It is an often forgotten point, but central banks only control short term interest rates. All other rates are determined by the market.
In the US, the Federal Reserve are being reminded of that lesson right now. The Bank of England would do well to watch and learn.
In the wake of the credit crunch, the Fed reduced rates dramatically. However, all other rates remained stubbornly high. The Fed's frantic rate cuts might have prevented an immediate banking crisis, but it destabilized price expectation. Commodity prices shot up, the US dollar hit record lows against the Euro, and inflation is now rising. The focus on bank balance sheets has also eroded the Fed's counter inflationary credibility. Ideally, the Fed should raise rates, but it is unwilling to do so, and people are now beginning to expect a lot more inflation going forward.
These higher inflationary expectations are now feeding through into long-term interest rates. Last week, US mortgage rates soared amid a sharp rise in Treasury market yields. 30-year fixed-rate mortgages hit a three month high of 6.02 per cent. The previous week, rates were 5.81 per cent. Meanwhile, the "jumbo" mortgages – loans above $417,000 – rose to 7.21 per cent from 7.05 per cent. These market-driven interest rate hikes will only serve to exacerbate problems in the US housing market.
Over here in the UK, there is a to be learnt from the US experience. It points out the futility of cutting rates in the wake of rising inflationary pressure. The yield curve will soon twist upwards as inflationary expectations increase.
While the Bank of England avoided the mad dash to negative real rates, nevertheless, the MPC have kept rates far too low. Inflation is rising and the BoE seem reluctant to respond. Wage setters are beginning to pick up that the BoE are not serious about controlling inflation. If the MPC thinks that low rates will sustain growth, then the yield curve will confound them.