how much. Initial rises are likely to be cautious: to just 0.25 per cent or 0.50 for the bank rate. It seems odds-on we’ll get a hike by the endof the year.

The OBR warned that inflation could go even higher – above 5 per cent – and in in a worst-case scenario the implied interest rates that would be required to get inflation back down would be a bank rate of 3.5 per cent. 

What difference will that make to me?

Even in the best-case scenario, mortgage rates will start to creep up and the best current mortgage deals will start to be pulled.

If you are on a variable rate deal or a tracker you could see an increase in monthly payment very soon after any rate hike. If you are on a fixed deal then, you are protected until it expires. But it does mean some of the best deals that are around now might not be by the time you come to arrange a new mortgage.

What can I do?

If you are on a variable rate – especially if it is an expensive standard variable rate – you might want to think about applying for a two or even a five-year fixed rate while they are cheap. Those on fixed rate deals already can apply for a new rate six months before their mortgage expires so it might pay to start looking now.

But at least savings rates will start to rise?

We can hope. But it is really up to banks how quickly and how much they pass on rate rises in the form of better savings rates. Historically, they have been much quicker to hike mortgage rates than savings rates.

 

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