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Economic Update – Rate rise would not enhance MPC’s credibility

Roger Bootle’s response to February’s MPC meeting


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  • The Monetary Policy Committee (MPC) is right to resist calls to raise interest rates to defend its credibility. Given the huge amount of uncertainty about the underlying strength of both economic growth and inflation, the Committee would be foolish to rush into a premature tightening of policy. Indeed, as the fog clears, it should become clear that interest rates need to remain at an ultra low level indefinitely.
  • Admittedly, with oil prices reaching $100pb and agricultural prices still rising, CPI inflation now looks likely to get above 4% - and possibly close to 5% - within the next few months. What’s more, the rebound in the closely watched CIPS/Markit business surveys in January suggests that the economy has bounced back after its dip at the end of last year.
  • However, the weather distortions mean that it is impossible to gauge whether the recovery is really back on track. Indeed, my suspicion is that it isn’t. Consumer confidence plunged in January, employment is falling again and the housing market is still weakening.
  • Meanwhile, I think that the panic about the rise in inflation is overdone. Of course, there are risks of so-called “second round” effects. However, there is no evidence that the gilt market is currently getting alarmed about the MPC’s lack of grip. Similar rises in inflation expectations have been seen in both the American and the French bond markets, reflecting global factors.
  • What’s more, price expectations often follow what happens to prices, rather than the other way round. In 2008, households’ inflation expectations rose sharply, but then fell to a low of 0.8%, mirroring the collapse in actual inflation.
  • I think the view that the MPC can raise interest rates by ¼% or ½% to restore credibility without damaging the economic recovery is simply wrong. If the MPC raised rates now, it would be admitting that it had been wrong about inflationary prospects – and markets would demand that interest rates went much higher.
  • The result would be that in both the markets and the real economy, people would assume that this was the beginning of a huge turn in the interest rate cycle. This could derail the recovery altogether. The Japanese experience urges caution. In 2000, the Bank of Japan raised official interest rates prematurely but was soon forced to cut them. Indeed, if the MPC lost its nerve and did raise rates, it might well have to reverse the increase before too long.
  • My view is still that a rate rise would do nothing to boost the MPC’s credibility, but would significantly hurt the economic recovery. My long-held view has been that interest rates should, and will, be at 1% or below for years to come. That can accommodate two ¼% rises. Even so, the sensible thing is for the MPC to avoid playing with fire and to keep rates at ½% for a prolonged period.

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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