Sunday, May 15, 2016
Amid all the referendum excitement, the long wait for a rate hike goes on
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.

Thursday’s Bank of England inflation report press conference was, by my calculation, the 29th since interest rates last changed. I may have missed one or two but sat though most.

If you think that’s a burden, think of the members of the monetary policy committee (MPC) itself. The latest “no change” verdict from their May monthly meeting was the 86th in a row. The personnel have changed along the way, and MPC members would not doubt say there was nothing they would rather have been doing. But no wonder, perhaps, the Bank is reducing the number of MPC meetings from 12 to eight a year.

There was a time when the Bank was expected to be the first of the big central banks to hike rates. Then, when it became clear that America’s Federal Reserve would be the first-mover, which it was last December, that the MPC would follow soon after. Now, it is fair to say that there is more speculation about a cut than a rise.

Part of that, of course, arises from the part of the Bank’s inflation report that Mark Carney, its governor, described as “the elephant in the room”. Its view that a decision to leave would have “material economic effects”, including weaker growth, higher inflation and rise in unemployment, was explicit.

Sterling would fall, “perhaps sharply”, and: “Aggregate demand would also likely fall, relative to our forecast, in the face of tighter financial conditions, lower asset prices, and greater uncertainty about the UK’s trading relationships. Households could defer consumption, and firms could delay investment. Global financial conditions could also tighten, generating potential negative spillovers to foreign activity that, in turn, could dampen demand for UK exports.”

The Bank’s frankness has provoked predictable fury from the Leave camp. My tip for them would be not to challenge the Bank’s independence or its governor’s integrity – these verdicts were unanimously agreed by all nine members of the MPC and the 10 members of the financial policy committee – but to argue that a bit of short-term pain would be worth it for what they see as the long-term gain. I doubt if they will take that advice.

The referendum is the latest obstacle to a return to some kind of normality for interest rates, adding to a very long list. The Bank held rates at their record low to help the economy cope with George Osborne’s fiscal tightening, and kept them there and unleashed another round of quantitative easing when the eurozone was mired in its deepest crisis. It passed up an opportunity to raise them in 2014 when growth was strong and unemployment falling far faster than it expected, and well below the 7% rate cited by Carney in his forward guidance the previous summer.

When rates were first reduced to 0.5%, in March 2009, MPC members did not think they would stay there long, probably less than a year. Now, according to the markets, it will be touch and go whether they go up before the 10th anniversary of that cut, in 2019.

Andrew Sentance, the former MPC member and long-time hawk has promised to assemble a live band outside the Bank to celebrate the first hike. I think it will take more than that, maybe a streak down Threadneedle Street. Either way, according to the markets, it looks a long way off.

Is that a reasonable expectation? Let me take two scenarios, Brexit and non-Brexit. The Bank’s response to big events usually has the virtue of being clear-cut. In the global financial crisis cutting rates was a no-brainer.

In the case of Brexit, as Carney and his colleagues made clear, the decision would be more balanced. The slump in sterling and the consequent rise in inflation would argue for higher rates, while the hit to growth would make the case for a cut. A cut would not do much – I am pretty sure the Bank will not want to follow other central banks and opt for negative rates, so from 0.5% to zero would be as far as it goes. A half-point cut in interest rates would not do much to offset a growth shock. As the governor said, there is only so much that monetary policy can do.

Which way would it go? The Bank is not saying. If it thought the rise in inflation resulting from Brexit was temporary, then it could “look through” it, as it has done before, and cut to try and keep growth going. If, on the other hand, a post-Brexit slump in sterling turned into a rout, the Bank might have no option but to raise rates to prop it up. After two decades in which sterling has not been a driver of interest rate hikes in Britain, it could make an unwelcome return. This is the kind of nostalgia we can do without.

The other point about interest rates post-Brexit is that even if policy rates were cut, actual rates in the economy might well rise, because of the increase in bank funding costs. Carney told me that the Bank would do its best to mitigate such effects by providing liquidity, but even that might not do the trick.

What about interest rates under a Remain scenario? That is easier to address, because it is the assumption on which the Bank has based its new forecasts. There is a view that, once the referendum uncertainty is out of the way, the Bank will feel liberated enough to give serious thought to raising rates. Not immediately – August would be too soon – but perhaps as early as November.

A post-referendum bounce in economic activity would provide the context, while the Bank’s forecast that inflation in two years will be back above 2% would give the justification. Quite a few economists in the City subscribe to this view. Add in one or two more rate rises between now and November from the Federal Reserve and the Bank could see itself as going with the flow.

On the other hand, as noted above, there have bene plenty of opportunities to grasp the nettle on rates in the past few years, and it has gone ungrasped. In its inflation report, the Bank devoted a large panel to the effects of uncertainty, and how they can linger even after the event that has caused the uncertainty has come and gone. The post-referendum bounce in the economy would have to be big and very obvious for the Bank to move. And 2016, for all its other excitements, would go down as another year in which nothing happened on interest rates. In which case, maybe next year?