Andrew Donnelly

The Bank of England has raised interest rates to 4%, supposedly to tackle inflation. There is just one problem with this decision. The Bank knows that much of the inflation we are suffering is being driven by rising oil and energy prices, largely resulting from conflict in the Middle East. It also knows that raising interest rates cannot reduce those prices. So why is it doing this? The answer is that the Bank believes it must suppress demand elsewhere in the economy to compensate for rising energy costs. In other words, it is deliberately making mortgages more expensive, increasing business borrowing costs, discouraging investment and reducing household spending power. And all this when people are already struggling with higher energy bills. That is problem number one. There is, however, another problem. Higher interest rates increase costs for businesses, which can then feed through into higher prices. They can, in that case, add to inflation rather than reduce it. The Bank is imposing economic pain to address a problem its chosen policy cannot directly solve. That is not sound economic management. It is the consequence of an economic dogma that refuses to recognise the difference between inflation caused by excessive demand and inflation caused by supply shocks. When will we learn?