By Juliet Davenport, CEO

News that inflation rose to an 8-month high of 3.7% in December sparked a barrage of calls for the Bank of England to increase interest rates. Somewhat misleading in my opinion, and according to my own understanding of basic economics. The BoE has an inflation target of 2% to aim at, with interest rates being the main weapon in its armoury. But the recent increases in inflation are being driven by rising food, fuel and energy prices – wheat prices have gone up due to a lack of rain followed by too much rain; energy prices are being driven by trading conditions on world energy markets; and fuel prices by underlying oil prices, weather and VAT – none of which would be affected by hiking interest rates.

Interest rates are effective at reducing consumer demand for goods and services, and therefore inflation when it is consumer demand that is causing inflationary pressure. But this is not the situation the UK economy is in at the moment; demand for the staples of life - food and energy - is relatively constant. Increasing the cost of borrowing will push up another staple cost, mortgages, and won’t do anything to help households reduce their use of energy.

A far more effective weapon against inflation would be putting policies in place to allow householders to cut their energy costs - either by generating their own energy or reducing the amount they need through better energy efficiency. In the current economic situation, increasing interest rates are a blunt and in my opinion, virtually useless instrument!