The Great Rate Debate

Tony Ward

June 27, 2017

Tony Ward is chief executive of Clayton Euro Risk

It’s all kicking off at the Bank of England. Last week we had not one but three members of its Monetary Policy Committee (MPC) publicly discussing interest rates.

First off the block was Governor Mark Carney (pictured). In his Mansion House speech, he argued that “now was not the right time for an interest rate rise” concurring with comments I made in my previous blog. The reasons he cited were falling wage growth and the lack of clarity over Brexit’s impact on the economy. Mr Carney said: “From my perspective, given the mixed signals on consumer spending and business investment, and given the still subdued domestic inflationary pressures, in particular anaemic wage growth, now is not yet the time to begin that adjustment [rate rises].” He added: “In the coming months, I would like to see the extent to which weaker consumption growth is offset by other components of demand, whether wages begin to firm, and more generally, how the economy reacts to the prospect of tighter financial conditions and the reality of Brexit negotiations.”

Confusion at the Bank of England

Yes indeed. Makes sense to me.

However, later in the week, we had dissent in the ranks from the Bank’s chief economist Andy Haldane. He announced he may vote for a rate rise in the second half of the year on the grounds that leaving a rate hike until too late risked steeper rate rises in future. Mr Haldane said: “Provided the data are still on track, I do think that beginning the process of withdrawing some of the incremental stimulus provided last August would be prudent moving into the second half of the year.” Mr Haldane said the risk of moving too late with a rate hike had grown, after UK economic growth and inflation had proven more resilient than expected.

Hmmm.

More was yet to come from Kirsten Forbes, MPC member, one of the three who voted to raise rates at June’s policy meeting. She suggested that the Bank of England’s radical shake-up in the wake of the financial crisis has shifted its focus away from inflation and made it harder to raise interest rates. She said rates had been kept on hold in the current environment despite signs that the UK’s ‘overstimulated’ economy is ‘behind the curve’ on rate hikes. She warned that there was now ‘some urgency’ for policymakers to lift rates from a record low of 0.25% to keep a lid on inflation and return price growth sustainably to the Bank’s target of 2%. ‘‘Given that UK inflation is now likely to reach 3%, and is forecast to remain above 2% for at least three years, this suggests some urgency in tightening monetary policy,” she warned, adding that officials had been ‘much quicker to adjust monetary policy in response to downside risks than upside’.

I’m not so sure about that. Ms Forbes’ use of the word ‘urgency’ worries me. I don’t believe it is urgent to do anything with rates just now. Low interest rates have become the new norm: we have lived with these for many years so any rise will have a huge impact on consumers. The decision to raise rates cannot be taken lightly. If a rise comes, it must be at a time when the economy is in a more secure place once Brexit negotiations and the political landscape have stabilised.

The latest findings from Nomura support this view. Their analysis suggests that homeowners have never been so vulnerable to a rise in borrowing costs. The investment bank says that mortgage repayments for the average homeowner would jump by nearly 10% relative to their household income if interest rates rose by a single percentage point. This is the most sensitive housing ‘affordability’ has ever been to a rate increase.

Homeowners are particularly vulnerable because borrowing has been exceptionally cheap for so long. “This just underlines how important it is for the Bank to make it clear that any rate rise is year is a one-off, not the start of a bigger tightening of monetary policy,” said George Buckley, chief UK economist at Nomura. The prospect of higher rates would add to the squeeze in consumer spending, Buckley added.

Some economists argue that the shift in thinking on the Bank’s monetary policy committee has come at the worst possible time. I find myself agreeing with former committee member David Blanchflower: he thinks raising rates in the face of a slowing economy, falling retail sales and the prospect of Brexit is ‘the economics of La La Land’. Mr Blanchflower put it very aptly: “You can argue that a quarter of a point rise doesn’t make much difference but that’s like saying you’re going to punch yourself in the face, but it’s all right because you won’t punch yourself too hard.” he said.

With our economy so vulnerable, even the softest of blows could leave a nasty bruise.

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