Borrowers beware: Mark Carney’s clear message in his speech at Lincoln cathedral last week was that interest rates may have to rise soon – something anyone who has bought a home or taken out a loan in the past eight years will never have experienced.
Yet the other signal that came through – aside from some chin-stroking on medieval inflation and the Magna Carta – was that the fragile, lopsided state of the post-crash British economy means the Bank must proceed with great care.
The arguments for a rate rise are easy to assemble, and cheerleaders for the hawkish cause, such as ex-monetary policy committee member Andrew Sentance, have been making them for several months.
Growth has picked up; wages are finally increasing; business confidence is strong. Moreover, the earlier in the cycle rates start to go up, the argument runs, the more ammunition policymakers will have to respond to any future crisis. And leaving rate “lift off” too late might allow inflation to take hold, so that the policy response when it came would have to be more drastic.
As David Miles, whose term on the MPC is about to end, put it in a speech last week, “waiting too long to start on a path back to a more sustainable rate is a bad mistake. What you really need to avoid is sharp rises in interest rates.” Miles, who was previously considered a dove, insisted: “The time to start normalisation is soon; that is not something to shrink from.”
Yet there are several reasons, all of which Carney acknowledged, not to rush towards higher rates.
First, as the Bank’s own recent financial stability review pointed out, despite the wrenching adjustment that followed the financial crisis, UK households remain among the most heavily indebted in any major economy.
And, as the governor stressed, our predilection for floating-rate mortgages (or our banks’ predilection for selling them to us), means that compared to the US, for example, a larger proportion of borrowers would see an immediate impact on their monthly repayments if base rates increased. Credit card borrowing has also increased rapidly since 2012.
Research by the Resolution Foundation last year found that even modest rate rises would see one in four mortgage borrowers forced to spend more than a third of their income on repayments.
Second, sterling has strengthened significantly in recent months – and jumped again on Friday – both in anticipation of a rate rise, and because the eurozone crisis has been weighing on the value of the single currency.
That not only puts the brakes on the export drive George Osborne has repeatedly promised, by making British goods less competitive; it also depresses the price of imported goods, dragging down inflation.
Third, the global environment still looks risky. China’s stock-market crash has underlined the uncertainties about its profound economic transformation; a string of heavily indebted emerging economies are bracing themselves for the US rate rise expected later this year; and the eurozone crisis rolls on.
Fourth, as Carney stressed, the Conservative government’s next round of deficit reduction means “the IMF expects the UK to undergo the largest fiscal adjustment of any major advanced economy over the next five years”. Notwithstanding Osborne’s welcome decision to jack up the minimum wage, these cuts will sap economic demand, forcing the Bank to keep monetary policy loose.
Indeed, Simon Wren-Lewis of Oxford University has argued powerfully that it is reckless for the government to press ahead with deficit cuts when the Bank has so little power to offset it with fresh rate cuts.
And as for the argument that central bankers should rush to raise rates now, so that they have more scope to lower them later: it’s little more than the Grand Old Duke of York approach to monetary policy – as other central banks, including Sweden’s, have learned in the wake of the crisis. In Sweden, the Riksbank began raising rates in 2010, believing that the worst of the credit crunch was over, and concerned about rapid increases in household borrowing. By mid-2011, it had pushed up interest rates seven times; but as the krona strengthened sharply and the economy slowed, it was forced into a swift about-turn. Rates were cut from early 2012 and are now lower than during the depths of the crisis.
This is not the first time Carney has tried to telegraph an imminent policy tightening. He started his term by persuading his colleagues to embrace the whizzy new approach of “forward guidance”, specifiying the unemployment rate – 7% – at which the MPC would consider raising rates.
When that 7% threshold came and went without sparking the expected recovery in wages, and GDP growth continued to underperform, forward guidance was effectively shelved (and, as ex-Bank economist Tony Yates pointed out last week, its effectiveness as a tool in any future crisis has been blunted). At last summer’s Mansion House speech, the governor suggested the markets might have been underestimating the likelihood that rates were about to rise. They weren’t.
This time around, with inflation still at zero, Carney almost seemed to lack the courage of his own convictions. “The MPC will have to feel its way as it goes,” he said, “monitoring a wide range of indicators and adjusting the pace and degree of bank rate as it learns about the effects of higher interest rates on the economy.” That’s about as close as a rock star central banker can come to “suck it and see”.
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