Has the Bank of England developed a bit of a personality disorder? Looking at the mixed signals given by the Bank in the last six months, you might be forgiven for thinking so.
The Bank’s Governor Mark Carney has a habit of keeping the markets guessing - something City analysts suspect he enjoys - and he has certainly been true to form of late.
In November the Bank hiked interest rates for the first time in ten years, while at the same time issuing an inflation report that returned to the dovish language of August and suggested this was to be a “one and done” rate hike.
Fast forward to last week, when against all expectations the Bank warned interest rates may have to rise more quickly, and perhaps more steeply, than markets had thought.
Yet when asked a direct question in the following press conference about the future path of interest rates, Mr Carney appeared to row back on that warning, suggesting a return to normal interest rate levels – somewhere around 5 per cent - was still a long, long way off and may never happen.
So what on earth is the City supposed to do? Until last week, most analysts had pencilled in a 50 per cent chance of a rate hike in May but, in reality, didn’t really expect a rate hike until November at the earliest and possibly not at all this year.
Now City analysts give a rate hike in May an 80 per cent chance. Interest rates were forecast to reach 1.25 per cent by around 2020. Now some analysts think they could rise to 1 per cent by the end of this year.
Despite the about turn in the Bank’s tone, not a great deal has changed in the data. The Bank’s November inflation report suggested it was expecting CPI to return to its 2 per cent target over a three-year time horizon, and weak economic growth for several years to come.
The global economic boom has changed only some of that. With Europe, the US and China all growing at a decent clip at the same time, the UK, it seems, will be a residual beneficiary.
Instead of seeing 1.4 per cent growth this year as forecast by the Office of Budget Responsibility (OBR), the Bank thinks Britain’s economy could expand by a slightly healthier 1.8 per cent.
Moreover, Mr Carney suggested last week that spare capacity in the economy had all but been used up.
If this is true, then wages will have to rise as businesses struggle to find employees, it also means businesses are expanding and investing more than previously thought. All of which is inflationary, and at a time when inflation remains at an uncomfortably high 3 per cent.
But there are problems with this argument. Firstly, the UK’s productivity growth remains on life support, according to the most recent official figures, so the evidence of business investment is lacking.
Secondly the number of people registered as self-employed in recent years has exploded, so it’s hard to know how much pressure on wages there will really be, and the quality of the jobs available to a lot of people remains quite poor, and the numbers are often mixed up with the self-employment figures thanks to the creation of the “gig economy”.
That’s not all. Raising interest rates too high, too fast presents a systemic economic risk of its own.
A family with a £200,000 mortgage paying interest of around 2.5 per cent today could see their monthly repayments leap from £897 to £1,414 a month if interest rates were to return to normal.
If you think this is scaremongering, the average two-year fixed rate mortgage in 2007 - when interest rates were a ‘normal’ 5 per cent - charged 7.08 per cent.
So people could lose their homes. It really could be as stark as that.
Brexit, Brexit, Brexit
It’s still possible the Bank won’t raise rates in May. And it is unlikely to want to move beyond 1 per cent in a hurry.
But the Bank now sees two major threats to the British economy: inflation and Brexit.
The Bank has calculated it needs to tackle inflation now, in case some of the more frightening Brexit economic forecasts leaked last week turn out to be true.
At that point, the Bank’s only stimulus weapon will be to lower interest rates again. But if interest rates remain at 0.5 per cent, any further cuts won’t go deep enough to make much difference.
It may not have been mentioned much by the Bank, but what it remains really worried about is Brexit. Better to raise rates this year and have some room to cut next than have nowhere to go at all.