Anatole Kaletsky
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At noon today the Bank of England’s Monetary Policy Committee will decide whether to raise interest rates for the second month in succession, or whether to wait for another month or two. I have no idea which way the MPC will vote and, in the great scheme of things, it is hard to get very excited about a change of just a quarter of a point. Over time, however, repeated quarter-point moves can add up to quite big economic changes.
Any family with a mortgage debt of about the national average level of £90,000 can readily attest this, since their annual interest payments are now roughly £700 higher than they were six months ago. If the Bank acts again today, then we can add another £225 to that annual figure and if interest rates rise again in the summer, as many economists are expecting, then the average homeowner’s interest payments will have jumped by well over £1,000 in less than a year. So in comparison with the average household income, which today is about £25,000 before tax, the cumulative effects of the quarter-point rate rises announced already, and the ones that may soon be coming, would bite quite painfully into their spending power.
Why, then, do I hope that the MPC will ignore any pain it may cause to the public and announce another rate increase today? The arguments for further action are quite simple. Inflation in Britain is already running at its fastest rate since the early 1990s. The housing market, far from slowing in response to last year’s rate rises or even stabilising after Christmas, seems to be taking off into the stratosphere. Meanwhile, economic growth, far from weakening as many analysts had expected, has accelerated quite strongly in the past few months.
Moreover, the same seems to be happening outside Britain. The world economy had been widely expected to slow in 2007 mainly because of a sharp decline in the previously booming US housing market. It now appears, however, that the widely dreaded US property crash is not going to happen. Nearly all the surprises in recent economic data, whether from America, Asia or Europe, have been in the direction of stronger growth. And, in the latest blow to hopes of lower inflation, the price of oil, which seemed to be on the verge of collapsing, has rebounded strongly in the past few weeks.
Putting all these factors together, it seems clear to me that inflation is now substantially higher than it should be and, more importantly, that the balance of risks points to even more inflationary pressure in the months ahead. What I think, however, is of no importance. What matters are the views and attitudes of the Bank of England and how these attitudes will affect economic performance and the quality of economic management in Britain, not just for months but for years ahead.
These issues have to be considered from at least three standpoints. How would the monetary decisions made today affect the British economy’s immediate prospects? How would these interact with the longer-term trends in the British and world economies? And how would they fit into the institutional framework for managing the economy that Gordon Brown created in 1997 and that has so far been remarkably successful?
The answer to the first question is now a lot clearer that it was even a month ago. The British economy is growing strongly and a further increase in interest rates would pose no immediate risks of a sharp slowdown, never mind a recession or financial crisis. Given that inflation is too high and oil prices are no longer falling, while property prices and mortgage borrowing are booming, there are good reasons for the Bank to tighten monetary policy a little further — and with no serious risks in acting now.
What about the longer-term outlook? Would higher interest rates today cause serious problems in the year or two ahead? Even if interest rates do have to rise eventually to higher levels, perhaps it would make sense for the Bank to move slowly, putting off unpleasant decisions for a few more months. Often there is a case for putting off decisions until the economic outlook becomes somewhat clearer or particular uncertainties, such as the price of oil, are resolved.
This, however, is not such a time. The next few years are likely to see an acceleration of global growth as America pulls out of its present slowdown, China and the rest of Asia continue to power ahead and Europe recovers from the temporary slump it is likely to suffer this year as a result of German and Italian tax rises. By early 2008 the whole world economy could well be experiencing a co-ordinated boom. Thus global inflationary pressures are likely to be much stronger in 2008 and 2009 than they are today. If Britain’s inflation is not back under control by the end of this year, it will be much harder to tame by next year.
This brings me to the third issue the MPC must face in making today’s decision: the Bank of England’s position as guardian of monetary stability and linchpin of economic management in Britain. A narrow, legalistic view of the Bank of England’s mandate leaves little room for doubt. The Bank’s job is to keep inflation, as defined by the consumer prices index, as close as possible to the 2 per cent target. If that target is missed by more than one percentage point, the Governor of the Bank must write a public letter to the Chancellor, explaining why this happened and how he plans to get inflation back on target.
Last month Mervyn King narrowly missed having to write such a letter, because inflation came in at 3 per cent rather than the 3.1 per cent that would have triggered the letter. Mr King explained in a thoughtful speech, however, what he would have said to the Chancellor if the figures had forced him “to restore the lost art of letter writing to British life”.
The main point he emphasised is that the Bank’s objective is not just to keep inflation a hair’s breadth below the 3.1 per cent ceiling, but to get it all the way back to 2 per cent. Unless the Bank can now show it is serious about achieving this, the credibility of the whole economic framework created in 1997 would be thrown into doubt and expectations about where inflation will settle in the years ahead will creep inexorably higher.
