Damned if it does and damned if it doesn’t: Bank’s rate hike quandary

A quarter of one percent hardly sounds like big potatoes. As most people with a current bank account know, even holding a balance £1,000 will only return £2.50 after a year.

But the prospects that the Bank of England will raise the main interest rate it uses to regulate the economy by 0.25% to 0.5% on Thursday is putting the wind up homeowners, businesses and families running large debts on their credit loans or via payday loans. And with good reason

If the Bank’s monetary policy committee goes ahead with the hike, it will be the first rate rise since July 2007. Since 2009, when the MPC cut rates to 1.5%, rates have been lower than any time in the Bank’s 323-year history. More importantly, every young adult in work or running their own firm has only ever known historically low borrowing costs.

Of course, interest rates will have to go up at some point. The strange thing is that although the need for a rate hike this week is in the balance, the bank has managed to box itself into a position where it almost has to raise rates.

There are two stories here: what is happening to the economy and the Bank’s communications strategy. On the economy front it is fair to say the balance is in favour of tightening monetary policy and raising rates.

the Bank has sent out a number of signals that have guided financial markets towards a rate rise

The latest official figures show that the economy is growing at 0.4%, and is accelerating. Unemployment is at a historic low which often means inflationary wage rises down the line. Inflation is already at 3% and so at the outer limit of the Bank’s remit. Stock markets are high and rising while the budget deficit came in lower than expected, handing the Chancellor Philip Hamond more money.

On the other side of the equation retailers are more pessimistic than at any time since the 2009 recession. House price growth is slowing as is wage growth while the construction sector is contracting.

In other words, there is no clinching argument either way but an overwhelming one each way.

The problem is that the Bank has sent out a number of signals that have guided financial markets towards a rate rise. Governor Mark Carney has indicated he is with the majority of the MPC who said in September that rates would “increase somewhat”. He also told BBC Radio 4 that it was “talking about easing a bit off the accelerator”.

That is very much par for the course for a central bank that wants to manage expectations over the course of monetary policy as the chair of the US Federal Reserve, Janet Yellen and her predecessor Ben Bernanke have done over the past five years.

The problem is that Carney has a mixed record on his signals. In 2014, he put borrowers on notice that a rate rise could happen “sooner than markets expect” but then followed up with evidence to the Treasury Select Committee a month later than pointed to no change. MPs branded him an “unreliable boyfriend”- an epithet that has stuck. It turns out he did the same thing at the Bank of Canada.

Whatever the Bank does it will be damned by someone

It is fine to change one's mind - John Maynard Keynes has an apposite saying on that front - but there is danger for a central bank governor doing it one too many times. As a result, Carney will be under pressure not to call wolf again given the risk of severe damage to his reputation - and financial market volatility - if it does not.

At the same time that leaves him vulnerable to another piece of bad news that will make any rate hike look perverse. Whatever the Bank does it will be damned by someone.

Into that mix must be put the households and businesses whose finances rely on cheap financing. To some extent it was their decision to load up on debt that has left them vulnerable but consistent signalling over the last couple of years might have helped them adjust.

Overhanging all this is a risk of a policy error. The European Central Bank erred when it decided to raise its rate in June 2008 in the midst of the global financial crisis and again, in 2011, while the eurozone was gripped by the sovereign debacle. Japan also has form on the mis-timed rate hike. The issue could become whether any rise is a mistaken decision.

The reassurance for indebted firms and families is that Thursday’s decision will be split with Gertjan Vlieghe, Sir David Ramsden and Sir Jon Cunliffe tipped to vote against. That could make any subsequent rate rises gradual. Many will breathe a sigh of relief.

More about the author

About the author

Phil has run Clarity Economics, a London-based consultancy, since 2007 and, before that, was Economics Correspondent at The Independent.

Phil won feature writer of the year Work Foundation Work World media awards in 2009, and was commended by the Royal Statistical Society in 2007.

He is the author of Brilliant Economics and The Great Economists.

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