Interest rates

How will and how should the Bank of England, and the Treasury, react to this morning's continued fall in the value of the pound? I've been talking to former Bank of England executives and ex-Treasury officials, who make clear that the stakes are incredibly high and that reassuring markets will not be easy. This further devaluation in the currency is a serious problem for Chancellor Kwasi Kwarteng after his maxi ‘mini-Budget’ on Friday because it means the price of imports will continue to rise, stoking already-high inflation. And it raises the spectre that the government will struggle to borrow what it needs at acceptable interest rates, because of the falling value (in dollar terms) of sterling-denominated assets.

Rising interest rates is a key pillar of Trussonomics. Liz Truss herself has always stopped short of saying this explicitly, pointing fingers instead at the Bank of England for its failure to curb spiralling inflation. But the economists advising her have made clear, in no uncertain terms, that they think interest rates have been too low for too long.  Right from the start of her leadership campaign, Truss was far more vocal about her criticisms of the Bank; a point made even clearer once she entered No. 10 and her Chancellor Kwasi Kwarteng set up bi-weekly meetings with the Bank’s governor Andrew Bailey. With this new pressure being applied on the Bank, many thought it would make history today by implementing its first 0.

There is no shortage of reasons to feel gloomy about the American economy right now. First, there’s inflation. In 2021, the Biden administration claimed that the cost of a summer barbecue had declined by 16 cents from the year before. It probably now wishes it hadn’t made that claim. This summer, the cost of that barbecue is up not 16 cents but 17 percent. Hot dogs are up 37 percent over a year ago. This is the highest inflation in forty years, with the consumer price index up 8.6 percent from a year ago. Some necessities, such as gasoline and food, have risen even more sharply, with gas having gone from $2.18 a gallon when Biden was inaugurated to $5.

To nobody’s surprise, the Bank of England has hiked its base rate, and, equally unsurprisingly, it has chosen to do so by a relatively modest 0.25 per cent, bringing rates to 1.25 per cent. In 25 years of its existence, the Monetary Policy Committee (MPC) has never raised rates by more than 0.25 per cent at a time. That stands in contrast to the Fed’s decision to raise rates by 0.75 per cent on Wednesday. If the modesty of the rise was supposed to calm markets, however, it doesn’t seem to have worked. The FTSE100, already down nearly 2 per cent on the day, plunged further on the announcement.

Here’s the Rishi Sunak paradox: he proudly defines himself as a low-tax Tory but under his watch taxes are reaching a 71-year high. There are plenty of Tories who want to ditch next month’s National Insurance increase but Sunak is firmly opposed – mainly because he wants to link up in people’s minds that more money for the NHS and social care doesn’t manifest out of thin air. But pressure is on at tomorrow’s spring statement to make clear what kind of Chancellor he really is. Does he come from the long line of Tories who like tax cuts in theory but not in practice – or does he have another agenda? Sunak’s starting position is that to cut tax, you need to restrain spending. For the Chancellor, it’s a simple point about trade-offs.

So is this really it: the end of the era of virtually zero interest rates? There was a marked pullback in US markets on Wednesday when Jay Powell, the chair of the Federal Reserve, indicated that yes, he really did mean it: interest rates are on the way up, if not quite yet. ‘The committee is of a mind to raise the federal funds rate at the March meeting assuming that conditions are appropriate for doing so.’ Share prices, which earlier in the day had risen in expectation of a doveish stance, fell back sharply. The very idea that a central bank might increase interest rates to tackle rising inflation seemed to catch investors unaware – so used have we all become to ultra-low borrowing rates.

The Omicron variant of Covid-19 is rampant. Bars and restaurants are in crisis as thousands of bookings are cancelled. And travel restrictions are back in place, with a full lockdown looming. To make matters worse, so far there is little sign of the Chancellor Rishi Sunak stepping in with any support.  Most businesses probably imagined that the very last thing they would have to cope with right now was a rise in interest rates. As a result, there will be plenty of business owners complaining that the Bank of England’s decision to up rates to 0.25 per cent will be the final blow that will push the economy back into recession. But hold on. In fact, the Bank is completely right to hold its nerve and raise rates – and Omicron was no reason for postponing.

It is called managing expectations: the steady drip of forecasts and scenarios designed to prepare us for bad news, so that when that news does finally arrive it doesn’t seem nearly as bad as it would otherwise have done. So is that what the Bank of England is up to with its deputy governor, Ben Broadbent, telling us that inflation next April could ‘comfortably exceed’ 5 per cent? It is reminiscent of the moment in July when the Bank’s departing chief economist, Andy Haldane, dropped in the suggestion that inflation by the end of 2021 could be closer to four percent than three percent.

He isn’t Canadian. He doesn’t dominate the Davos circuit with platitudes about climate change. And he isn’t constantly warning that the British economy will turn into a cross between Ethiopia and Argentina now that we have left the European Union. In many ways, the current Governor of the Bank of England Andrew Bailey is an upgrade on his high-profile predecessor Mark Carney. And yet, in the most important respect, he is turning out to be very similar. He is constantly threatening to raise interest rates, and then backing off at the last moment.  An increase in interest rate from the ‘emergency’ level of just 0.1 per cent was not quite a done deal for today’s meeting on the Bank’s Monetary Policy Committee. But it was widely expected.

The most important macroeconomic development of the last three decades has been the extraordinary growth of the Chinese economy. In 1990, it was largely a subsistence peasant economy with a negligible footprint in world trade. China now provides the largest share of world exports, and by some standards has already become the world’s largest economy. In 1990, the wage of an average Chinese worker was perhaps 1/40th of that of an American worker. By 2020, it was just about a quarter: a tenfold gain in just 30 years. Before the 18th century, all societies were basically subsistence peasant agricultural societies with a small upper layer of landowning nobles and clerics. Then the Industrial Revolution began.

Andy Haldane’s departure from the Bank of England opened up one of the most influential roles in guiding UK monetary policy — and that role has now been filled. Huw Pill has been announced as the BoE’s new chief economist, taking up the post from next Monday. Some of the snap reaction is focusing on Pill’s similarities to those who came before him. Despite resources being poured into diversity teams to recruit a mix of applicants, it was Pill who was selected, a former Goldman Sachs economist and most recently a senior lecturer at Harvard Business School. Pill won't take kindly to ideas about reneging the Bank of England's independence But his ideology may prove very different from the other eight members of the Bank’s Monetary Policy Committee.

The economy is growing at a blistering pace, and likely to recover all its Covid losses by the autumn. Labour shortages are emerging across a range of industries, as the supply of Eastern European workers dries up. Prices are starting to edge upwards, house prices are soaring, and commodities are getting more expensive. But, hey, it is probably a good moment to keep the printing presses rolling and pump plenty of freshly minted pounds into the economy. The Bank of England’s Monetary Policy Committee (MPC) decided not just to keep base rates at 0.1 per cent today – that was largely expected – but also to maintain its programme of quantitative easing at £875 billion. And it may well have blown its chance to nip inflation in the bud before it starts to escalate.