Sunday, October 01, 2006
Crunch time for Bank as rate rise looms
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

You wait ages for an interest rate hike to come along (two years in the Bank of England’s case) and then they all come along at once. Or so it seems.

The monetary policy committee’s finger appears to be itching on the trigger and the only question is whether it hikes this week, which would surprise the City, or next month, which wouldn’t at all.

We have learnt to be on our guard, with good reason. The “shadow” monetary policy committee (MPC), which meets under the auspices of the Institute of Economic Affairs, votes decisively, by 6-3, for a rate hike this month. The last two occasions in which it has voted for a rate change, before the August meetings of 2005 and 2006, the real MPC duly obliged.

As in August, a move this week would come as a considerable surprise. Only one out of 52 City economists polled by Reuters predict it, though 48 expect a hike in November.

But the view of the six hikers on the shadow MPC is simple: Why wait? The economy is buoyant, inflation is above target and the money supply is rising strongly, partly on the back of record mortgage lending. This is an economy, they believe, that needs cooling.

Thus John Greenwood, chief economist at Amvescap, highlights rising goods-price inflation, Ruth Lea of the Centre for Policy Studies the risk of higher earnings growth, Andrew Lilico of Europe Economics the fact that monetary policy looks loose and Gordon Pepper of Lombard Street Research strong monetary growth.

Of the other two shadow MPC hikers, Peter Spencer of the Ernst & Young Item Club thinks 4.75% is below the “natural” or neutral interest rate and Anne Sibert of Birkbeck College says the economy is close to capacity and that benign effects on pay growth of Eastern European immigration are unlikely to be repeated.

All strong arguments, which can be read in detail on the Lombard Street Research website ( from tomorrow.

I, however, have always regarded it as my constitutional role to ensure the other side of the argument is heard. In normal circumstances, when all the other doves have flown the cote, I’ll still be there.

So I am going to surprise you. The Bank, I think, has to raise rates. Let me explain. Ahead of the August hike, I set out why the case for raising was so easy to make, but why the MPC should not do so. This time, the case for not hiking is also quite easy to make.

The downward revision in second quarter growth, and most particularly in economy-wide inflation from 3.4% to 2.2%, came after most shadow MPC members had declared their hand. Low pay settlements, as the Bank’s lone dove David “Danny” Blanchflower has made clear, support the idea of an economy wih plenty of spare capacity. He’s worried about a sustained unemployment rise as the public spending taps are turned off.

True, house prices rose strongly (1.3%) this month and retailers have had a good September. But this sits uneasily alongside the fact that real incomes are being squeezed and is unlikely to last. The housing market is not yet reflecting the turn in the interest rate cycle. Add what looks to be a sharp housing-led slowdown in America, which will affect us.

I have not mentioned falling oil, and the spectacular drop in petrol prices. I am, I’ll say again, entirely unconvinced by the “all news is bad news” argument from some in the Bank, in which higher oil prices were bad news because they pushed up inflation, but lower oil prices could also be bad news because they will encourage consumers to make whoopee on the high street and firms to relax their grip on wages.

So why do I think the Bank will have to hike? It is because there is another issue here. I don’t think the MPC has handled things at all well recently, giving the impression of being relaxed about inflation in July and then very worried about it in August. Mervyn King always says it takes one meeting at a time but that was taking it too far. I think the committee could have held its collective nerve, partly for the reasons that Blanchflower outlined.

It did not, and in raising Bank Rate (the traditional name has been revived) from 4.5% to 4.75%, it let the genie out of the bottle. It has created the expectation of further hikes, and near-unanimity about the prospect of another move in November. Sir John Gieve, one of the Bank’s two deputy governors, referred specifically to this expectation of a November hike in a speech last week. To prevent it, either we have to have some noticeably weaker data, or the MPC has to start telling a different story.

We had an isolated rate cut last year, the possibility of which King was keen to emphasise soon after it happened. Nobody has been talking about an isolated hike this year, and he warned (wrongly in my view) that inflation could rise above 3% this winter.

So the Bank’s credibility - hard-won but easily lost - requires another rate rise, though it sticks in my craw to say it. Whether it happens this week or in November is largely a tactical question. The European Central Bank will probably hike to 3.25% this week so there would be safety in numbers. Betting against the shadow MPC may be a mug’s game but I would favour the November option, if only because to hike this week would create an impression of even greater urgency than the Bank intends. The expectation then could easily be of a further increase before the end of the year.

After that, where next? Those looking for cuts next year emphasise the slowing US economy and of falling energy prices on inflation. The MPC, after all, can be as flexible as it likes. More likely, I suspect, is a prolonged period of unchanged rates. Too much excitement is not good for an Old Lady.

PS In Manchester, watching Bill Clinton’s syrupy address to Labour’s conference, I noticed two small children readying themselves for something important. They were there to interview Gordon Brown for the BBC’s Newsround. Watching it later, and hearing him telling them about interest rates, and I suspect being cut off before he got on to the fiscal rules and endogenous growth, you realised he’s a long way to go as a communicator. Three-quarters of the TV audience agreed, texting in that he would not be their choice as prime minister.

The chancellor needs to learn to talk to people but his pitch is already clear. Solidity and experience, including what by next spring will be 10 years at the Treasury, will be contrasted with the Tories’ youthful flightiness. In a scary world, who you gonna call?

The task of the Tories, at their conference in Bournemouth this week, is to show that they may be young but bristling with bright ideas. On the economy, they have it all to do. Apart from well-meaning stuff from David Cameron about focusing on general well-being rather than gross domestic product, and the formula of sharing the proceeds of growth between higher public spending and lower taxes, it is a blank sheet of paper. Asked to fill a postage stamp on Tory economic policy, I’d have room left over.

Perhaps, like the Newsround audience, people aren’t much interested in such things. But surely they are. The Centre for Policy Studies, with its alternative manifesto, out today, wants slower growth of public spending to allow £20-30 billion of tax cuts over a parliament, allowing the abolition of inheritance tax, capital gains tax and stamp duty. It also wants to renegotiate Britain’s relationship with the EU, to focus purely on the free trade benefits. Appealing though all that would be to traditional Tory supporters, I suspect nobody would be more delighted than Brown if we heard it from the Bournemouth platform this week. But the party has to say something.

From The Sunday Times, October 1 2006


Well given that it took two years for MPC to hike rates and given that even the rise before last followed talk of a cut,it remains that the MPC will be very careful in raising rates again.

I personally feel that there should be two more cuts of 25bps in the light of a drop in oil prices.

Mortgage lending is strong because supply considerations in housing, which the government should now address,has created equity for home owners which in the first place should have been resolved by supplying more building land.

We need a government that will look at housing proactively, and the MPC should be least concerned about house price inflation.

Posted by: Hitesh Damani at October 4, 2006 02:32 PM