With inflation still surging ahead of the Bank of England’s 2% target, a predicted interest rate hike this year could pose a threat to retail

Why are we talking about interest rates?

Interest rates affect consumers’ available spend. Retailers breathed a sigh of relief as the Bank of England decided last week to keep interest rates flat at 0.5%, the same as since March 2009. Inflation has surged over the past year, reaching an eight-month high of 3.7% in December - well above the Bank of England’s 2% target. Some economists have speculated that an interest rate hike is needed to quell inflation.

How worried are retailers?

Directors of Next and John Lewis have warned that a potential interest rate hike is a threat to retail this year. Raising interest rates would increase repayments on many people’s mortgages.

“Mortgage payments are the largest single monthly outgoing our customers have. It’s fixed, they have to pay it, whereas they can always buy fewer or cheaper clothes,” Next finance directorDavid Keens told Retail Week this month.

So what is the outlook for interest rates this year?

The majority view among economists is that rates will rise to at least 0.75% before the year is out. Deutsche Bank predicts a hike will come as early as May.

But Capital Economics disagrees and thinks the uplift in inflation is temporary, because of the VAT rise and increased food and commodity prices. Capital Economics’ Vicky Redwood believes the Bank of England will “hold its nerve” and keep the rate on hold until at least 2013.

Deloitte strategic retail adviser Richard Hyman sees inflation rising for some time and therefore rates having to up.

What effect have interest rate rises had on sales in the past?

Big-ticket items such as furniture and electricals, which closely connected with the housing market, are traditionally hardest hit.

Would an increase this year be any different?

Consumer coffers are already being squeezed so an interest rate rise could be grave for retail. Combined with headwinds such as job fears and commodity price inflation, a rise could be a contributor to a perfect retail storm.

“Retail sales have never been under so much pressure,” says Hyman. “Retail spending has not decreased in Britain for 30 to 40 years. That’s going to change in the next two years. Increasing interest rates is going to shave that extra bit off an already dwindling disposable income pot.”