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Economic Update – Rate rise not the solution to MPC’s credibility problems

Roger Bootle’s response to March’s MPC meeting


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  • I agree with the Bank of England’s Governor Mervyn King that a token interest rate rise to demonstrate the credibility of the Monetary Policy Committee (MPC) would be futile. In fact, I think that in the current circumstances it could end up doing both the economy and the MPC’s reputation more harm than good.
  • Admittedly, near-term price pressures have got even stronger, with the oil price rising to above $115 this month. If sustained, this increases the chances that inflation in the coming months will reach, or even surpass, 5%.
  • What’s more, some have leapt on the rise in average pay settlements at the start of the year from 2.2% to 2.8% as evidence that so-called “second round” effects from the rise in inflation are already appearing.
  • However, I don’t see either of these developments as a reason to raise interest rates. Although higher oil prices will push inflation up further in the near-term, their adverse impact on demand is clearly disinflationary in the medium-term. With consumers’ incomes already set to fall this year, the rise in oil prices could not have come at a worse time.
  • Meanwhile, a closer look at the pay settlements shows that those at the top of the range are part of multi-year deals that are automatically linked to RPI inflation. I would not take this as evidence that workers are actively pushing through big pay rises in this year’s negotiations.
  • The average settlement is still well below the 3.7% level reached when inflation last got this high in 2008. Indeed, with unemployment high and employment falling, I would be surprised if wage growth were to take off.
  • Meanwhile, the latest economic news has done little to clear up the uncertainty about the underlying pace of the recovery. But over the next few weeks, I expect it to become increasingly clear that the economy is struggling. We already have a mass of evidence that consumer spending growth has slowed sharply since the initial post-snow bounce-back at the start of the year.
  • The Monetary Policy Committee (MPC) says that it is worried about the potential impact of a rate hike on confidence – in which case, the latest consumer confidence figures provide a powerful reason not to hike. Both the main measures of confidence are at their lowest levels since the start of 2009, when the UK was still in recession.
  • I therefore continue to think that raising interest rates just to be seen to be doing something would be madness. But it’s not my vote that counts - and the Committee has clearly been edging closer towards a rate hike. Indeed, it is possible that, despite today’s vote to leave policy unchanged, the “hawks” gained the support of another member.
  • Accordingly, a rate rise within the next few months would hardly come as a shock. Indeed, my long-held view has been that interest rates should, and will, be at 1% or below for years to come and that can accommodate two ¼% rises. But raising rates now would just mean that it will take even longer for them to get back to “normal” levels. If rates do rise, I expect the move to be a small one – and if I am right about the economic outlook, even this might later be reversed.

Roger Bootle, Economic Adviser to Deloitte (Tel: 020 7823 5000)

This assessment contains general information only and is not intended to be comprehensive nor to provide professional advice.  It is not a substitute for such professional advice and should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business.  Deloitte LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from acting as a result of any material in this assessment.

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