Caution is warranted,” said Gertjan Vlieghe last week, as he argued now isn’t the time to raise interest rates. I’d say Vlieghe, a member of the Bank of England’s Monetary Policy Committee, should reconsider.
The UK is heading for a downturn, believes the half-Belgian economist, as the fall in sterling after last summer’s Brexit vote pushes up inflation, so squeezing household finances. “The consumer slowdown, which initially didn’t materialize, now appears to be under way,” said Vlieghe during a speech in London, arguing rates should stay put at an ultra-low 0.25pc.
Long seen as a “dove”, who favours low rates, Vlieghe’s view is shared by the majority of the nine-member MPC. Last month, only one member voted to raise – and that was Kristin Forbes, whose three-year MPC term is about to expire.
Yet I think Forbes is right to argue that inflation could soon be a problem, so rates should go up. The consumer price index was 2.3pc higher in February than the same month in 2016, sharply up from 1.8pc in January. As recently as last June, price pressures were subdued, with inflation down at just 0.5pc. Since then, the CPI reading has shot up, breaching the Bank’s 2pc target for the first time since 2013.
For now, consumer spending remains strong. Retail sales jumped 1.4pc in February, way above most forecasts. The latest Bank of England survey of 700 British businesses suggests investment intentions have also rebounded since the UK voted to leave the European Union.
The economy remained buoyant in March too, with the services sector performing strongly. The PMI services index, based on company surveys, hit a 3-month high of 55, where readings above 50 signal growth. While the equivalent readings for manufacturing and construction slowed slightly, the powerful services sector, four-fifths of the UK economy, pulled up the overall PMI reading from 53.7 in February to 54.7 in March.
Vlieghe is correct that wages are showing “no sign of sustained upward momentum yet”. But I don’t accept his related assertion that “despite better than expected growth, we have not had higher-than-expected underlying inflation pressure”.
Producer price inflation hit 3.7pc in February – a five year high. Factory input prices were up no less than 19.1pc year-on-year – a reflection of rising oil prices. Crude oil, after all, was below $35 for almost the whole of the first quarter of 2016 and has spent much of the same period this year above $55 – some 60pc higher. The latest PMI surveys tell of service-sector companies raising their selling prices at the fastest pace since 2008.
It seems certain the Bank’s forecast of a 2.8pc inflation peak in mid-2018 – a view implicitly accepted by Vlieghe – will be overshot. The prediction from the respected National Institute of Economic and Social Research, which says inflation will reach 3.7pc, looks more likely to be correct.
UK interest rates haven’t risen for almost a decade. During the months that followed the 2007/08 financial crisis, they were rapidly slashed to a then all-time low of 0.5pc. Since then, after our Brexit vote, the Bank cut again – a move this column said at the time was wrong. The UK’s quantitative easing programme was also restarted, with the Bank committing to purchasing £60bn of government bonds a month, on top of the £375bn of QE implemented since March 2009.
While emergency measures were justified in the immediate aftermath of the 2008 Lehman Brothers collapse, they’re far from justified now. The economy is growing at a relatively buoyant 2pc a year. Unemployment is close to a 40-year low. Inflation, while definitely heading for 3pc, could even hit 4pc over the next 12 months. It seems screamingly obvious rates should rise – yet the currency markets are pricing in only a 25pc chance of an increase during 2017.
The reason, of course, is that stock and bond markets have priced in near-zero rates and “QE to infinity” – and policy makers worry that if cheap money looks likely to end, and monetary easing ceases, we’ll see another financial collapse. In March, though, the Federal Reserve did raise rates, for the third time in just over a year and the second increase in three months – taking America’s base rate to 1pc. The Fed has now called the turn of the global interest rate cycle and the Bank of England needs to follow.
What’s desperately needed, as this column has written before, is for the US, Japan, the Eurozone and Britain to get together and agree a coordinated rate rise – signaling to global investors the start of a return to normality. Acting together reduces the chance of any particularly country suffering a loss of currency competitiveness. It also draws a symbolic line in the sand, marking the beginning of the end of emergency measures.
Endless QE and negative real interest rates are storing up enormous dangers. Far from generating sustainable growth, such measures sustain zombie companies and weak banks, starving new productivity-boosting firms of investment and preventing necessary restructuring. Forced to chase yield, large institutional investors have meanwhile invested heavily in over-valued equities and other bubbly, crash-prone assets.
A UK rate rise, carefully handled, need not cause a slow down. Only around a third of households have a mortgage, and over half of those are fixed rate.
Central bankers should understand, more fundamentally, that out in the real world, away from high finance, countless business owners are so spooked by outlandish monetary policy that they’re not investing. That’s why a sure sign we’ve turned the corner, and rates will gradually rise, far from slowing the economy, would more likely act as a stimulus.