Yesterday, the Bank of England passed up another opportunity to tackle inflation. It chose to keep rates fixed rather than hike them and tell the world that it would get serious about rising prices.
There is always next MPC meeting. If the MPC again fails to act, there is always the meeting after that. Difficult decisions can always be pushed into the future. Why risk taking a tough and unpopular decision when it can wait until next month.
Unfortunately, inflation isn't waiting around for the MPC. It is raging and looks ready to cross over the 4 percent mark by the end of the summer. Once it is there, a 5 percent inflation rate doesn't look so far way. Within 12 months, the MPC could find that short term real interest rates have turned negative.
The MPC will, of course, cite the "balancing act" defence. It has to "balance" the inflation risks with the threat of a downturn. This defence is becoming a little worn out. With every passing month, inflation keeps rising and the threat of a recession keeps growing. The MPC might think it is trading off higher growth for a little more inflation. In reality, it may end up with both.
If the economic difficulties of the 1970s prove anything, it is that there is no long run trade off between growth and inflation. Trying to keep growth bubbling along with low real interest rates only serves to push up inflation. Wage setters quickly react when central bank shows any cowardice before the inflationary enemy. Expectations begin to rise, and before you can say stagflation, the economy starts to suffer from a nasty case of a wage-price inflationary spiral.
There is still a short window of opportunity before the inflationary expectations begin to take off. The MPC could delay a rate hike for a few more months. Who knows, maybe the MPC might get lucky. Commodity prices might fall sharply; sterling might mysteriously begin to appreciate, and inflation might begin to fall.
Alternatively, inflation could continue to keep rising, and wage setters begin to demand higher wage settlements. Then, the MPC may look back on those lost opportunities, when in the summer of 2007, it could have acted decisively to bring inflation down, but instead waited in the hope that good fortune would help them out.
7 comments:
Alice,
Interesting comment. I too think the BoE dropped their bottle but I think total meltdown in the banking system is a bigger threat than price rises on oil and food.
Putting the rate up would aid the pound (and thus prices hit by the oil bubble) but wouldn't affect inflation. It might accelerate the deflation, which would be a good thing so long as there's no systemic collapse.
King is between a rock and a hard place so I think doing nothing isn't such a bad move.
Nick
There is no way that by keeping interest rates low, consumers will spend their way out of a recession... simple maths should tell anyone that after paying their taxes, food bills, energy bills and just getting to work, there is no money left. (Something Gordon Brown should do is to take a GCSE maths course!)
An economy that is based on borrowing IS NOT SUSTAINABLE, we need to actually start earning a living by making stuff and exporting it rather than passing the same money around between us for services and borrowing the rest to fund champagne lifsetyles.
The UK has had a party for the last 12 years or so and now it is time for the hangover and to pay for it.
God knows what could bring the UK out of recession this time ?
Alice, re your comment at mine, the Table you used is number 1.9 (I think).
On this basis, your original Nequity-o-meter was slightly wrong - your chart shows a straight line, but there is in fact a significant kink. i.e. a 30% fall in prices (another 20% to go!) means that only about 15% of mortgagors are in Nequity, as opposed to 30%, which your chart implied.
Any more than 30%, then the shit really hits the fan!
Mark,
Me? make a mistake, that could never be!
More seriously, it vaguely remember that I had to turn the data backwards to generate the chart (i.e sort it).
I will look at it again, and if I did make a mistake, I will of course repost and correct it. I will take a look at the data again in a few days.
Alice
markbaldy,
dunno if that was a reference to my comment, but I agree the consumer won't spend their way out. The point of keeping interest rates low is to stop the banks defaulting on their loans to each other.
Nick
Reply to Nick... No it was not a ref to your comment - all my own opinions.
The BOE rate seems to be pretty meaningless anyway as banks set whatever rate they want for savers and borrowers - depending on what level of risk they want and how desperate they are for funds.
They are in fact doing the BOE's job for them - the BOE/MPC are a weak set of jobsworths influenced by a government that is incapable of steering a trolley through Tesco's, never mind steering the UK through difficult times...the sma government that steered us into the mess actually !
markbaldy: Spot on analysis of the UK economic situation. Could someone tell Gordon?
Post a Comment