Has the Bank of England lost touch with reality?

Catching up with reality is never easy. The Bank of England’s Monetary Policy Committee is finding it particularly hard, electing instead to raise the Bank Rate to the dizzying heights of 1 per cent on Thursday. Bizarrely, this minimalist rise accompanied an admission that inflation in the UK could reach double figures, which is surely at the pessimistic end of others’ projections.

Perhaps, with a nod to that famous inventor of “forward guidance”, Mark Carney, the majority of the MPC decided that the mere mention of 10 per cent price rises would be enough; a sort of mouthy monetarism. We see such terrible things ahead that a mere 0.25 per cent rise in Bank Rate should be enough to stop them happening.

It’s hard not to feel some sympathy for Andrew Bailey, the Governor who has caught the hospital pass from Carney. He may, or may not, be up to the job, but most of the blame must surely go to his predecessor, parachuted in from Canada in 2013, and who richly deserved the epithet “the unreliable boyfriend” for persisting with forward guidance in the face of its failure.

Inflation, for those of us who can remember, is a slow-turning engine, hard to start and very painful to stop. Forecasting the future is always difficult, but the signs that the beast was alive and kicking were obvious long before the war on Ukraine. The monetarists, who essentially believe that inflation is a phenomenon of too much printed money, were warning of excessive supply before the pandemic. Inflation had refused to stir for so long that they were ignored, not least by the MPC, with the notable exception of Andy Haldane, who left the committee in June last year.

In December last year, Carney’s brilliant predecessor, Mervyn King, was warning of trouble ahead: “The case for substantial monetary expansion in March 2020 was framed as a response to ‘dysfunctional markets.’ But the monetary injection was not withdrawn once financial markets were operating normally. The stimulus was then justified in terms of ‘supporting the economy.’”

By the end of that month, the warning signs were glaringly obvious.

So what now? A Bank Rate of 1 per cent is still laughably low by any standard other than the very recent past. Capital Economics now forecasts 3 per cent next year, and even that might not be enough to stop a wage-price spiral. Much depends on the path of house prices. Driven by teaser rates on mortgages, demand has produced an unprecedented boom, fueled by some foolish government policies. The buyers, desperate to get onto what has been a house price escalator, do not look beyond the next few months’ payments, while the banks, awash with spare capital, are pushed by the lending rules into domestic mortgages above everything else.

The combination of dearer energy, higher National Insurance, and the disappearance of ultra-cheap mortgages is toxic. It is very hard to see how house prices can continue to rise against such a backdrop, however desperate people are to own their home. Something has to give.

A different Mortgage story

We can’t say we weren’t warned. It is over a year since Britain’s most successful fund manager signalled that 22 years was long enough running Scottish Mortgage Investment Trust, and that he would go in April this year. Those shareholders who decided the announcement meant that things would never be the same again have saved themselves a 20 per cent loss as the price has tumbled with the re-rating of the world’s technology giants.

James Anderson saw the future of technology like no other UK fund manager, making big bets on the likes of Tesla when most of us just saw an overpriced obsession. Scottish Mortgage became the UK’s leading technology stock, a nice irony since almost none of the underlying investments was a British company. The shares multiplied ten-fold in a decade.

The Anderson faithful are now having their loyalty and patience tested. From a peak of £15, the shares are down to £9, a two-year low. The handover to Tom Slater, who has been helping run the portfolio for seven years, is as smooth as these things can ever be, and the discount to the underlying asset values is a slim 3 per cent, indicating continued enthusiasm for tomorrow’s world.

Yet Slater is operating in a different environment. Constantly falling interest rates helped sustain valuations of businesses whose profits (if any) were over the horizon. Rising rates reduce today’s value of those future earnings, bringing down share prices even where prospects look just as good. Besides, as Simon Elliott, Winterflood’s investment trust king, put it: “Anderson is not a man content to simply make money for his investors but one who also wants to win an argument,” No pressure, then, Tom.

Taxes, not sanctions (again)

Pssst…wanna buy some cheap oil? If you’re not fussed that it’s Russian, there’s a $35 a barrel discount. Your risk is that America, which is pledged not to buy any, steps up the pressure on Putin by causing money problems for any company, anywhere, caught purchasing it. The mere suggestion is enough to discourage many state-owned buyers, and the discount offers an indication of how big a tax the western nations could levy on imports from Russia.

It would certainly be enough to encourage users to find alternative sources, and if the billions of dollars raised were to be paid to the International Monetary Fund towards the cost of rebuilding Ukraine, it would also infuriate the Russian president. Much better than sanctions.

Today’s A Long Time In Finance podcast with Jonathan Ford and Neil Collins features Paul Tucker on the 25th anniversary of the independence of the Bank of England. Mr Tucker was on the MPC for five years until 2013.