To be fair to the governor and his nine-strong rate-setting committee, their job isn’t really to set a course and sail on through no matter the economic weather. Central bankers must be pragmatists, not romantics, responding to the facts, not blindly following feelings.
But the seas of the global economy are seldom still. And while the Bank of England may think it is sitting safely in the harbour, refusing even to contemplate the choppy waters could prove the more dangerous decision. Without setting sail towards higher interest rates, the Bank may be worryingly exposed when the weather turns, the next crisis arrives, and the rain pours down.
In this week’s City A.M. Shadow Monetary Policy Committee, I voted for interest rates to go up. With strong consumer confidence, wages growing at their strongest pace in years, long-term and youth unemployment both coming down, and the US Federal Reserve gearing up to hike rates as early as next month, normalisation should be on the agenda.
The Old Lady, however, refused to budge. And few were expecting yesterday’s Inflation Report to make for such dovish reading, with the Bank potentially sitting still until 2017.
The delay is bad news. First, everybody knows that interest rates will go up – extraordinary lows of 0.5 per cent are unsustainable. Low interest rates are designed to stimulate the economy in times of trouble. These are anything but.
There are clouds on the global horizon, but the UK economy has been growing for 11 quarters – the third longest spell of continuous expansion in recent history. Of course, targeting 2 per cent inflation is the Bank’s primary remit, so when the headline rate stands at -0.1 per cent, the textbook says to do everything but raise rates. But this is not a textbook case. This low inflation is caused primarily by the low cost of imported, volatile goods, like oil, and the strong pound.
The argument for raising rates runs deeper than just pointing to the positives and asking “if not now, when?”. There are genuine concerns about the distortion such easy access to cheap credit is doing to asset prices, capital allocation and consumer debt. While borrowing is still comfortably below its unsustainable pre-crisis levels, the Bank is justifiably concerned that the household debt-to-income ratio, at nearly 140 per cent, is high. In an era of poor returns, households are saving just 4.7 per cent of their post-tax income – half what they were in the decade before the crisis. With a yawning current account deficit, this needs to change.
The Bank believes rock-bottom interest rates are a safety line, securing Britain to a familiar dock at a time when dark clouds are on the horizon. But the impression of being sheltered is misleading. Carney cannot wait forever – at some point he will have to cast off into open water. The longer he leaves it, the harder it will be.