In other circumstances, we’d raise rates. But with Brexit looming, how can we?
Arguments for the Bank of England to raise interest rates are many and growing. It’s why an increasing number of Threadneedle Street policymakers have voted for a rise and even the governor Mark Carney has felt the need to hint that an increase is not too far away.
Top of the list is the business cycle. This esoteric term is often used in economic circles to describe the natural lifespan of an economic boom, or at least consistent expansion.
The concern is that this period is just what its proponents say it is – natural – and is nearing its end. Any attempt to delay this process is just storing up trouble for the future.
The most immediate analogy is the 2008 financial crash. It can be argued that the natural business cycle was coming to an end in 2003. The economy was slowing as many important industries paused for breath after a good eight years of expansion. Gordon Brown, being a good Keynesian, had promised to end boom and bust. To this end, he opened the public spending taps and gave the economy a modest boost. In response, UK plc sailed on.
Without going into too much of the history, he missed the fact that more of the boost to borrowing was coming from the banks – as were his tax receipts – so when the economy was hit sideways by the US sub-prime disaster, the UK suffered more than most – and more than it would have done if some of the excesses had been weeded out by a milder slowdown five years earlier.
The Bank of England is worried that the UK stands in the foothills of the same debt mountain. Public spending is under pressure to ameliorate the worst of an economic slowdown while the banks, still wedded to a bonus culture that spurs reckless lending, are shovelling money out of the door in any way they can. At the moment that means unfeasibly low-cost car loans. Who knows what they’ll be up to tomorrow? To those who worry about unstable financial markets, what this situation needs is calming down.
Regulators are trying to keep a check on the finance industry’s worst excesses with tighter lending rules. Last week the Bank of England demanded that lenders re-examine the worst-case scenarios they use when lending to businesses and individuals, amid fears that banks are basing their decisions on a benign economic environment lasting forever.
Regulators have their uses, say the supporters of higher interest rates, but there is nothing the banks understand better than a hike in the cost of borrowing: they must pass it on and it must prevent the flakiest customers from accessing credit. More than that, there would be a cleansing of the stock of debt. This means that many of the firms and individuals who have borrowed large sums and are so broke they struggle to pay the interest on their loans would be exposed.
Next on the list is the exodus of migrant workers as they return to their home nations across the Channel. This movement of people is expected to raise pay rates for the domestic population and feed through into higher prices. With inflation already at 2.9%, the thinking goes that the effect of the weaker pound on import costs, although waning in the second half of the year, will be superseded by higher wages as a spur for inflation. To calm down wage-induced inflation, what could be better than higher interest rates?
If a central bank policymaker subscribes to these arguments, they might see themselves voting in August to reverse the emergency interest rate cut made last year – the one made in response to the panicky aftermath of the Brexit vote. Two more rises could follow in 2018, should the expected inflationary pressures stay in place.
Michael Saunders, one of the three policymakers to vote for a rise at the monetary policy committee’s meeting last month, qualified his call for a rise when he told the Guardian: “If rates do go up, it will be in the context of the economy doing OK and unemployment being low and probably falling.”
And there lies the problem. The economy is already weakening and the main measure of economic activity, GDP, is likely to slump in the second half of the year.
Saunders says the Brexit negotiations are no constraint on MPC decision-making. But the uncertainty created by the Brexit talks is a key reason his colleagues will reject a rise. This is the kind of denial of realpolitik that we have come to expect from some Bank of England officials: everyone can see it is just too risky to increase the cost of credit when David Davis is in the middle of a tense arm-wrestle with Michel Barnier.
The atmosphere is already heavy with doubt and uncertainty. Inevitably, a rate rise in this context would be seen as irresponsible.
Next year, the economic situation will be the same or worse. And in the years after Brexit, wages growth will remain stuck in first gear, while big businesses scan the EU for cheap locations to build their next factory. So when will interest rates rise? Not for a very long time.