Carney’s rate rise was the correct decision
The Bank of England has finally – finally! – raised interest rates. The Monetary Policy Committee on Thursday voted by 7-2 to increase the base rate from 0.25pc to 0.5pc – the first increase since mid-2007.
We’ve since heard howls of anguish. Numerous City economists and others benefiting from the asset price boom have criticised this rise. But all the Bank did was to reverse the quarter point cut of August 2016, after the Brexit referendum.
No one is saying that some heavily indebted people, their finances at breaking point, won’t suffer because of this rate increase. But just 30pc of households now have a mortgage – making the overall economy, and consumer spending in particular, far less vulnerable to a tiny uplift in borrowing costs than during previous rate cycles. Rates, of course, are still close to rock-bottom – having returned to what was, prior to last summer, a 320-year low. And there were very good reasons to raise rates – which is why this column has argued for an increase for many years.
Inflation in September registered 3pc – a five-year high, and well above the official 2pc target – with the Bank predicting a further increase. Brent crude is now above $60 a barrel – some 20pc more expensive than this time last year. That will fuel price pressures in food, transport, manufacturing and other industrial sectors. And with unemployment at a 42-year low, and the labour market tight, inflation remains an issue. The main reason for raising rates, though, is that the 2008 financial crisis is over and there is simply no justification for them staying so low. Keeping interest rates below inflation – negative in real terms – has, along with years of quantitative easing, warped asset markets.
Bond yields have become and remain compressed, creating a bubble in both debt and equity markets. No one knows how this will unwind. Raising rates gradually, letting the air out of these bubbles, hopefully before they go bang, is eminently sensible – the only hope, in fact, of defusing this situation. Ultra-low rates have, meanwhile, penalised savers and made life much tougher for pension funds and other institutional investors. Needing to match their assets with long-term liabilities, they’ve been forced to “search for yield” in ever more risky assets – again, increasing the chance of a future crash.
Low rates have also kept thousands of “zombie” companies alive – firms able only to pay debt interest, rather than clear debts themselves. Around a quarter of a million struggling UK firms are in this situation, kept on life support by unnaturally low rates. Unable to invest and expand, they’re a major reason productivity is so low – tying up resources that should be channelled into healthier firms.
Had the Bank not raised rates, the pound could well have plunged. Governor Mark Carney has been making “hawkish” sounds for weeks, signalling rates would go up – causing the pound to strengthen. That, in turn, has helped contain inflation by making imports cheaper. Having led the markets on in the past, then failed to act, the Bank’s credibility was on the line. Had this rise not happened, sterling could have plunged sharply, causing a nasty inflation spike.
As it was, the pound still fell two cents against the dollar during the hours after the Bank’s announcement. That’s because the Bank’s quarterly Inflation Report and other official comments pointed towards a more gradual pace of rate rises. The Bank’s technical forecasts indicate it expects rates to go up by another 75-100 over the next three years, if inflation is to drop to its 2pc target rate – a less aggressive set of increases than was previously assumed.
Some commentators argued it was “one and done” – with rates now staying put for several years. That view was based on the Bank’s 1.6-1.7pc GDP growth forecast – well below the long-run trend, based on fresh warnings about Brexit.
While the Bank rightly points to “uncertainties associated with leaving the EU”, it has been far too gloomy on this subject. For one thing, its scaremongering forecast that simply voting to leave the EU would cause an “immediate recession” was entirely disproved. UK manufacturing grew strongly again in October, according to PMI index data released last week, the 15th consecutive month of expansion. A top BMW executive then said its UK operations would remain crucial after we leave the EU. Building engines and cars in Britain makes sense, said the German motoring giant, because it sold 250,000 cars here, the UK remaining one of its most lucrative markets.
And what of the Bank’s forecast that the City could lose 75,000 jobs as a result of Brexit – a warning that drove numerous headlines? I don’t buy it. US bank JP Morgan said before the referendum it would move 4,000 jobs beyond the UK. Now it’s 1,000. Swiss thoroughbred UBS previously warned of 1,000 losses. Now it says 250.
The UK is the world’s biggest exporter of financial services – and that won’t change any time soon. EU companies and governments need the City’s deep and global markets to raise cash. Financial services are likely to thrive after Brexit, as we focus more on markets beyond Europe.
This rate rise makes it more likely Chancellor Philip Hammond will cut stamp duty on house purchases in this month’s Budget statement – which would be good news. And with the UK now joining the US Federal Reserve in raising rates, the Bank has just signalled the start of a return to normality. UK companies, spooked by mad monetary policy, have been sitting on cash for years, failing to invest. That’s why last week’s small but symbolic rate rise, to be followed by others, will draw such cash back into the economy, providing Britain with a boost.
‘Ultra-low rates have, meanwhile, penalised savers and made life much tougher for pension funds’