Here’s the puzzle that the Bank of England has now set us: the prospect of a rise in interest rates for an economy suffering low income growth and beset by a fog of uncertainty over Brexit.
Surely this is the least opportune time for the bank to utter dark hints that a rise in interest rates may come sooner than the markets had been expecting?
While maintaining rates at their ultra-low level of 0.25 per cent last week, it said higher inflation and a pickup in growth could lead to a rate hike in “the coming months”.
Let’s not get overexcited. The Bank’s Monetary Policy Committee has met no fewer than 97 times since rates were cut to an “emergency” low in March 2009. And in 96 of those meetings the result was no change in interest rates. The one exception was in the wake of the EU referendum last year – when rates, far from being raised, were cut.
Two members of the Bank’s rate setting committee, Ian McCafferty and Michael Saunders, voted for the third meeting in a row to increase rates. A move now, they argued, would prevent a sharper rise.
Can it really be true that after more than a year of dire warnings over Brexit consequentials, faltering business confidence and investment and near-stagnant growth in household incomes, the economy is now judged to be displaying a momentum justifying a marked change in interest rate policy?
After all, as Liz Cameron, head of the Scottish Chambers of Commerce – which now seems to have supplanted the silent CBI Scotland as the voice of business – “increases in average weekly earnings are failing to outpace inflation, which continues to impact consumer spending and restrain wider economic growth”.
Now it pays always to be on guard for the counter-intuitive in economic policy. And here we seem to be on the edge of one such moment: a rise in interest rates as a precursor to a pick-up in growth – a pick-up barely evident in the daily deluge of business commentary.
Yet here we are. As bank governor Mark Carney put it: “The majority of members of the Monetary Policy Committee, myself included, see that that balancing act is beginning to shift, and that in order to... return inflation to that 2 per cent target in a sustainable manner, there may need to be some adjustment of interest rates in the coming months… That possibility has definitely increased.”
The minutes of the latest decision by the Monetary Policy Committee recorded the view that there was a “slightly stronger picture” for the economy since its forecasts last month thanks to signs of a firmer housing market, stronger employment and a rebound in retail and new car sales.
As a consequence, the nine policymakers on the panel believed “some withdrawal of monetary stimulus was likely to be appropriate over the coming months”.
Paul Hollingsworth, UK economist at Capital Economics, said the MPC could increase interest rates in November, “if the economy continues to hold up, and could come somewhat earlier than we had previously envisaged, possibly as soon as the next meeting in November alongside the Inflation Report”.
It’s an assessment that appears to fly in the face of consensus views about the health and vigour of the UK economy and forecasts about prospects ahead.
But it is one with which I broadly agree. Throughout the year, and notably in the past few months, we have seen a better than expected performance by the manufacturing sector and stronger Purchasing Managers Index readings than we had been led to expect.
This is not to deny that many companies are apprehensive about the impact of higher input costs as a result of the falling pound. But here we come to an alternative interpretation of the bank’s dark statement last week. Might it have been calculated to staunch the recent fall on the pound and cause sterling to rise, thus moderating the concerns of businesses and households alike about rising import costs?
That’s the view of James Athey, investment manager at Aberdeen Standard Investments: “They’re doing this,” he says, “because they want financial markets to support sterling since this would help deal with the current bout of inflation. But the reality is that they aren’t going to raise rates particularly soon. They’re playing a game of chicken with financial markets and will keep this up as long as they can.”
It’s a dangerous game to play – but it has had an instant result: the pound climbed more than 1 per cent against the dollar to $1.336 after the bank’s announcement. And as if that wasn’t enough, a senior bank official said on Friday that the “moment is approaching” when it might need to raise interest rates.
Gertjan Vlieghe, who sits on the MPC, said there are signs the UK economy is picking up and can handle a rate increase. His comments were followed by a further rise in sterling above $1.35 to a 15-month high against the dollar.
I suspect it’s not a bluff and that we are at a turning point.
Time for SNP to fulfil manifesto promise
If the SNP administration is critical of a rate rise at this time, they should be equally averse to any further rises in income tax in Scotland.
As the Scottish Retail Consortium pointed out in its recent budget submission to Holyrood, disposable incomes do not stretch as far as they used to and are set to be challenged over the coming 18 months by a combination of inflation, rising council tax and higher employee pension contributions.
With 441,000 Scots in pension auto-enrolment, the statutory minimum contribution is set to rise in spring and again in 2019. “Against this backdrop, income tax rises make little sense. A 1p increase across the three existing income tax rates would reputedly take £475 million out of consumers’ pockets, equivalent to almost 2 per cent of total retail sales in Scotland.”
Scottish ministers, it suggests, should consider bringing forward their manifesto commitment to create a new £250 zero-rate income tax band. This would effectively increase the tax-free personal allowance over and above existing plans – giving the opportunity to increase the allowance more quickly than in the rest of the UK – and bring a timely boost to consumers, the economy and employment. Let’s hope they listen.