Sunday, October 29, 2017
The case for a rate rise may be weak - but the Bank should do it
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.

Small numbers can make a big difference. Had the third quarter gross domestic product figures come in at 0.3% a few days ago, this column would have been a lot more challenging to write. Yes, a rate rise this week from the Bank of England would still have been more likely than not, but it would have been a very close call.

As it was, of course, the GDP figure came in at 0.4%, weak by normal standards but stronger than the Bank and the markets expected. Now it will be a considerable surprise if we do not see a quarter-point rate hike on Thursday.

It is not, of course, a nailed-on certainty. When the Bank said in September that a majority of members of the monetary policy committee (MPC) favoured what is described as a removal of some monetary stimulus in coming months, it did not name a date.

Two MPC members, Sir Jon Cunliffe and Sir Dave Ramsden, have indicated that they will not be supporting a hike. The small difference in the GDP number may not have convinced them that growth is anything but weaker than it should be.
They may also be worried about what is coming down the track. Ramsden was the Treasury’s top economist while Cunliffe led the work 14 years ago on Gordon Brown’s famous “five tests” exercise, which kept Britain out of the euro.

Even so, the expectation is that they will be in a minority on Thursday, with the City looking for a 7-2 vote for a hike. That, perhaps, is the Bank’s first difficulty.
In the long wait for an interest rate hike, which now stretches for more than 10 years, I had always thought that when the moment came it would be a big and important enough moment for it to be a unanimous vote.

Others disagreed but my argument was that if you could not convince everybody around the table of the need for a tightening, how could you expect to convince the public and business?

This brings me onto the Bank’s second problem. Again, when thinking ahead to this point, I expected we would reach a time when the case for a rise in interest rates would be both unanswerable and easy to explain in layman’s terms.

That is not the case now. An unanswerable case for a rate rise would be a situation in which above-target inflation was expected to persist, alongside accelerating wage inflation and strong growth.

As things stand, only one of those three conditions is met. Inflation is 3% and set to move a little higher in the autumn. The Bank expects inflation to remain above the official 2% target until well into 2020, so that box can safely be ticked.

Admittedly it has “looked through” periods of above-target inflation before, and Mark Carney has laid the blame for this overshoot entirely on sterling’s Brexit slide. But this time the MPC majority appears unwilling to ignore a persistent target rmiss.

When it comes to wages, you have to look very hard to find any case for higher rates. Official figures show average earnings growth stuck at a little over 2%. A survey of employers a few days ago by the specialist consultancy XpertHR showed median pay awards of 2% are anticipated over the next 12 months.

This maintains a pay pattern that has been in place since January 2013. And, while formal pay awards are by no means the whole of the market these days, this suggests that very little is moving.

The quest for a wage case for higher rates takes us into the statistical detail. As I noted last week, the Bank thinks that the so-called compositional shift to lower paid jobs is depressing average earnings. It also thinks that with unemployment at a 42-year low of 4.3%, it can only be a matter of time before wage pressures build.

Not only that, but an error by the Office for National Statistics earlier this month highlighted the fact that unit labour costs in the second quarter were up by 2.4% on a year earlier. When productivity is so weak, even going backwards, it does not take much of a pay rise to produce a significant increase in unit labour costs. These are all good arguments about pay, though they are far from representing a slam dunk for higher rates.

Neither, it should be said, do the growth numbers. Until the Bank’s language changed in the summer, the assumption was that quarterly growth rates of 0.3% or 0.4%, well below normal, were just too weak to contemplate higher rates.

The construction industry has shrunk for the second quarter in a row, meeting the technical definition of recession. Consumers are being squeezed by falling real wages, the CBI saying on Thursday that retailers were suffering the biggest drop in sales since March 2009, and businesses are holding back on investment. Not only have the numbers this year been weak but the growth outlook is poor. Britain has entered the slow lane and appears to be stuck there.

Making the case for a rate rise on the back of this is not easy and, again, the MPC’s hawks have to dig a little deeper. This is the argument that, such has been the damage to the supply-side of the economy, and so weak had been the productivity performance, that the economy’s speed limit has been reduced.

The economy is growing at an annual rate of 1.5% and that, according to the Bank, is pretty much all it is capable of. Even at this year’s very modest growth rates it is bumping up against capacity, potentially keeping inflation high.

We are left with a reasonably clear argument for raising rates on inflation grounds, but much more tentative and harder to explain arguments on pay and growth. Communicating the rate rise, assuming it happens on Thursday, will be a challenge.

There are other arguments. A decade on from the start of the financial crisis, we are still at emergency levels of interest rates. The desire to begin the process of normalising policy, also seen with the Federal Reserve in America and the European Central Bank starting the tapering of is quantitative easing last Thursday, is a strong one among central banks. Prolonged near-zero interest rates have consequences, and many of those consequences, including an excessive build-up in debt, are adverse.

Communication will also be important on the future direction of rates. The Bank’s watchword will be limited and gradual, a slow pace of rate rises to a new norm of around 2%.

The case for starting that process this week is weaker than it might be. The ducks are far from all in a row and there have been better occasions to raise rates in recent years. But the Bank has to start somewhere. And I don’t think anybody could bear it if, having teased us with the prospect of higher rates once again, the Bank decides to pass up on the opportunity. So it should bite the bullet.