Sunday, July 08, 2018
Speculation mounts. Yet the case for a rate rise is a weak one
Posted by David Smith at 09:00 AM


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

We have reached that moment in the quarterly interest-rate cycle when speculation is again mounting about whether the Bank of England will bite the bullet and actually raise interest rates next month.

We have been here before, many times, and we know that it ends in one of two ways. Either the Bank’s monetary policy committee (MPC) raises interest rates, something it has done only once in the past 10 years. Or we face a re-run of a familiar script, with Mark Carney, the governor, accused again of being an “unreliable boyfriend” when it comes to interest rate guidance.

Why is there heightened speculation about an interest rate rise next month? It is mainly because the Bank’s view, that growth in the weak first quarter of the year was affected by severe “beast from the east” weather, and that there would be a bounce in the second quarter, is supported by the surveys and some official data.

The Office for National Statistics, it should be said, had played down these weather effects in reporting that gross domestic product (GDP) rose by just 0.1% in the first three months of the year, an estimate since revised up a little to 0.2%

Purchasing managers’ surveys for last month point to a strong bounce for the service sector, a more iffy picture for manufacturing and construction growing again. Taken together they are consistent with 0.4% GDP growth in the second quarter, which would be enough to lift the 12-month rate of growth from 1.2% to 1.4%.

Carney, in a very good speech in Newcastle warning of the risks posed by Donald Trump’s knuckleheaded protectionism (my words, not his), said “the incoming data have given me greater confidence that the softness of UK activity in the first quarter was largely due to the weather, not the economic climate”. Though he did not specify next month, he said households were right to be prepared for a rate rise in the next year.

The Bank is also concerned about what the governor described as a firming up of pay and domestic cost pressures. The latest report from the Recruitment & Employment Confederation suggests that candidate shortages have pushed pay growth for permanent staff to a three-year high, lending support to such fears.

There is also the weight of numbers on the MPC itself. Three of its nine members voted for a rate hike last month, so only two more need to move over to the hawkish side of the fence to give a majority for hike. Given that one of the three hikers, Ian McCafferty, will have his final vote at the committee’s August 1-2 meeting before leaving the committee, there may be no time like the present.

There may be another reason, even if only subliminally, for raising rates now. The next realistic opportunity after next month will be November, given that decisions to change rates usually coincide with the publication of a new quarterly Bank forecast. By then, Britain could be embroiled in even more Brexit uncertainty than now, and too close to the cliff-edge for comfort. Raising rates under those circumstances would look inappropriate.

There is also a long-held desire to begin the process of normalising interest rates. It is more than nine years since the Bank, in the teeth of the gale blowing as a result of the global financial crisis, reduced official interest rates to a record low of 0.5%. The emergency the Bank was responding to is long over but the emergency level of interest rates persists and creates economic distortions, including all-time low for Britain’s saving ratio. For the Bank normalisation, or as it would put it removing some of the monetary stimulus, is a desirable end in itself.

So why is the case for raising rates not cut and dried? Why, in fact, is it rather weak at the moment? The growth bounce in recent months is real, but is not particularly strong. Chris Williamson of Markit, which compiles the purchasing managers’ surveys, points out that the pace of growth is considerably lower than rates which would normally be associated with rate increases. Purchasing managers’ indexes across services, manufacturing and construction averaged 54.2 in the second quarter, below the 56.5 level traditionally associated with rate hikes.

There is, in addition, plenty of evidence of retail distress, alongside a subdued housing market and falling house-price inflation. If the Bank wants to prick something, often a motivation for raising rates, there is nothing to prick. Consumer price inflation, meanwhile, is falling and the dog of faster wage growth is mainly one that has failed to bark in recent years.

The Bank can answer some of this by pointing to the fact that the economy’s speed limit has come down as a result of stagnant productivity, so even modest growth can be inflationary. That justifies raising rates alongside lower purchasing managers’ readings than in the past. But that speed limit for growth, which the Bank puts at 1.5%, is not being seriously challenged. Independent forecasts, compiled by the Treasury, are for just 1.4% growth this year, 1.5% next.

Then there is the potential for Brexit disruption. Carney repeated what he has said before about Brexit, which is that the Bank has assumed it will be smooth, mainly because that is the government’s intention. The Bank cannot realistically assume a disruptive Brexit. Friday’s Chequers meeting has reduced the risk of a disruptive, cliff-edge Brexit, though the risks have not gone away.

Does it make sense for a central bank that has to look forward to raise rates if there is a risk of Brexit disruption later in the year and next year? MPC members have previously given short shrift to the idea that it could be good to raise rates now in order to leave room for cutting them later.

If the Bank does raise rates next month, as a majority of City economists now expect, it will not do any great damage, though being forced to cut them again soon afterwards would not do a lot for the Bank’s reputation. We are still talking, after all, of baby steps, a quarter-point at a time. But it is important that the Bank is able to explain its actions to business and the public, and the case for raising rates is weaker than on many occasions in the recent past.