Interest rates need to rise
There can be little doubt that the UK would be a healthier economy today had interest rates been higher these past few years. Not hugely more elevated, but meaningfully so. Slashing them and cranking up the (digital) printing presses did help get us out of recession all those years ago, of course, and prevented a crisis from turning into a Depression. But that was then. Pretending that the credit crunch and recession never ended, and keeping rates at emergency levels for so long is now hurting us more than it is helping.
We are hooked to a dangerous drug, and have lost the ability to see just how distorted our economy has become as a result. Hardly anybody under the age of 30 can even imagine that rates could rise, let alone that they could one day hit five or even 10pc. Asset prices have shot up, helping to wreck the housing market and fuelling a political backlash among the young that could yet bring Jeremy Corbyn to power. Productivity growth has remained weak as a result of the over-allocation of wealth into property, and the fact that so many dud loans were never liquidated; this in turn is keeping wages low and fuelling further rage. Banks and some other financial institutions are finding it hard to make money in traditional ways, and that is undoubtedly hurting the availability and distribution of credit and capital across the economy, as well as distorting savings and investment decisions.
The madness of our monetary policy can be seen by the fact that real Bank rates are falling through the floor again and are too low on any reasonable metric. The Bank rate of 0.25pc, when deflated by the CPI measure of inflation, currently at 2.9pc, gives us a rate of minus 2.65pc. Many longer-term commercial rates are also negative; people are being paid to borrow wherever one looks (though that doesn’t apply to students or credit cards, obviously). That is ridiculous at a time when unemployment is collapsing and GDP is growing by (an admittedly lowish) 0.3pc a quarter. Monetary policy has become looser in another way too, of course: as David Owen, of Jefferies, calculates, sterling is now down some 13pc on a broad trade-weighted measure since the referendum. That is equivalent to a substantial cut in interest rates, or to a large amount of quantitative easing. All in all, a full decade after Northern Rock collapsed and the scale of the financial crisis started to become apparent, this suggests a monetary policy that has completely let leave of its senses: our policymakers are simply too scared to upset the apple cart. They are debilitated.
But we are where we are. It’s one thing to argue that rates should be higher; it’s genuinely trickier to put them up at a time when chunks of corporate Britain are acting like headless chicken at the prospect of Brexit. Partly because of the Government’s inability to communicate clearly, sentiment is fraught and this helps to explain why business investment is not performing as well as it should. One can understand why the vote to hike rates was lost 7-2 at the Monetary Policy Committee.
As a good contrarian, I would still go for it and start hiking rates, partly to send a signal of confidence to the markets and to begin to tackle some of the side-effects of ultra-loose monetary policy. I wouldn’t do it to tackle the consumer price index: while the Bank now thinks that inflation on that measure will breach the 3pc level, it still looks almost certain to fall back after that.
But I very much doubt that the Bank would be willing to act before we know more about the outcome of the Brexit negotiations, especially given the fact that is so deeply of the view that leaving the EU will be an economic disaster. Yes, the minutes implied that rates could start to rise as early as November, but we’ve been here before and nothing happened. I simply don’t buy the guidance contained in the latest minutes. I suspect that “bad news” from the Brexit talks, or lack therefore, will cancel out this week’s guidance.
It is also important not to read too much into the latest round of retail results – super-Thursday – at least when it comes to gauging the strength of the economy. It is obvious that growth overall is not especially strong, but the massive variation in results shows that these corporate stories are primarily firm-specific. The most noteworthy was Morrisons: the company had been almost written off a few years ago but is now bouncing back.
The central economic story remains the performance of the labour market, which now appears almost disconnected from that of GDP. Unemployment continues to fall but wages, at least on average and on the official measure, continue to increase by less than inflation. The MPC thinks that slack is disappearing, but it and every other economist keeps revising downwards its estimates of what full employment looks like.
The real turning point will come not when real wages start to turn positive again – that will happen when the CPI falls back down again and the pass-through effects from sterling’s devaluation wane. The real test will come when nominal wage growth begins to accelerate. I may be pleasantly surprised, but I doubt that we will see any movement on interest rates until then.
‘As a good contrarian, I would hike rates to send a signal of confidence to the markets’