In an interview published by the Financial Times a member of the Monetary Policy Committee of the Bank of England broached the issue of higher official interest-rates in the UK. Here is the headline quote from the interview with the MPC’s Martin Weale.
Britain needs to start raising interest rates sooner rather than later if it wants to avoid sharp and painful increases in the future,
This tells us that Martin Weale was one of those who thought that the UK economy was “becoming more balanced” in the most recent MPC Minutes. He added:
“What I’m increasingly going to have to do as more capacity is used up is balance off my sense of the risk of waiting too long versus acting too soon.
“I very much can see risks both ways and ‘becoming more balanced’ means an increasing sense of having to balance and judge those risks.”
Actually he is tying himself up in knots here and by repeating the current central bank mantra that it is all down to spare capacity he makes matters even more opaque.
“I wouldn’t say that 0.9 had gone down to 0.7 or 0.6 but I think it’s fair to say there is less capacity than there was on the basis of the figures I looked at.”
He means 0.9% and 0.7% or 0.6% as an estimate of how much spare capacity there is in the UK economy. This poses several issues of which the most obvious is that with the current growth rate of the UK economy then, in my view, he is denying what is happening right now. Next we have the issue that at current growth rates the margin he estimates will be gone in the summer, which means that on his own logic he should have already voted for a base rate rise.
A theme of this blog is that concepts such as the “output gap” and “spare capacity” look objective but in fact are in the eye of the beholder and therefore extremely subjective. Of course that is why policy-makers and central bankers have zeroed in on them! It avoids having an explicit target such as an unemployment rate of 7% which is then embarrassing when you hit it and nothing changes in response.
By how much will the base rate rise?
Mr Weale said his definition of a “gradual” rate rise would involve the bank tightening by “no more than” 25 basis points (o.25%) a quarter.
Here he is much more on message as the Governor of the Bank of England Mark Carney regularly states that any rises will be slow and gradual. But perhaps only one or two rises will be needed or much more, they simply do not know.
Where does this leave Forward Guidance?
We are long past the stage where this policy of “open mouth operations” should stop and frankly Martin Weale should have voted for that at the last MPC meeting. After all it is quite plain that he no longer believes in interest-rates being lower for longer. In fact the very concept of Forward Guidance was of course misleading and it is getting worse. It was the last throw of the dice of a “maxed-out” policy regime.
What about Quantitative Easing?
If you are holding a large amount of UK Gilts then one of the last things you want to see are rises in the UK base rate as these are historically associated with Gilt price falls and yield rises. As the Bank of England is the largest holder of UK Gilts via its £375 billion of Quantitative Easing this leaves it with quite a headache. Regular readers will be aware that I have been making the case for not rolling over individual bond maturities for a year or so now. This would not wipe out the problem but it would at least get us on the road. Sadly the official policy is to often buy ultra-long Gilts instead, in a policy that looks designed to maximise rather than minimise the likely losses. For example the Bank of England owns over £7 billion of a Gilt which matures in 2060.
This area does not get much publicity and it is my opinion that this is deliberate. After all the terms of office of those involved are likely to be over before the full-scale of any capital losses are ever announced. This is in marked contrast to the interest-rate gains (we are paying coupons in effect to ourselves) which are now squirreled away as soon as they happen.
What about inflation?
As Martin’s job is supposed to involve keeping the official UK consumer inflation rate as near to 2% as possible there is a clear problem. Whilst the annual rate nudged up to 1.8% in April, Martin was on an MPC which sat on its hands and did nothing when inflation pushed above 5% back in 2011. So 5% inflation can be ignored but 1.8% cannot?
Of course just as important is the issue of where we think that inflation will go next. Unfortunately for Martin he is part of a body which issued this Inflation Report just over a fortnight ago.
Inflation has been near to the target in recent months, and is expected to remain at, or a little below, 2% throughout the forecast period.
Perhaps Martin Weale is thinking of this category to which we discovered yesterday we can add one more to the list. The London Congestion Charge is to rise from £10 per day to £11.50 which this morning has been justified on LBC radio by London Mayor Boris Johnson on the basis “it was in line with inflation”. If we look at the official inflation rate it has in fact risen by just under 10%.
Mind you he was not alone in have problems number-crunching. From the Federation of Small Businesses via the BBC.
Londoners deserve a grown up debate about the merits of the current scheme in operation which is why an 11.5% increase is a regressive step.
What about the value of the pound?
This is an issue that Martin Weale’s interview appears to have missed. Even with the recent dip to US $1.67 the rise in the value of the pound’s exchange-rate is worth nine of the 0.25% rises in base rate that he discusses. It has had a strong dis-inflationary effect without so far having too much impact on output in something of a nice double act for the UK economy.
If we look forwards what troubles me is that a base rate rise now might give us an example of having too much of a good thing. Foreign exchange markets are likely to see a rise as the beginning of a sequence which could push the value of the pound higher. We have been in an overshooting period before and it did us little good. So we have an irony for UK monetary policy which is that right now, it is a strong rather than a weak pound driving UK monetary policy.
In my view this position is exacerbated by uncertainty over what the European Central Bank will do next Thursday. So far in 2014 it has promised much but delivered little and it would be very helpful for UK policy if it made its move so we could see the impact on the value of the pound.
I have described today how Martin Weale is suffering from various types of intellectual confusion. This is not the first time either that he has dithered because he actually voted for a 0.25% base rate rise from January to July 2011 before putting his tail between his legs and changing his mind.
As for me the current situation was rather aptly described by the Rolling Stones some years ago.
You can’t always get what you want
In the early days of this blog I argued that we should nudge base rates (to~ 1.5%) to respond to the above target inflation that I (correctly) saw on the horizon. But we did not do that and as a matter of timing it could go very wrong if we raise them now and see the pound push higher. That mistake has been made before.
Small business lending
Meanwhile the Bank of England’s flagship Funding for Lending Scheme continues to struggle.
Bank lending to SME businesses was -£723 million in the first quarter of 2014 under Funding for Lending.
Even the best bit looks very expensive.
The bad news is that the extra £536 million of Lloyds SME business lending cost us £2 billion of