Sunday, February 07, 2021
Negative rates? No, the Bank should be starting to think of when to raise
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.

Many is the Thursday lunchtime I have waited with bated breath for the Bank of England’s interest rate announcement, and many is the time when it has been much ado about nothing. So it seemed last week, when the eight men and one woman on the Bank’s monetary policy committee (MPC) left official interest rates at a record low of 0.1 per cent and opted not to increase its quantitative easing (QE) total from an already massive £895 billion, including corporate bonds.

The announcement was not without its moments, however. The Bank wants to add negative interest rates to its toolkit, but the banks will need six months to prepare, so that probably kicks it firmly into touch, which for me is good thing. It is also examining how it might reverse some of that massive QE and has asked Bank staff to investigate. Its position used to be that this could not happen until Bank rate had risen to 2 per cent (later reduced to 1.5 per cent). It may be that its future position will be that it can happen at any time, which would also be a good thing.

If all goes to plan, or at least according to the Bank’s new forecasts, the next few months will see both a powerful growth bounce and an upturn in inflation. The only debate, on both counts, is by how much.

Recent history suggests that there could be a rise in inflation as the impact of this crisis fades. Inflation rose to 5.2 per cent in September 2011 after the financial crisis. Some of this was due to the rise in VAT to 20 per cent at the start of 2011, but most of it reflected other factors, including a recovery in oil and commodity prices.

The Bank of England’s survey of public opinion on inflation, conducted by the market research company Kantar, shows an expectation that prices will be rising by more than the official 2 per cent target in 12 months’ time.

The latest survey, carried out at the end of last year, showed a median expectation of inflation of 2.7 per cent a year on. Nearly a fifth, 18 per cent, think inflation will be more than 5 per cent. Two-fifths, 39 per cent, think inflation will be 3 per cent or more.

A significant proportion of economists also think that a period of above-target inflation is on the way, either because the Bank will allow it to happen, or because it is unable to prevent it. The Centre for Macroeconomics of the Centre for Economic Policy Research recently carried out a survey.

Of those surveyed, 22 per cent thought the Bank would allow inflation to exceed the target, while 19 per cent said it would be unable to prevent an overshoot. The combined total, 41 per cent, exceeded the 37 per cent who expected the target to be met.

Some prominent economists have been warning of higher inflation for some time. Tim Congdon of the Institute of International Monetary Research has long argued that the big increase in the money supply as a result of aggressive quantitative easing (QE) by central banks will push inflation to 5 per cent or more. He has also pointed to the recovery in commodity prices and other “early warning signs” of rising inflation.

Commodity prices are recovering – the Bloomberg commodity index is up by more than 35 per cent from its low point last March – and the Bank is more optimistic than the consensus about growth. It predicts that the economy will grow by 5 per cent this year and just over 7 per cent next. This year’s recovery, which is subject to the speed of the vaccine rollout and the extent to which people feel confident enough to spend again, sees the economy “projected to recover rapidly towards pre-Covid levels”.

It is quite a punchy forecast and it removes one of the arguments for inflation staying very low. It currently just 0.6 per cent. How much inflation goes up is essentially a tug of war between two sets of factors. One set comprises the huge economic shock from the pandemic and the spare capacity it leaves in the economy, bearing down on inflation. The other consists of the impact of the Bank’s huge monetary stimulus – a 0.1 per cent Bank rate and lots of QE – and a big post-pandemic economic bounce.

On the first, the Bank expects unemployment, now 5 per cent, to peak at 7.75 per cent in the middle of this year (equivalent to nearly 2.7 million people) but it thinks this will be short-lived and that it will be back to 5 per cent next year. This means, on its broader measure of spare capacity, that there is some this year but that it will have disappeared by next year. All of which leaves the other set of factors, the monetary stimulus and the rebound, to push it higher.

There is, then, no serious debate about whether inflation will go higher, merely a question of degree. For the Bank going higher means hitting the 2 per cent official target and staying there, or slightly above it. For others it will be a much bigger overshoot.

The question is whether the Bank will do anything about it. It has bought itself enough time to avoid a move to negative interest rates, but its forecasts are conditioned on continued ultra-low official rates.

There are good reasons why it should be preparing the ground for return to some kind of normality for interest rates and for beginning the gradual unwind the massive QE it has undertaken this year. When it “looked through” the rise in inflation after the financial crisis, it got stuck with record low interest rates and a greatly expanded balance sheet as a result of QE.

It should not do so again. A year ago its position was that “a modest increase in interest rates” would probably be needed over time to keep inflation on target. As the effects of the pandemic on the economy ease and the nightmare subsides it should return to that position. The Bank, it should be said, is not thinking this way yet. When the emergency is over the sirens can be switched off.