Carney needs to be careful with that monetary sledgehammer
‘The most the Bank should be doing is a quarter-point cut … even then, fiscal tax cutting would be far preferable’
It’s “super Thursday” next week, a confluence of four separate announcements from the Bank of England including a likely cut in interest rates, publication of the minutes of the Monetary Policy Committee’s deliberations, the quarterly Inflation Report, with forecasts updated to take account of the Brexit vote, and a letter from the Governor of the Bank to the Chancellor explaining why the inflation rate is still undershooting the target.
Yet amid this smorgasbord of actions and disclosures, there is only one that really matters, the scale of the now almost certain monetary easing.
Last week’s faintly alarming purchasing managers’ survey seems to have convinced waverers on the Monetary Policy Committee, including the hawkish Martin Weale, that action is indeed required, even if the survey’s findings may give a somewhat misleading impression of what’s really going on in the economy.
The survey may be more a reflection of the immediate post-Brexit panic, when there was also a high degree of uncertainty over what shape the new UK government would take. Theresa May’s rapid coronation as Prime Minister, and the decisive way she has stamped her authority on the nation since, has done much to calm nerves. We’ve also seen a big inward investment, in the shape of Softbank’s £24bn bid for ARM Holdings, enough to fund the current account deficit for nearly three months. Confirmation later this week that EDF is pushing ahead with the £18bn Hinckley Point C nuclear power station conveys much the same message – that foreigners are by no means deterred from investing in Britain by the Brexit vote.
All the same, there is growing anecdotal evidence that policy uncertainty on Europe is weighing heavily on wider spending, hiring and investment decisions. On the stitch-intime principle, some sort of action is plainly called for to prevent a prolonged downturn. Andy Haldane, the Bank’s chief economist, thinks the risks are high enough to justify overkill; he talks of using a sledgehammer to crack a nut.
Yet I’m not convinced that any such action is best applied in the monetary sphere. With the Bank Rate already close to zero, further reductions will struggle to have much, if any, effect. Indeed, they may prove positively harmful. Both Royal Bank of Scotland and NatWest have warned they may charge business customers for money left on deposit should official rates go negative. Their threat sounds outrageous, but is in a sense the whole point of negative rates – to force businesses and households otherwise tempted to hoard their money to borrow, spend, and invest it instead.
Regrettably, further cuts in Bank Rate may have precisely the reverse effect, crimping banking profits, and therefore credit availability, incentivising the accumulation of physical cash, and causing households and companies to save more so as to counter negative returns.
The same goes for further quantitative and credit easing. With bond yields already so low, it is hard to see the point of lowering them even further. The problem is in demand for credit, not its price or availability. In any case, further stimulus seems far more likely to be effective if applied in fiscal rather than monetary form – temporary cuts in stamp duty, or even VAT, to get things moving again, as well as further, targeted infrastructure spending.
As it is, the Bank is faced with what it referred to in its pre-Brexit analysis as “a challenging trade-off ” between the downward pressures on growth, which argue for easier monetary policy, and the upward pressures on inflation, which theoretically require higher rates.
As things stand, inflation is still way below target, so it may not seem to be anything to worry about. But that’s largely down to the effects of the low oil price, which will soon be falling out of the comparative figures. What’s more, the pound has just suffered a thumping great devaluation. Many overseas suppliers are already pushing up their prices to match. There is also evidence of domestic suppliers doing the same, rather than using the devaluation for competitive advantage. Pricing is ever more global in nature these days, rather than local.
All this suggests that the inflationary shock may be rather higher than anticipated, and if that’s the case, then we may see some sort of repeat of the squeeze on living standards that followed the financial crisis, with wage growth lagging prices. This is turn would weigh on consumption.
Some of the warnings made in the heat of the referendum battle on the consequences of leaving the EU may already look a little overdone, but that doesn’t mean the UK economy is out of the woods. Far from it.
On the evidence so far, the Treasury’s central scenario for the economic consequences of Brexit – which is that growth would be 3.6pc lower than otherwise over two years – looks as if it might have been about right, predicated as it was on the assumption that Article 50 would be triggered the day after a vote to Leave, with the object of achieving a negotiated, bilateral settlement similar to that enjoyed by Switzerland.
In the event, Article 50 wasn’t triggered immediately, and may not be for some months yet. It is also widely assumed in the City, perhaps wrongly, that Brexit will be pursued via the less disruptive path of membership of the European Economic Area, or something similar, at least initially. Perhaps deliberately, this less economically harmful scenario was not modelled by the Treasury in its assessment of the short-term impact, or if it was, it wasn’t published, again perhaps because its consequences were not judged destructive enough for campaigning purposes.
As the ministers in charge of Brexit, David Davis and Liam Fox have been given the opportunity to come up with a workable alternative plan, but it seems doubtful they will succeed. For May and her Chancellor, Philip Hammond, the overarching responsibility is that of ensuring continued economic and political stability. This is more plausibly pursued through the so-called “Flexcit”, or Brexit-lite, approach to disengagement from the EU than the clean break from the single market advocated by Leave campaign purists.
All this leads one to question whether Mr Haldane’s proposed monetary “sledgehammer” is entirely appropriate. The most the Bank should be doing is a quarter-point cut in the interest rate, and even then, fiscal tax cutting would be a far preferable approach to any supposedly necessary economic stimulus.