After a series of false alarms, the moment of truth on interest rates is set to arrive this week. The Bank of England’s Monetary Policy Committee is widely expected to raise interest rates from their ultra-low level of 0.25 per cent on Thursday.
It will be the first time rates have been raised since 2007. There are still lingering doubts as to whether the MPC will indeed press the button – on at least two occasions, previous predictions by Bank governor Mark Carney that a rate rise was looming have proved false.
And on basic economic grounds, there seems little reason to move at this time. While the inflation rate has hit three per cent – well above the target rate at which the Bank is required to aim – this is mostly due to Brexit uncertainties that have worked to lower the sterling exchange rate, rather than to domestically induced demand pressures.
Consumer confidence is low. Household incomes are still falling in real terms and retail spending is down. As for business expansion and investment, the figures look decidedly weak. Business lobbies, most notably here the Scottish Chambers of Commerce, have persistently warned that with firms already facing intense pressure on costs, now is not the time to be raising interest rates.
So there is little to cheer – and potentially much to fear – from a rise in borrowing costs.
But set against this is the evidence of a persistent resilience in the economy. Numbers in work are at near record levels and unemployment at its lowest level since the 1970s. Firms are continuing to hire staff and there is evidence that the era of minimal wage growth may be coming to an end.
This, coupled with a growing conviction that the pound has little further to fall and indeed may be set for a modest recovery, suggests that a delay in raising rates now may leave the Bank struggling to control cost pressures in the period ahead.
And businesses may not be quite as vulnerable as previous warnings about the consequences of a rate rise have suggested.
Only last week the Scottish Chambers of Commerce no less released a notably upbeat assessment showing optimism in most Scottish businesses continuing to improve during the third quarter, reaching levels higher than a year ago in construction, financial and business services, manufacturing and tourism.
The survey, produced in conjunction with the redoubtable Fraser of Allander Institute, showed Scottish businesses “remaining resilient in the face of significant policy uncertainty and a fragile Scottish economy which continues to grow at below trend levels”.
Tourism was a stand-out performer over the third quarter due to the weak pound. And the financial services sector also appears to be building on its strong start to 2017.
Overall activity in construction continues to remain relatively fragile despite improving optimism.
A big problem highlighted by co-author Professor Graeme Roy is not that employers are cutting back and shedding labour in the face of Brexit uncertainties. It is that record high employment levels are increasingly leading to recruitment difficulties across most sectors.
Against such a resilient background, if we cannot begin to wean ourselves off ultra-low interest rates – originally introduced as a short-term temporary measure in the wake of the global financial crisis – when can we raise them? Better, surely, for the Bank to act now and go slowly than to act later and under pressure to follow faster with further rises.
However, as both Carney and Chancellor Philip Hammond well know, we are in a febrile period with the tortuous Brexit process and the attendant risk of political turmoil that could hit the pound. Business confidence is already sensitive to headlines on the growing likelihood of a “no deal” Brexit and the challenge to the government’s majority at Westminster.
And many households are on a knife edge. A report last week from the Financial Conduct Authority warns that half of us are “vulnerable” when it comes to our monthly finances. An extra bill, a period of illness meaning we are unable to work, an increase in interest rates on our mortgages, higher rents – all could lead to financial problems.
If debt or rent bills went up by £100 a month, nearly half said they would “struggle” with payments.
And “among those paying mortgage or rent, one in six state they would struggle if monthly payments increased by less than £50”, the FCA survey revealed.
Such considerations add to the pressure for an expansive Autumn Statement on 22 November with the Chancellor urged to boost economic activity by stepping up government investment while also easing up on welfare spending controls.
A rise in rates this week could be used as an argument to relax government “austerity” – and it would make Hammond’s determination to continue bearing down on debt and deficit. Sajid Javid, the communities secretary, has suggested that the government should borrow more for housebuilding. Other cabinet ministers have also suggested that some fiscal largesse might be just what the country needs.
But here the Bank risks being caught in a Catch-22: higher rates could add to pressure for the government to boost spending and thus domestic inflation pressures.
However, two points need to be borne in mind. First, the rate rise being pondered is small – an increase from 0.25 per cent to 0.5 per cent – hardly the stuff of which major business contractions are made.
For households such a rise would cause the typical variable mortgage to go up by £15 a month. It would need two or three similar rate rises to put people under significant stress.
The Bank governor would almost certainly wish to emphasise that a rise this week does not mean the Bank is intent on triggering a series of immediate further increases.
And second, there is a risk to the authority and credibility of the Bank were it not to act. It would be seen as another failure by the governor to follow through on the warnings he has given that a rate rise was likely. And it would open a flood of corrosive speculation that the economy is indeed in a parlous state and in no condition to move on from an emergency level of borrowing costs. If that is indeed the case, we would have more to fear than a rate rise this Thursday.