Photo by Sharon McCutcheon on Unsplash
So the Bank of England has finally raised interest rates above their 2008 low! Don’t get too used to this: the Old Lady immediately signalled for calm through a plausibly deniable interview by an outgoing policy maker.
Writing about monetary policy committee’s decision for a property publication, I was reminded of an article I wrote for The Scotsman way back in 2012. It was one of my first real scoops for the business desk, after I was passed a Credit Suisse note arguing that accommodative monetary policy was here to stay.
It’s hard to believe, looking back, that six years ago markets were on edge because there was an expectation that the record low interest rates and quantitative easing (QE) programmes central banks had introduced to counter the financial crisis and recession would soon be put into reverse. Even as a relatively junior business reporter, I was inclined to think: ’why?’
The economy was a long way from anything that could be considered ‘overheating’. As a new homeowner myself at the time, it was also clear that in the UK at least, raising rates back to their pre-crisis levels of around 5% would lead to a crash that would make the credit crunch look like a minor correction. Quite simply, there was just way too much debt out there, and people’s ability to service it was sketchy at best.
At the same time, the Government also had a huge and growing debt pile and plans to bring it under control amounted to gently balancing the books over a number of years. Anything else would have been too great a shock on the fledgling recovery, and therefore counterproductive. But the state was reliant on low rates and QE to ensure the debt was serviceable – at the time, that was how the UK was avoiding the kind of capital markets crises that shook even relatively spendthrift Spain, despite the UK having a much higher ration of debt-to-GDP.
Far from being on the point of raising rates, therefore, it seemed to me that the Bank of England was desperately trying to hold on to the last vestiges of credibility regarding its commitment to fight inflation, while at the same time pretending that things were nowhere near as bad as they were. The ECB was the only Western institution to be resisting unconventional policy measures and that was looking like a mistake. It still does, because it was always going to take a generation of low rates and unchecked mild inflation to gently bring the West’s debt/growth/employment problem under control.
Some of that work is now done: According to the Office for National Statistics, prices in the UK in 2018 are 30.28% higher than prices in 2009. In effect, we’ve inflated away almost a third of our pre-crisis debt, without lifting a finger and with no fanfare. Modest genuine GDP growth means the government has fared even better with its real-terms debt.
As my friends at Credit Suisse argued back in 2012, this is reminiscent of the monetary and fiscal policy of the decades following the Second World War. Back then, a number of blunt instruments such as capital controls were deployed to ensure financial institutions played ball and acquiesced to roughly 30 years of real negative interest rates before deregulation began in the 1970s, just as rates finally rose to check inflation that was finally becoming a real problem.
These days, central banks have not resorted to such draconian measures… although the Solvency rules drafted to underpin financial stability have tone convenient effect of making institutions hold cheap government debt. Arguably though, the biggest weapon central banks have at their disposal to combat inflation is expectation: Again and again since 2008, we have seen stock markets fall on good economic news because traders believe it increases the chance of central banks finally raising rates.
Central bankers have constantly talked up the possibility of rate rises. It is in their nature to do so. They simply have to pretend that they are aggressively targeting inflation and are ready to hike rates to protect their national currencies at the drop of a hat: otherwise, growth-friendly policies will be seized upon as weakness and cause an inflationary spiral. It is all the more surprising, therefore, to hear an outgoing member of the Bank of England’s Monetary Policy Committee say what he’s thinking.
Ian McCafferty, one of the MPC’s external members, used his valedictory interview shortly after the August meeting to predict that the era of low interest rates will last for at least another 20 years. He believes the base rate will gently rise, but will stay well below the pre-financial crisis standard of 5%.
“It is too much to say never, that we won’t ever go back. But there is a 20-year horizon under which there will be factors keeping it low,” he said.
That fits in nicely with the post-war timescale, given that we are now a decade into the current monetary easing programme. No doubt, small rates rises will be drip-fed tactically to keep the fig leaf of inflation-targeting policy fresh: but the job is far from done. Growth may seem healthy when viewed from the ivory towers of industry in Northern European capitals, but the man and woman on the street still consider that they are paying the price for the banks’ great folly.
Like their grandparents who went through WWII, people now expect to enjoy their time in the sun after struggling through a decade of being denied growth. Whatever your opinion of the moral equivalence of this perception, new generations expect opportunities to at least match those afforded their predecessors, with many already turning to populism when this is not forthcoming. Central banks, therefore, have their hands tied.