Reading the Bank of England's internet site always makes me laugh. There is a wonderful disconnect between rhetoric and reality. The bank talks a good game when it comes to inflation. Here is what they say about their principal objective:
A principal objective of any central bank is to safeguard the value of the currency in terms of what it will purchase. Rising prices – inflation – reduces the value of money. Monetary policy is directed to achieving this objective and providing a framework for non-inflationary economic growth.
This week, they had a chance to put their rhetoric into action. The monetary policy committee could have raised interest rates. Instead, they chose to do nothing, despite the growing and incontrovertible evidence that UK inflation is accelerating.
The reason for the decision is well understood. The monetary policy committee would like to keep commercial bank funding costs low. They would like to increase the difference between the interest rate banks pay to depositors and the rates banks receive on their loans. This is known as the fat spread strategy. Its purpose is to recapitalise the banks surreptitiously by imposing the costs on savers.
The absurdity of the situation is amply demonstrated by a simple thought experiment. Suppose that the financial crisis had never happened and that the Bank of England was faced with the same inflation data. What would be the most appropriate interest rate response to an inflation rate that has been above target for 40 out of the last 48 months? It would be a rate hike, of course.