If Britain’s coalition government is serious about moving towards a healthy, ‘normal’ economy and correcting the excesses of the past, then sooner or later interest rates will have to return to their normal 4-6% range. Certainly many believe that a rate rise is necessary in order to bring inflation – currently at 4.5% – under control. However I see two reasons why rates won’t return to these levels anytime soon.
Firstly, interest rates of 0.5% – their lowest level since records began back in 1694 – are providing vital economic life support. Raising interest rates to anywhere near historic norms would result in a dramatic re-pricing of property and other assets and would certainly result in a severe recession – something which is simply not socially or politically acceptable.
Secondly, the assumption among many is that the government actually wants to bring down inflation. This is not a view I share. If the inflation rate can be kept at 4% for 7 years the government will have eroded nearly 25% of its debts. Wiping away a quarter of the UK’s £4.8 trillion total debt through inflation is likely far more appealing to our political leaders than dealing with the social backlash associated with a deep recession.
I wouldn’t be at all surprised to see the Bank of England (BOE) raise its inflation target from the current 2% to 4%.