Fi­nan­cial folly

In­ter­est rates need to rise

The Daily Telegraph - Business - - Front Page - Al­lis­ter Heath

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’

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