Bank of England should be reckless and pause rates

It’s now inevitable that the Bank of England will hike interest rates tomorrow by 0.25 per cent, possibly even by a half a percentage point to 5 per cent.  

This would be the Bank’s thirteenth interest rate rise in a row and comes after May inflation showed that prices stayed the same as for April. In the vernacular, prices stayed sticky. Core inflation – which excludes food and energy – proved stickier even than toffee, rising to 7.1 per cent, the fastest rate for 30 years.

What most of the members of the Bank’s Monetary Policy Committee hope – and clearly believe – is that by raising rates again they will snuffle out demand in the economy. It hopes to make borrowing so expensive that consumers will rein in their spending, that mortgage holders in particular will be forced to stop spending on other goods because they are paying so much more on their mortgages and that businesses will curtail their investment plans. 

Yet there is clearly a problem with the classical approach being taken by the Bank – and being backed to the hilt by an even more myopic government. Raising interest rates is not working as they had hoped as demand has neither been dampened nor flattened across the economy.

Apart from one niche group of people: mortgage holders, who are being crucified on the altar of saving the economy. The Bank may think it’s using a Swiss army knife to slice away at spending but for Britain’s ten million homeowners it’s turning out to be an axe. 

Economists at Cebr reckon that homeowners renegotiating their mortgage deals in the next two years will face a whopping £8.7 billion increase in their payments as a direct result of tighter monetary policy. 

And startling new figures today from the Institute for Fiscal Studies estimate that 1.4 million homeowners will be spending more than a fifth of their disposable income on higher mortgage payments. Overall, those with mortgages face paying nearly £280 more each month than a year ago  – rising to nearly £360 for 30 to 39-year-olds. And for those living in London the hit will be bigger, with mortgage payments rising by around 12 percent of disposable income on average. 

In this sense, the Bank’s strategy is having an impact. Yet the target is a vulnerable one – the younger in society, often families with young children, most of whom have taken out big mortgages on their first home encouraged by ultra-low interest rates. 

But in terms of the Bank’s overall strategy, the target is too small: there are now only ten million mortgage holders in the UK and the number of households with mortgages has fallen sharply to around 30 per cent compared to 40 per cent after the financial crash. We all know why – a combination of higher prices and too few homes. 

There are several reasons why the Bank’s strategy is faltering; the pain is being aimed at a smaller group of people than previous experiments with interest rate hikes and many households are resorting to savings – or being helped by grandparents – to help make up for the higher mortgage and higher prices. 

There’s another even more pertinent reason: one that comes directly from one of the more dovish members of the MPC’s committee, Professor Silvana Tenreyro. And that is that the Bank should be setting rates on the basis of what will happen in the future and not what is happening now. 

In a significant speech a few months ago in the US – which went largely unremarked upon here in the UK – Tenreyro warned that the Bank had already pushed up rates too high and that they are now far higher than the economy can bear. Indeed, the Professor added that those who still want to raise rates are in danger of becoming Milton Friedman’s ‘fool in the shower’ who scalds himself by being too impatient.  Here’s Friedman’s full quote: “When the fool starts the water and it runs cold, he keeps turning the faucet and, eventually, because he’s impatient, gets burned.”

As Andrew McNally wrote for Reaction a year ago this week, inflation is always a government-induced phenomenon. What is extraordinary is that Rishi Sunak and Jeremy Hunt are prepared to get badly burnt by continuing to support Andrew Bailey’s Bank rises with their “whatever it takes” comments. Do they think they are Super Mario, the nickname given to the ECB’s Mario Draghi who famously warned he would bring out his big bazooka to save the eurozone? And they keep pledging that inflation will be halved by the end of the year without doing anything concrete to help achieve the ambition.  

Worse still, one of Hunt’s economic advisory council has even declared the Bank of England needs to “create a recession” in its efforts to stamp out the toffee. 

It’s difficult to judge whether Sunak and Hunt have given up on economic and industrial policy altogether, hoping they can push all the blame and pain onto Bailey at the Bank (who should share in the blame for keeping rates so low for so long) or have they just given up altogether, getting ready to leave a note to Labour saying the money has run out? 

It’s difficult and depressing to know which of the two is the more accurate, but either view is depressing. Because there are alternatives and so much more that can be done.  

First, ministers should be putting a rocket under other measures already in the pipeline to ease up the labour market, make it attractive for the millions of people who have chosen not to work either because it doesn’t pay because of our punitive tax regime. They need to find ways of acting far faster to entice those who are among the nine million “economically inactive” to come back into the workplace with better childcare, work coaches and occupational health interventions for those who are off sick.  

Another great idea is from economist Simon French at Panmure Gordon who suggests providing potential workers with a National Insurance holiday for six months for those going back to work from Universal Credit, or a period out of employment.

Perhaps most reckless of all would be the decision to pause interest rate rises now and wait to see the future as Tenreyro so sensibly suggests. There is absolutely no harm in saying when the facts change, I change my mind. So should those of the policymakers. Otherwise this Conservative government will go down in history as the one who made owning a home as expensive as owning a castle. For the few, not the many.

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