Sunday, January 24, 2016
The dangers of leaving rates too low for too long
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

Mark Carney has spoken, in a speech to celebrate 50 years as a professor of economics at London’s Queen Mary University of Lord Peston (Robert’s dad). I don’t think he will have the gall to pop up again this summer and warn us be on the alert for a hike in interest rates at the end of this year.

For the Bank of England governor, who has the ability to generate headlines, being twice-bitten (he gave such warnings in both 2014 and 2015) should mean that this year he will choose to be a little shy.

He could, of course, generate plenty of headlines by starting to drop hints of interest-rate cuts. The Bank’s chief economist, Andy Haldane, appears to be genuinely agnostic about whether the next move in interest rates should be up or down. The Bank has said there are no technical barriers to cutting even from a record low 0.5% rate. Haldane has even talked about the possibility of a negative interest rate.

Carney and most of the other members of the Bank’s monetary policy committee (MPC) continue to insist that they fully expect the next move in rates to be up. Looked at logically and in the context of the governor’s speech, however, it is clear that there are circumstances in which a rate cut could occur.

His three conditions for raising rates were: growth being above its long-run trend, which in practice means quarterly growth of at least 0.5%-0.6%; evidence of a firming of cost (particularly wage) pressures, and a rise in core inflation consistent with getting back to the 2% target.

It is a reasonable set of conditions, but it also opens the way to a possible rate cut. What if quarterly growth were to slow to 0.1% or 0.2%, alongside a further weakening of wage growth and a few more months of inflation being stuck at close to zero, or even going significantly negative on the back of a new round of energy price cuts?

I do not expect it to happen, and I don’t think it would be a good idea, but it is not impossible. There is perhaps a 10% chance of a cut. Earlier this month George Osborne said that a rise in rates would be a sign of strength in the economy. If there were to be a cut he would need another script.

The remaining probabilities I would say are for no change at all this year, maybe 50% (some would put it a lot higher), with a 40% probability still clinging to a very late move this year, though not until November.

The governor’s speech, which was preceded by the MPC’s 82nd consecutive monthly decision to leave interest rates on hold, was unremarkable in its conclusions. With global markets plunging and the oil price slumping, the dust needed to settle. Most of those 82 decisions have been unremarkable.

If you were looking for an ideal time to raise interest rates, with every duck lined up in a row, such times have been in short supply. And, to the extent the MPC is waiting until a decision to raise rates is incontrovertible, a “no-brainer”, the longer we will have to wait for a move.

But, just because each decision to hold rates is defensible, is there a bigger picture danger, which is that ultra-low rates for too long, apart from depriving savers of returns, become dangerous?

Some would see those dangers in the housing market, where the latest Rics (Royal Institution of Chartered Surveyors) survey points to a further acceleration in house prices. For much of the period of very low interest rates, limited mortgage availability has offset the boon provided by low rates, though low rates have also encouraged investors to move into buy-to-let property. Now mortgage availability is improving fast there is a danger that low rates are stimulating the housing market – and pushing up prices – too much.

This is part of a wider point. Early last week I attended and spoke at a conference organised by the Spinoza Foundation in Geneva. One of the other speakers was Bill White, the Canadian former chief economist of the Bank for International Settlements, the central bankers’ bank.

White, who genuinely warned of the crisis before it happened (unlike many who claimed to do so) says central bankers made the mistake of pursuing excessively easy money policies before the crisis, and are making the same mistake again, supplemented by policies such as quantitative easing. Very low rates have had only a limited (and I would say diminishing) effect in boosting growth, while storing up other problems.

Indeed, as he put it in another recent speech, easy money policies may have had the opposite effect of that intended. “Much of what has been done recently smells of panic,” he said. “Arguably, by increasing uncertainty, it might even have encouraged people, both companies and households to hunker down and spend less rather than more.”

The BIS, which presciently warned of the “uneasy calm” in markets last month, thinks central bankers – including the Bank – are collectively making a big mistake. As it put it in its annual report last year: “Low rates are the most remarkable symptom of a broader malaise in the global economy: the economic expansion is unbalanced, debt burdens and financial risks are still too high, productivity growth too low, and the room for manoeuvre in macroeconomic policy too limited. The unthinkable risks becoming routine and being perceived as the new normal.”

The fact that there is even a possibility of a rate cut in Britain from 0.5% would meet the BIS’s definition of “unthinkable”. So would the fact that we are fast approaching the seventh anniversary of a cut to 0.5% in March 2009 that at the time was regarded as emergency and short-term.

The common theme between the pre-crisis period and now is inflation. Before the crisis, central banks focused too much on inflation and missed the dangerous credit bubble that was building. Since the crisis, the Bank ignored above-target inflation for some years, but now sees itself as constrained from raising rates by very low inflation.

Whether these post-crisis easy money policies will ultimately prove to have been dangerous and damaging is hard to say. But there is at least a risk that we will come to regret having near-zero interest rates for so long.