Interest rate rise: Better late than never, but not enough
Oh no! The cost of borrowing £100,000 has gone up by £150 a year! How could the Monetary Policy Committee hit us so hard while Covid rampages through the country? In fact, yesterday’s rise in Bank Rate to the dizzy heights of 0.25 per cent mostly betrays how absurdly low it had become, as if nearly-free money was the answer to all the nation’s woes. Still, we rejoice at a sinner that repenteth, especially when the sinner has been under such political pressure to delay (again) the moment to admit economic reality.
In practice, the increase in borrowing costs will have very little impact outside the money markets. Some of the unprofitable mortgage offers will disappear, but for most consumers the cost of a loan detached itself from Bank Rate long ago. Still, it is a valuable signal which breaks the spell, and a timely reminder that interest rates can go up as well as down, something of a novelty for much of the UK population.
Such a small number will have no discernible impact on inflation, which the Bank of England now expects to hit 6 per cent. It’s just as well the MPC is pretending to ignore the “discredited” Retail Prices Index, which has already hit 7 per cent, the highest for more than 30 years, and could well go up further when the next domestic gas price cap is imposed. The impact of that will coincide with the 2.5 per cent rise in tax from National Insurance increases in April, to produce a vicious cut in living standards for the worse-off quarter of the population.
This is hardly the fault of the MPC. It is far more responsible for dithering for so long and pretending that 0.1 per cent Bank Rate was appropriate. The fault goes back to Mark Carney, the previous governor whose predictions were so impressively wrong and who missed chances to start on the road to sensible interest rates.
Perhaps, since bottling the decision last month, the committee listened to the words of Carney’s predecessor, which finally allowed the scales to fall from their eyes. Last month Mervyn King spelled out brutally just how dangerous a path we are on. In what was dubbed his “King Canute lecture”, he warned that: “The case for substantial monetary expansion in March 2020 was framed as a response to ‘dysfunctional markets.’ But the monetary injection was not withdrawn once financial markets were operating normally. The stimulus was then justified in terms of ‘supporting the economy.’”
This latter is little more than wishful thinking, or a determination to ignore how important money is in influencing future inflation rates. Milton Friedman’s mantra that “inflation is always and everywhere a monetary phenomenon” has been quietly forgotten, when years of monetary expansion failed to produce inflation.
Well, we are about to find out whether it was just that the response has been much slower than it used to be. Nowhere is UK inflation more embedded than in the housing market, its double-digit rise supported by a raft of subsidies like the Green Homes Grant, now scrapped, which reached 47,500 homes rather than its 600,000 target, with admin costs of £1,000 per home. That “slam dunk fail” as Meg Hillier described it, is a mere rounding error when set against Help to Buy, the incentive which doubled housebuilders’ profit margins and boosted demand already inflamed by the (entirely unnecessary) stamp duty concessions.
Only this week, with timing that at least proved there were no leaks from the MPC, the Bank eased the rules to allow aspiring homeowners and their lenders to take on more risk. Successive policies which have encouraged this, accompanied by mortgage rates below inflation, have succeeded in taking prices and thus home ownership beyond the reach of millions for whom it is a natural choice. The remedy is not yet more subsidies, but conditions which reverse some of the recent rises in house prices. In essence, this means dearer money and tighter, rather than looser, lending conditions.
It is far from clear whether the MPC has yet grasped this, since the programme of money printing known as quantitative easing is being allowed to run on. The Bank buys government bonds, keeping the price artificially low, and allowing the government to borrow more cheaply. Stopping it yesterday would have sent a more powerful signal that this particular game is up.
More generally, it looks as though the generation-long bull market in bonds, driven by low inflation and minimal interest rates across the world, is finally coming to an end. There have been moments like this before, and the market has rallied, but the prospect now is for more rate rises to come. Today, lending to the UK government for 10 years will earn just 0.83 per cent per annum. Set against the Bank’s own forecast for inflation, that looks like money down the drain.