If that happens, interest rates will end up considerably higher than they have been in the decade past — and mortgage borrowers will suffer not just months, but years, of unnecessary hardship. When Mr King first became Governor, he often quoted the adage that “a stitch in time saves nine”. Today this is truer than ever.
Anatole Kaletsky is an Associate Editor of The Times and one of the country's leading commentators on economics. Previously Economics Editor of The Times, he has won many awards for his financial and political journalism. Before his appointment at The Times, Anatole worked for 12 years on the Financial Times in a variety of posts
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When commentators as rose-tinted as Anatole Kaletsky are acknowledging that inflation is back, and unemployment consistently rising, how long will it be, or how much evidence that it must take, to persuade the Chancellor and the Bank of England that the UK is headed for a period of stagflation?
Martin Kelly, Glasgow, UK
Central Banks have been printing new paper money like confetti for a long time now This has to go somewhere! Traditional economists expect events to move more quickly than they usually do in a complex world. It looks as if it takes many decades before decisions on printing money feeds back into inflation, but it happens one day. This is not quite fair; as the more ruthless politician or bank governor knowing this can put of the evil day until they have safely moved on or retired. But that is the nature of the humanbeing - short-term oriented. After all tomorrow never comes!
Brian Lewis, Manila, Philippines
I believe that the average family mortgage debt is around half that claimed at 'about' £45,000
al, Denby Dale, UK
You still have not made clear how the eurozone is doing so well at present and seems to have inflation more under control than we have.Could you also explain how you regard Britain as being a more successful economy than Germany's;to an ignoramus like me Germany's incredible export figures seem more preferable to our constant trade deficits.We are B&Q they are BMW and Mercedes.Do not say unemployment - the old Soviet Union had full employment and that economy was not much cop.
Joe Dignan, War5rington, England
The excessive financial liquidity in our economy has been engineered to allow consumers to finance their spending by borrowing. This has exacerbated our structural economic problems with both a public and private debt overhang that, as a nation, we are less and less able to afford. The Bank of England should now give a sharp shock rather than these petty little quater point rises. If they fail to get to grips with our spending bubble we will see some major currency revaluations that will cause severe economic pain.
Steve Marchant, Torquay, Devon
One may wonder whether a more dynamic and less transparent approach to production of some inflation statistics, (with occasional change to the contents of the basket) may now slightly obscure comparison with earlier decades.
The combination of the channelling of the inflationary force of cheap money into property and financial assets, and competitive pressure on farming and food retailing may, in recent years, have given a more benign appearance to some indicators of cost of living inflation, in particular as regards different sectors of society.
The question remains whether the technical advances in economic management, (principally increased accuracy and speed of feedback data and its numerical processing) and ongoing policy change will continue to moderate expected cyclical corrections to the comfort zone, or whether the effect is merely to timeshift increments forward to a possible future large adjustment.
dr venables preller, Warminster, UK
A large proportion of the population have paid off their mortgages and will view any increase in interest rates as a Good Thing. This will apply especially to retired people who are dependent on the interest on their savings.
Miranda Green, Hitchin, GB
The excellent simplicity of this analysis makes it difficult to argue against.
The fact that CPI inflation has been allowed to reach 3% demonstrates the mistakes of the MPC (and of the economists that correctly predicted their interest rate decisions!) over the last two years. By underestimating the effects of higher oil prices, taxes, public spending, and the booming housing market on general levels of inflation interest rates were kept too low for too long.
I now agree with the few economists who suggest that interest rates will need to be at 6% before the end of this year, otherwise they will have to be much higher in 2008. If the MPC knows rates will need to rise, then they should obviously move sooner rather than later.
A Clarke, London, Great Britain
The BoE is meant to set rates to control the CPI but this does not accurately reflect rises in the cost of living. The RPI is diverging from the CPI and as it does so people will start to lose faith in the BoE's ability to control price rises. Sure, consumer stuff like iPods, TVs and clothes are still getting cheaper, but try doing something essential like paying your gas bill, council tax or booking a plumber and you will really appreciate that prices for such important things are rising substantially. In these circumstances people will inevitably question whether the current inflation policy is effective which, as the article says, can feed back into raising inflation further as we anticipate price rises in the future. In my opinion basing interest rate policy on the CPI is something of a fudge and may be endangering the economy.
Stephen Grindle, London,
Article predicts "China will power ahead". I worked there last year and thus observed their boom firsthand. I think a financial crash/ correction out there in the next couple of years is inevitable. There is too much investment in property
and the financial institutions are not robust enough.
Chris, Sutton Coldfield, England