INTEREST rates won’t be going up any time soon, even though the economy is now booming. The reason is simple: the Bank of England is deadly serious about using other tools to calm down the housing market if it feels that it is overheating; interest rates, or at least the Bank base rate, are now the instrument of last resort to control asset prices.
In the words of Mark Carney, the Bank’s governor, they are “the last line of defence” if all else fails. The new tools at the Bank’s disposal are macroprudential levers: for example, banks could be asked to hold a lot more capital against the mortgages they write, which would immediately push up the cost of borrowing for new homebuyers. That would make mortgages less affordable for everybody bar cash buyers, cut the demand for housing and stabilise the market.
There are two problems with this approach. It will deliberately and directly target people who are about to buy a home with a mortgage; in the past, everybody for whom the Bank rate mattered would have been affected too, with winners (savers) as well as losers (those with floating rate debt). The politics of a macro-prudential tightening are trickier: there are no winners, and the costs are concentrated on a small group of people, many of whom could suddenly see their plans to buy a house collapse. They are bound to protest loudly.
The biggest issue with the Bank’s new approach is that it will allow key distortions to remain unchecked, even if it succeeds in popping the odd bubble. It makes no sense that the base rate remains negative in real terms; it is crippling savers, keeping zombie borrowers alive on life support and having all sorts of hidden but very real effects on the economy.
Prices need to be meaningful to avoid a misallocation of resources and miscalculations by economic agents; keeping the base rate so low for such a long period of time will have dire consequences.
One reason why the Bank does not want to hike rates is that it believes that there is lots of slack left in the jobs market, despite a surge in employment and rocketing vacancies. The Office for National Statistics estimates that 9.6 per cent of the workforce would like to work more hours, and is thus, on that definition, under-employed; this is significantly higher than the 6.3 per cent under-employment rate we saw in 2002-07, prior to the crisis.
But under-employment is bound to continue to fall rapidly. The number of people in work is up by 2.4 per cent over the past year and the total number of hours worked has risen 2.7 per cent. Employment for those aged 25-34 has surged four per cent over the past year. These are remarkably strong numbers, marred only by bad news on productivity. Output per hour worked, which had started to grow in the past couple of quarters, fell back 0.1 per cent or so in the first three months of the year. Wages remain weak, but this masks huge variations.
Earnings are crashing in financial services, where they are down 0.7 per cent over the year to the first quarter, but pay is accelerating in other sectors, including manufacturing (2.7 per cent), construction (2.1 per cent) and retail (3.6 per cent).
There is another problem. While there is more under-employment, we are also seeing increased over-employment (defined by people who want to work fewer hours). This has increased from eight per cent of the workforce to nine per cent, as Citigroup’s Michael Saunders points out; the gap between under and over-employed has fallen from 1.8 per cent of the workforce in the first quarter of 2013 to 0.6 per cent now. The slack is fast diminishing.
We won’t know for several years yet the outcome of the Bank of England’s great gamble. I’m sorry to say that I’m not optimistic. Keeping interest rates so low for so long will end in tears, regardless of the Bank’s fancy new macroprudential tools.