Days of near-zero interest rates look to be over for good
NOTIONALLY, this week’s fall in inflation is good news for consumers, house-buyers and the economy in general. But it doesn’t feel that way. The fall in the Consumer Prices Index (CPI), from 3.4 per cent to 3.2 per cent, was less than many economists were expecting, and the markets had priced in.
It means that the expectations for interest rates have shifted. Hopes of a rate cut in May have now been all but dashed. It looks as if the earliest we can expect a cut is now June, and we may have only two, not three rate cuts, this year.
Next month, there should be a more substantial fall in the CPI as last year’s stiff rise in energy prices drops out of the figures. Anything not closer to the Bank of England’s target of two per cent will be a shock. But the wider picture is that the inflationary beast remains far from being slain. It is merely slumbering, just waiting to be prodded with a stick before roaring back to life.
The energy crisis precipitated by Vladimir Putin’s invasion of Ukraine has abated as Britain and other European countries find sources of oil and gas to replace those from Russia. Yet the situation in the Middle East could quickly deteriorate following Iran’s failed drone attack on Israel last weekend.
EVEN without that, OPEC (Organisation of the Petroleum Exporting Countries) members have lowered oil production to keep prices high. And that is already impacting garage forecourts, and will in time exert an upward influence on the CPI.
Meanwhile, wages are growing at a markedly higher rate than inflation. The real-terms fall in wages has finally gone into reverse. Over the past 12 months, average earnings rose by six per cent – a real-term rise of 2.8 per cent. That would be fine if it were matched by rapidly-rising productivity but sadly it is not. Giving ourselves a pay rise that is not justified by rising output is inflationary because it means there is too much money chasing too few goods and services.
But if the outlook for inflation at the moment is far from benign, far worse could lie just over the horizon. By the end of the year, we are very likely to have a Labour government.
While Keir Starmer and Rachel Reeves preach fiscal responsibility, history teaches us to expect otherwise. There has never been a Labour government which did not rack up large debts. Gordon Brown, who came to the Treasury in 1997 promising tough fiscal rules, maintained discipline for several years, yet left office with a huge deficit. Unlike Tony Blair’s government in 1997, however, a Keir Starmer administration would be starting from a position of weak public finances. The deficit from Gordon Brown’s time has never been closed – indeed, no government of either colour has balanced the public finances in 22 years.
That means that accumulated debt has been growing year on year to the point that the government is forced to pay £100billion a year in interest just to service that debt – equivalent to two-thirds of what it spends on the NHS.
It is no credit to the current Government that it has failed to balance the books – even with a pandemic. But does anyone honestly think Labour will make a better job of it?
The minute that Starmer and Reeves arrive in Downing Street, they will be besieged by demands from public sector unions, quangos and others, all expecting a big payday as the new government reverses ‘years of Tory austerity’. Whatever they promise now, don’t expect Starmer and Reeves to resist all those demands for extra spending. Nor does Reeves have a lot of hope of raising extra tax revenue to meet spending commitments. She has already ruled out increases in rates of income tax, national insurance, capital gains tax and corporation tax.
She has also come out against a wealth tax – which, even if she did introduce it, would send wealthy individuals scarpering for the exits with their money.
WE SAW during Liz Truss’ brief premiership what happens when global bond investors lose confidence in a government’s ability to repay its debts. They start demanding sharply higher interest rates, sending mortgage payments for millions soaring.
Don’t let anyone say it can’t happen again. We’ve seen it happen to Greece, Italy and Spain in the past decade.
We may be seeing inflation falling, and interest rates should follow suit. But the days of near-zero interest rates look to be over for good.
Anyone taking out a mortgage or loan should prepare for the possibility much higher rates will persist in future.
‘The deficit from Gordon Brown’s time has never been closed’