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Last Updated: Thursday, 3 August 2006, 13:26 GMT 14:26 UK
Q&A: Why are interest rates rising?
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Spending plans may have to be cut
The Bank of England has raised interest rates by a quarter of a percentage point to 4.75%.

It's just the latest in a series of worldwide rate rises, but why are central banks hiking them now?

Who else is raising interest rates?

It's not just the Bank of England that is raising interest rates.

The European Central Bank also raised rates on Thursday to 3%, and earlier in the week Australia raised its rates to 6%.

In the United States, the Federal Reserve has raised rates on 17 consecutive occasions to 5.25%, and it may do so again next week.

And even Japan, which has had near-zero interest rates, saw its central bank make its first increase in rates in six years last month.

Monetary policy makers are worried that renewed economic growth, combined with high oil prices, could bring back inflation.

What is worrying central banks?

A common factor is the effect of high energy prices, which is feeding through the economy to affect everything from transport costs to the price of utility bills.

With trouble in the Middle East pushing oil to over $70 per barrel, expectations that the oil price rise would only be temporary are now being revised.

Inflation in the UK rose to 2.5% last month, 0.5% above the economic target set by the Treasury.

Central bankers are also worried about asset prices, especially the cost of housing in the US and the UK.

The concern is that low interest rates has encouraged people to purchase more property, both to buy and let, and pushed up prices.

The ratio of house prices to average earnings has reached record highs in these countries.

And there is a concern that people have borrowed too much money, partly against the increased value of their property.

Will interest rates continue to rise?

Central banks want to move cautiously for two reasons.

There are concerns that higher interest rates could choke off economic growth, especially in areas like the eurozone where recovery is just beginning.

And there are concerns that a rapid rise in rates could lead to a big increase in the cost of debt, causing widespread difficulties for individuals who are over-stretched.

But most central banks these days believe that the only way to beat inflation is to tackle inflationary expectations before they get started.

So they want to send a clear signal to individuals and companies that they will act firmly.

And this means that - if inflation continues to rise - they are likely to take action again if they are to maintain their credibility.

Who will be affected most by the rate rise?

Many central bankers have argued that the recent bout of very low interest rates around the world have led people to underestimate risky investments.

The cost of borrowing for weak companies was not much different from the interest rates charged to stronger companies, for example.

They hope that the rise in interest rates will encourage people to re-evaluate such risks, and expect that the cost of borrowing will rise faster for riskier types of investments, whether in companies or countries.

This could hit individuals, companies and countries who have over-borrowed.

UK banks have already made big increases in their provisions for bad debts.

Who will benefit from the rate rises?

The biggest gainers from the rate increase will be savers.

Central banks hope that consumers will be encouraged to save more and spend less, thus helping to rebalance the economy.

This is especially true in the US, where a consumer boom has sucked in imports from around the world and led to a huge balance-of-payments problem.

The rate rises could also help pension funds who depend on bonds rather than stocks for their income - they will be more able to fund future pensions.




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