Brexit’s sunny outlook
Quitting the EU could bring us a host of nice surprises from March Roger Bootle
Last week’s widely anticipated small rise in interest rates was the first increase from the postfinancial crisis low of 0.5pc, and is therefore the first step on the road back to normality. (The previous 0.25pc rise in November merely reversed the post-brexit referendum panic cut.) But the issue of where UK rates are going over the next few years remains both contentious and important.
In normal times, with the aid of its forecasting models, the Bank focuses its efforts on anticipating future inflation movements and setting interest rates to keep inflation at the 2pc target. Of course, this is still its job, but we are not in normal times. In particular, we are still living in the shadow of the Great Financial Crisis (GFC). We do not know a great many things but what we do know, though, is that rates are now at abnormally low levels and they will need to be higher in order to prevent the economy from being undermined by distortions created by absurdly low rates.
Accordingly, as long as we do not
‘Borrowers have enjoyed favourable conditions for a long time. It is about time that savers got a fair crack’
encounter serious weakness in domestic demand, much of the detailed forecasting work that the Bank of England puts into its Inflation Report is beside the point. It just needs to get on with the business of raising rates towards a normal level.
Admittedly, to add to the long list of things that we do not know, we also do not know exactly what the “normal” rate of interest is. Before the GFC, many analysts thought that it was probably something like 4-5pc. (Since the Bank of England was founded in 1694, Bank Rate has averaged about 5pc.) But because of the lingering effects of the GFC, including factors inhibiting corporate spending and bank lending, the normal rate is probably now a good deal lower. I suspect that it is probably something like 2-3pc. I think that a further rate rise in November should be followed by more increases next year. All the usual arguments for caution in raising rates are currently being paraded – plus two recent additions.
The first concerns anxiety about the high level of debt. Some commentators have argued that this makes raising interest rates particularly dangerous. But it also underlines the importance of doing so. We cannot continue forever on a path of heavy borrowing to sustain consumption. The balance of the economy needs to be shifted. It would be impossible for interest rates to do their job in helping this shift without putting pressure on people with large debts. In any case, borrowers have enjoyed favourable conditions for a long time. It is about time that savers got a fair crack of the whip.
Interest rates remain pitifully low. Indeed, once you take account of inflation, then real interest rates are negative, to the tune of about 2pc. And, remarkably, savers even have to pay tax on their pathetically small interest payments even though in real terms they are actually losing money.
Second, there is our old friend Brexit uncertainty. Some analysts worry that this could hold the economy back severely. We don’t even know the broad shape of the UK’S trading relationship after Brexit – or even, dare I say it, whether there will be a Brexit at all. Nor do we know whether we are already at the high point of Brexit uncertainty and/or whether such uncertainty weighs heavily on key decision-makers. And, of course, we do not know how consumers and firms will react to whatever Brexit outcome materialises.
This lack of certainty is not a good argument for doing nothing on interest rates. If it turns out that whatever our situation is after March next year does depress consumer and business confidence significantly, then rates can be cut at that point.
But such a loss of confidence is far from inevitable. We are currently being bombarded with negative stories about the need to stockpile goods, including medicines, and about prospective gridlock on the roads, chaos at the ports and airports and even a serious threat of civil unrest. As we get nearer to March, there may be a flurry of anxiety and some temporary dislocations. And, depending upon exactly what transpires, these may continue afterwards.
Yet we must also take account of the upside possibilities, which hardly ever seem to be discussed – either a Canada style deal with the EU or, after the initial disappointment and anxiety associated with a no deal outcome, the realisation that we can do perfectly well without such a deal.
The group called Economists for Free Trade (of which I am a member) has consistently argued that a no deal outcome in which we trade on WTO terms and move towards free trade through Free Trade Agreements (FTAS) and/or unilateral tariff reductions, can bring some large gains to GDP. These can be larger still if we radically reshape our regulatory regime.
Imagine what will happen after March if and when, as I expect, it turns out that the scare stories have been exaggerated. And then comes the good news about FTAS going to be signed with the US, Australia, New Zealand, Japan, India, China and many others.
Of course, signings will not happen overnight but the conviction that these FTAS will fall into place could start to build up quite quickly. We could readily be in for a long period of good surprises. According to the experts who produced the “Project Fear” Treasury documents, which forecast gloom and doom in the wake of a vote for Brexit, both businesses and consumers base their spending decisions on perceived future prospects. I wonder how long it will take them to apply this approach in a positive direction. If we achieve a clean Brexit and trade on WTO terms, once people start to perceive the UK’S excellent prospects outside the EU, then confidence could pick up strongly. This would strengthen the case for higher interest rates.