Bank of England rates
The Bank of England goes to considerable lengths to explain its thinking. Once a quarter, it publishes an inflation report (pdf) running to almost 50 pages and the minutes of the latest meeting of the Bank’s monetary policy committee. When inflation is more than one percentage point away from the target, as it is now, it also releases an exchange of letters between the Bank’s governor, Mark Carney, and the chancellor, George Osborne.
It is not really necessary to wade through all the analysis, though, because the late, great David Bowie summed things up in six words: always crashing in the same car. Wages and growth forecasts have been cut. Once again, the MPC has pushed back its estimate of when inflation will hit the 2% target. Carney is readying himself to send more missives to Osborne throughout the course of the year. Threadneedle Street thinks that the next move in interest rates will be up, but it is not 100% sure. The Bank’s sole hawk, Ian McCafferty, has given up the fight for the time being.
With all nine members of the MPC now unanimous in voting for borrowing costs to remain at 0.5%, the message from the Bank to anybody thinking about taking out a mortgage or a bank loan is that interest rates are going nowhere fast. Carney’s assertion in a speech in Lincoln cathedral last July that the rate decision would come into sharper focus around the turn of the year was quickly overtaken by events and now looks plain wrong.
Financial markets currently don’t expect interest rates to rise until the second half of 2018, by which time the governor’s five-year term at the Bank will be up. Threadneedle Street is cautioning against reading too much into what the markets think and it is certainly true that the mood in the City can change rapidly. Some economists still believe that monetary policy will be tightened in the second half of 2016.
So what would trigger such a move? Put simply, there would have to be evidence that ultra-low oil prices are having only a temporary downward impact on inflation and have helped disguise upward pressure on wages caused by falling unemployment. The Bank thinks that there is very little spare capacity left in the economy and the slack that remains will be used up during the course of this year. That would suggest an increase in the cost of borrowing long before 2018.
The problem, though, is that all the recent signs on wages and earnings have been pointing in the other direction. Since the last inflation report in November, the Bank has cut its estimate for average earnings growth from 2.5% to 1.75% in 2015 and from 3.75% to 3% in 2016. On past form, the chances are that the forecast for this year will be cut again, not least because the low level of inflation has started to drag down pay settlements.
There are three conclusions to be drawn from the inflation report, the minutes and the governor’s letter. The first is that it would now be a major surprise if interest rates rose this year. The second is that the Bank’s credibility has been dented by its failure to call the economy right and the confused messages it has been sending out to the public. Finally, the prospect of 0.5% interest rates extending into an eighth and perhaps a ninth year risks stoking up a housing boom. The Bank has so-called macroprudential tools that can be deployed to cool down the property market without damaging the rest of the economy. It is going to need them.