Pressure for interest rate hike rises as inflation soars

Commenting on the dilemma faced by the Bank's Monetary Policy Committee, Markit economist Chris Williamson said higher than expected inflation was still being driven by higher oil prices, which meant higher rates will have limited effect, as interest rates work via their impact on domestic demand. "This presents a huge problem for the Bank of England and the Government, as domestic demand is already wilting badly," he went on. "Households are clearly struggling with falling incomes and rising costs, the combination of which has caused confidence among consumers to drop to the lowest for two years, when the country was in the grip of the financial crisis. Regular pay is rising at just 2.2%. The further increase in inflation will therefore eat into spending power, and any hike in interest rates will only add to the problems facing households. As consumer spending accounts for around two-thirds of gross domestic product, this raises fears about the recovery. "The Bank is therefore caught between hiking rates to anchor inflation expectations, or leaving rates on hold to help prop up a fragile economy which faces the ramping-up of government spending cuts in coming months."