Bill Jamieson: Wanted urgently – a return of inflation

Where the European Central Bank has resorted to fresh stimulus measures to bolster the eurozone, will the Bank of England follow suit this week to boost the UK’s torpid economy?

Outgoing ECB president Mario Draghi has cut the bank’s deposit facility rate, paid by banks on reserves parked at the central bank, from an already negative minus 0.4 per cent to minus 0.5 per cent – the first cut since 2016.

He also said he was re-starting quantitative easing, buying €20 billion (£17.8bn) of debt a month from 1 November.

Sign up to our Opinion newsletter

The moves come as the ECB combats an economic slowdown. It has chopped its growth and inflation forecasts, warning of a serious slowdown even before taking account of a possible no-deal Brexit and any further deterioration in the US-China trade war.

“The protracted slowdown in the eurozone economy is actually more marked than expected,” he declared, cutting the bank’s forecast of 1.2 per cent this year to 1.1 per cent and from 1.4 per cent to 1.2 per cent in 2020.

On inflation, he said the outlook had been further downgraded. The annual inflation rate in the euro area is currently one per cent – the lowest since November 2016 and well short of the bank’s target rate of two per cent. More worrying for the ECB, longer-term market predictions point to inflation continuing to lag this target for most of the next decade.

In a new policy development, Draghi has resorted to the tiering of interest rates, to offset the damage caused by negative interest rates – reckoned to have cost the banks some €21 billion since negative interest rates were introduced five years ago.

Central banks have come under growing pressure for more quantitative easing and/or cutting interest rates even further in the face of looming deflation and slowing demand.

In the US, President Donald Trump has heaped further pressure on Federal Reserve chairman Jerome Powell, having already constantly badgered him to take action, labelling him at one point “an enemy of the people”.

“European Central Bank, acting quickly, Cuts Rates 10 Basis Points”, he tweeted last Friday. “They are trying, and succeeding, in depreciating the Euro against the VERY strong Dollar, hurting U.S. exports… And the Fed sits, and sits, and sits. They get paid to borrow money, while we are paying interest!”

The Fed’s Open Markets Committee is set to cut the Federal funds target rate range by 25 basis points to 1.75-2 per cent this week. Here, too, inflation at 1.6 per cent is running well below the 2 per cent benchmark.

However, Powell is unlikely to indicate that the Fed will embark on further rate cuts in the months ahead – an omission that could well ignite a further burst of fiery imprecations from the White House.

So might the Bank of England join the trend and cut interest rates from their current 0.75 per cent level when the Monetary Policy Committee meets this week?

That looks unlikely. First, the Consumer Price Index measure of inflation has been running fractionally 
above the 2 per cent target level at 2.1 per cent – though this may ease back to 1.9 per cent when August data is released on Wednesday.

And does the Bank need to take action by way of monetary stimulus? The UK economy got off to a significantly better-than-expected start to the third quarter as GDP rose 0.3 per cent month-on-month in July, easing fears that the economy is headed for recession.

This followed GDP contracting 0.2 per cent in the second quarter – the first time that the economy had contracted since the fourth quarter of 2012. July’s gain was the strongest performance since January after a flat performance in June. The uptick was the result of growth across all sectors. Output in services rose 0.3 per cent (its first growth since February) as did manufacturing output, while construction output rose 0.5 per cent.

Earnings growth hit a new 11-year high of four per cent in the three months to July and climbed to 4.2 per cent in July itself. And unemployment fell back down to a near 24-year low of 3.8 per cent.

The EY Item Club now forecasts that the economy will grow 0.3 per cent in the third quarter, helped by healthy tourism figures and positive government spending and investment. For the year as a whole it predicts growth of 1.2 per cent.

Meanwhile the fall in sterling in recent months – and its vulnerability to further falls should the UK’s political and constitutional crisis intensify – together with company and household stockpiling as 31 October approaches, could well push inflation back above two per cent.

Comments by Governor Mark Carney have repeatedly suggested that he thinks that the economy would need stimulus if there is a no-deal Brexit, thereby indicating that an interest rate cut would be more likely than a hike.

And if Brexit is delayed again, the extended uncertainty, EY’s Howard Archer predicts, would probably mean the economy growing by just 1.1 per cent in 2020, rather than the 1.3 per cent currently forecast.

Carney told the Commons Treasury Select Committee in early September: “On balance it’s more likely that I would vote to ease policy in event of a no-deal Brexit than not”.

However, a key constraint could be political: the Bank is barred from making any change in interest rates during the course of an election campaign. Given the huge uncertainty about when an election may finally be called and the febrile atmosphere at present, it may be reluctant to make any move for fear of being accused of bowing to political pressure.

This week’s MPC meeting will be the last before the UK is due to leave the EU on 31 October. The widespread expectation is that interest rates will be kept at 0.75 per cent with the MPC firmly in “wait and see” mode.

“Current heightened domestic UK political uncertainties,” says Archer, “reinforce the case for the Bank of England maintaining a watching brief. We doubt that any of the nine MPC members will dissent from this view.”

Barring some dramatic slump in our fortunes (and who dares rule that out these days?) that looks like a fair conclusion.