Ooohhh – events on the Bank of England’s Monetary Policy Committee are getting interesting. Earlier this month, the MPC kept rates on hold at an all-time record low of 0.25pc.
We learnt last Thursday, though, that the decision was strikingly close – 5 votes to 3, rather than the predicted 7 to 1. External members Ian McCafferty and Michael Saunders joined Kristin Forbes, who has been backing a rate rise for several months. They were right to do so – not least as the admirable Forbes is about to leave the MPC.
Having not already raised rates, the Bank of England is at risk of looking daft. News of this closer vote only slightly lessens that embarrassment. The “base” borrowing cost has been at ultra-low “emergency” levels for over 8 years, since the aftermath of the sub-prime collapse.
The UK economy remains quite buoyant, with the Bank expecting GDP growth of 1.9pc in 2017, slightly up from 1.8pc last year. And CPI inflation hit 2.9pc in May, we learnt last week – well above the 2pc target. This time last year, price pressures were subdued, with annual CPI growth of just 0.5pc. Since then, partly due to a weaker currency, inflation has shot to a four-year high.
As recently as April, though, when sterling had long since fallen after last summer’s Brexit vote, the Bank was predicting an inflation peak of 2.8pc in mid-2018. That estimate has been blown out of the water.
There is ample evidence inflation will keep rising. The old RPI index – which includes housing costs like council tax (and is more accurate, using arithmetic rather than geometric means – you’ll have to trust me) just jumped from 3.5pc to 3.7pc. Annual producer price inflation has been up at 3.6pc for three months in a row.
The main reason the Bank should increase rates, though, has little to do with macroeconomics – as strange as that sounds. Rates should rise, above all, for psychology reasons. For massively suppressed borrowing costs, given that they spook entrepreneurs and worry banks, are actually a hindrance to investment and growth – and that’s been true for some time.
UK interest rates haven’t risen for almost a decade. During the months that followed the 2007/08 financial crisis, they were cut rapidly to a then all-time low of 0.5pc. Since then, after the EU referendum, 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 purchasing £60bn of government bonds a month, on top of the £375bn of QE implemented since March 2009.
Emergency measures were justified in the immediate aftermath of the Lehman Brothers collapse. They’re not justified now. Growth is decent and unemployment is close to a 40-year low. CPI inflation, while definitely heading above 3pc, could hit 4pc over the next 12 months. It seems screamingly obvious rates should go up – yet financial markets continue to signal that, on balance, the MPC will sit on its hands. That’s because stock and bond markets have priced in “QE to infinity”, given the extent to which policy makers worry that if cheap money looks likely to end, we’ll see another financial collapse.
The US Federal Reserve, though, has just raised rates, for the second time this year and the fourth time since late-2015. US rates are now 1-1.25pc, back where they were in 2008. The Fed has called the turn of the global interest rate cycle and the Bank of England should follow. What’s needed, as this column has written before, is for the US, Japan, the Eurozone and Britain to agree a coordinated rise – signaling to global investors the start of a return to normality. Joint action lowers the risk of any one 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.
The MPC’s latest minutes appear to lay the ground for a rate increase at its next meeting in August. That would reverse the move it made a year earlier and see the Bank finally join the Fed in raising, if only once. On its own terms, the case to raise UK rates isn’t unambiguous. Rising inflation, falling unemployment and some uptick in business investment and net exports lessens the “slack” in the economy, so justifying higher rates. Against that, slower consumer spending, a slightly subdued housing market and flat real wages suggest rates should stay where they are.
Even if rates started rising, they would still remain heavily negative in real, inflation-adjusted terms. And given that only around a third of households have a mortgage, over half of those on fixed rate, the negative demand impact of higher rates is overstated.
Above all, though, these “regular” arguments don’t grasp where we actually are. For endless QE and negative real interest rates are storing up enormous dangers. Far from generating sustainable growth, such measures sustain zombie companies, 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.
Central bankers should understand 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.
The UK, of course, is drenched in political risk. Our Prime Minister is fragile and we have no government. All the more reason for the MPC to act like grown-ups and start raising rates.