If inflation goes above 3% the Governor of the Bank of England has to write a letter to Gordon Brown explaining why. The unexpected increase in interest rates to 5.25% last week probably means that Mervyn King will be putting pen to paper tomorrow.
A much better than expected Christmas trading season for retailers and an increase in a very small number of early pay settlements (and demands for increases in the near future from the public sector) are almost certainly contributory factors in the Bank’s Monetary Policy Committee (MPC) decision to bite the bullet on interest rates sooner rather than later.
However, an increase in inflation will probably prove to be the deciding factor when figures are released on Tuesday 16th January. If the Consumer Prices Index (CPI) goes above 3% it will be for the first time in a decade since the bank of England was given independence.
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This puts the economy in a difficult position. The Bank of England wants to keep pay down and also has to keep inflation at or below 2% but if the early indications of higher pay settlements prove to be false the higher interest rates will result in a significant squeeze on disposable income (see earlier story in knowledgebase)and retailers will look back on Christmas 2006 with a warm glow.
On the other hand if both salaries and consumer prices continue to increase the Bank will have no option but to keep on raising interest rates until they take effect, which means that retailers will look back on Christmas 2006 as something of a golden age, at least for quite a while to come.
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