Friday, 5 September 2008

Handing out the candy

These days, there is something ritualistic about the MPC's monthly rate decision.

The ritual starts with the breakfast shows, who pull in a few economists from the city banks, and ask whether rates will be cut. The economists say no, pointing out that inflation is too high. The reporters follow up with "if not now, then when". Disappointment levels are directly related to the suggested length of time before the next rate reduction. Sensing the disappointment, the eager economist reassures the reporter. "Don't worry, we will see lower interest rates soon.

The day finishes off with something similar. There is an ex-post one minute spot on the evening news. Reporters lament the lack of a cut, while the economists offer empathy and the happy prospect that the rate cut drought will soon end, "just as soon as inflation starts to come down".

The underlying assumption is always the same - rate cut good, rate hike bad. TV commentators are like children standing around the playground debating whether mum will buy some sweeties on the way home from school. Like children, who are never too keen on discussing issues such as dental care and calorific intake, the media are reluctant to seriously discuss the implications of a few more years of cheap money. The immediate satisfaction of eating something sweet and sticky is all.

The blind faith in rate cuts is troubling. Does anyone really believe that a brace of 25 basis point cuts will hold off a recession? What exactly would drive this recovery? Presumably, lower rates cut mortgage repayments bills. People go out and spend their savings, keeping UK firms in business. It also encourages consumers to pull out the plastic. As demand increases, firms take advantage of lower rates to increase investment.

Where does the huge levels of personal debt fit into this story? Here we come to a rarely considered implication of more rate cuts, centred around wage stagnation and debt. The rate cut gang think that wage pressures are muted. There is some evidence to support this view. Wages, adjusted for inflation, are falling. Most of the recent inflationary pressure has come from commodity prices, rather than inflationary wage demands.

However, if wages are falling, it is hard to see how spending is going to pick up, unless you think that lower rates increase consumer borrowing. More consumer debt; it is heavy price to pay for a rate induced recovery.

In the post credit crunch world, things really are different this time. Rate cuts are no longer the cheap and cheerful route to prosperity. The MPC has already reduced rates twice in the last year; the economy continued to slow; sterling crashed; and inflation picked up. The cuts didn't stop house prices from falling or loan default rates from rising. It is hard thing to accept, but lower rates will not pull the UK economy out of trouble.


Markbaldy said...

Gordon Brown took credit for the "miracle" UK economy which was just not sustainable - being based alomost entirely on borrowed money... personal debt taken out against self feeding house price inflation and gevernment spending - figures fiddled of course...PFI's etc...would you expect ANY truth from New Labour ?
Rate cuts will NOT work this time, people's appetite to get deeper into debt has evaporated, as their focus has shifted from "moving up the property ladder" to simply surviving - paying their bills and staying in work.
Gordon Brown and his cronies DO NOT live in the real world so they don't understand (or are in denial!) that the UK economy is close to collapse.. thanks to THEIR policies (even though they still blame the US sub prime market for our troubles).
By influencing the BOE to keep rates low, they are just getting the UK deeper into debt - a bit like revving the engine and spinning the wheels of a car when stuck in mud - the harder you rev, the further you sink... trouble is that Gordon Brown will sink and take the rest of us "hard working" families with him !

Anonymous said...

More good news:

House prices suffer biggest fall since records began
All comments ()

* Thursday September 04 2008 09:21 BST


Rebecca Wilder said...

Hi Alice,

I like this commentary a lot. I found myself thinking a similar thought today when the US employment report came out. Average hourly earning rose 0.4% - the inflation hawks over at the Fed may see this as negative news, but what's bad about it? At least workers, who are really strapped for cash right now, would be able to better afford to buy the things that they need ( I know that 0.4% is really nothing, and likely the function of low-wage income earners being forced out of the market). At some point, one needs to care about the welfare of the workers who are able to remain employed.

Thanks, Rebecca

Funny Circus Bears said...

Here is the best rant I've yet seen:

Anonymous said...

No, interest rate reductions (even if they come, and the ECB won't support them) will not save the UK housing market. But what is so tiresome is--as you point out--the endless rotation of demands for cuts followed by peevish queries of "Then when?" If the UK media had a single vertebra in their backbones, they would start asking a different question. Like: Why were interest rates kept so low for so long, resulting in the credit bubble and collapse? Too bad the only serious inquisitions are coming from bloggers with small audiences, like yourself. Reading UK newspapers and watching UK TV is a flaccid, vapid experience--undoubtedly reflecting the tastes and thought processes of the average Brit only too well, whose only interest is in getting bladdered and the date for the next Bank Holiday. Pitiful. bring on the crash.

Anonymous said...

The crash is going to be very refreshing. Think of all the debt as a giant, impacted turd that needs to be passed. Once passed, everyone will feel much better and lighter on the feet. Time to start eating the Ex Lax and buy some loo air freshner and get a good paperback - Britain is going to be in there for awhile.

electro-kevin said...
This comment has been removed by the author.
electro-kevin said...

I have a friend who's determined to get into buy-to-let.

His arguments sort of make sense. That there will be a flood of cheap property and that soon it will be time to start building a portfolio. His aim is a long-term purchase of properties using other people's money rather than to make quick profit.

I suppose your attitude to this depends on how optimistic you are about the future.

So what is the future for Britain over the next 20 years or so ?

My feeling is that we may well have 70m people looking for housing, but but so what ? Most of them will be impoverished and this - as well as the value of the pound - will determine a low value for your housing stock.

Is BTL still a good idea ?

In fact ... is Britain still a good idea ?

Mark Wadsworth said...

Alice, there's a fine tradition that you missed - that is that The Halifax release their monthly houseprice (crash) report a few hours before MPC announcement in the vague hope of nudging BoE rate down.