Interest rates rise – Where was the Monetary Policy Committee?

The monthly tea party for academic economists at the Bank of England – the regular meeting which Gordon Brown claimed meant he had “made the Bank of England independent” – looks more and more irrelevant. The other changes Mr Brown made to the Bank, taking crucial powers away, have exposed the Bank to torrid times trying to run the markets.

This week some mortgage rates have gone up, because market interest rates have gone up. The MPC has not met. It has not wanted rates to go up. It has expressed no view on the way money market rates these days may be up to 1% or 100 basis points higher than the rate they recommend.

It should be the Bank of England’s job not merely to host a meeting to settle what rates should be, but to spend the rest of the month making sure that decision is reflected in market rates. If they do not do so, the system breaks down and the MPC looks unimportant.

When market rates first started deviating from MPC rates last year we were in the high noon of the moral hazard period, when the Bank seemed to think it was fine that rates were higher than MPC rates. This week it looks as if the Bank of England does wish to bring rates more into line with MPC recommendations, but is finding it difficult to do so.

A central Bank can control market rates through its open market operations as a main player in money markets. The Bank has not been willing to commit sufficient funds to markets to get market rates down to its proposed rates. One of the reasons may be that the Bank has too much committed to Northern Rock and is short of fire power itself to deal with the shortages in the markets. It reinforces the case for securing earlier repayment of the money advanced to that institution, so the Bank of England has a freer hand to sort out money market rates.The MPC itself could meet and lower its recommended rate to offer a signal that it does not want market rates to rise.

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5 Comments

  1. Matthew Reynolds
    Posted March 28, 2008 at 9:14 pm | Permalink

    My view is that the money markets are better at sorting this mess out ! The rising interest rates merely reflect the fact that banks want the savings ratio to rise & to get more money from debt servicing . The reason being that if the banks run short of funds you get a Northern Rock debacle . So as with Black Wednesday when a correction happens the authorities are impotent because as Lady Thatcher pointed out : ” You cannot buck the markets , they can buck you ! ” The Square Mile will sort this out & I am afraid to say that if people do suffer as a result of spending money that they do not have then they only have themselves to blame . If you do not have the cloth – why try & make the coat ? That I find is a wise way of looking at money ! Labour have allowed the public & personal debt to surge & the boom has been less sustainable than the Lawson one . After all the PM’s talk of no more boom & bust his policies have left us in the UK very exposed as interest rates cannot be cut & taxes cannot be cut while a bank hits the rocks & no private buyer can be found . That is the precise opposite to what has happened in the USA . Would Polly Toynbee & the rest of The Guardian reading brigade care to explain why the USA under George W Bush will fare so much better than the UK under an Old Labour socialist like Gordon Brown ? This proves that Conservative economic policies work & left wing ones fail !

  2. Matthew Reynolds
    Posted March 28, 2008 at 9:14 pm | Permalink

    My view is that the money markets are better at sorting this mess out ! The rising interest rates merely reflect the fact that banks want the savings ratio to rise & to get more money from debt servicing . The reason being that if the banks run short of funds you get a Northern Rock debacle . So as with Black Wednesday when a correction happens the authorities are impotent because as Lady Thatcher pointed out : " You cannot buck the markets , they can buck you ! " The Square Mile will sort this out & I am afraid to say that if people do suffer as a result of spending money that they do not have then they only have themselves to blame . If you do not have the cloth – why try & make the coat ? That I find is a wise way of looking at money ! Labour have allowed the public & personal debt to surge & the boom has been less sustainable than the Lawson one . After all the PM's talk of no more boom & bust his policies have left us in the UK very exposed as interest rates cannot be cut & taxes cannot be cut while a bank hits the rocks & no private buyer can be found . That is the precise opposite to what has happened in the USA . Would Polly Toynbee & the rest of The Guardian reading brigade care to explain why the USA under George W Bush will fare so much better than the UK under an Old Labour socialist like Gordon Brown ? This proves that Conservative economic policies work & left wing ones fail !

  3. Jonathan
    Posted March 29, 2008 at 2:19 pm | Permalink

    I think this is a little unfair. Before the credit crunch started–causing market rates to rise–the BoE was raising rates (belatedly) because of higher inflation. Precisely because of the rise in market interest rates the BoE changed direction and started reducing the base rate. My point is that the bank always wanted rates to rise, but because of the credit crunch a given base case corresponds to higher market rates. In the absence of the credit crunch, the base rate would probably be about 6.5% (I think that was the expectation a year or so ago) so the fact that market rates are 100 basis points higher than the base rate may well be consistent with what the BoE thinks is appropriate, given the level of inflation. Of course, they might decide that as market rates continue to diverge from the base rate they need to cut the base rate to offset this, but that can be done at the monthly meetings.

    You say that a central bank can control market rates via open market operations. Of course this is correct and I would be surprised if they are not doing so to some extent. But the goal is never to set all the rates in the market, they have to be set according to market conditions. That is, the central bank buys and sells particular assets to control the interest rates on those assets, then the market decides what other interest rates should be taking the central bank's monetary policy as given. It's not the BoE's job to second guess the decisions of individual banks and building societies. Also, the implication of your argument that the BoE should be doing more to lower market rate via open market operations is that you think it should be printing more money, which risks causing higher inflation in the future.

    I think the BoE should be applauded for not overreacting to the credit crunch (as I fear the Fed may have done) and for taking responsibility for inflation after being rather lax in this regard for the past few years.

    Reply: I THINK THE BANK HAS BEEN NEGLIGENT, LEADING TO THE COLLAPSE OF NORTHERN ROCK, AND MUST NOW REASSERT CONTROL OF MONEY MARKETS TO AVOID A WORSE SLOWDOWN.

  4. Robert Winterton
    Posted March 29, 2008 at 8:50 pm | Permalink

    John,
    No the B of E was only negligent in keeping rates too low for too long and letting the money supply explode for several years. Real inflation that actually hits people's disposable income has been well above both RPI (useless and should discarded for ever) and CPI (which is still not reflective of the real world). Politicians of both parties prefer to use inappropiate benchmarks to measure inflation to keep the genie of wage inflation in a bottle, that combined with the massive legal and illegal immigration to kept wage levels low and the economy going. But eventually all 'good things' come to an end. As I have previously posted we are now going to 'reap what we sowed'. The posts above are right, the Bank can set the base rate and inject liquidity, but it will be the market that will decide what both LIBOR and ultimately the consumer rate will be. Spreads for mortgages will increase, in the longer term to excess of 100bp, in the short term they may even go higher. Before the money markets finally blew up we had some rates as low as 50-60bp. As ever the 'powers that be' ignored the housing bubble and money supply and believed it was different this time. As always it never is! As I have said before it is up to those very Banks who caused this crisis by their excess greed (chasing higher yield with much higher risks in a low yield environment)and their evident lack of ability to assess risk/reward who should now be lending to each other. They only have themselves to blame rather than the Bank, and then they have the nerve to ask it to bail out their stupidity! I am very happy to furnish you with several of my market commentaries over the last couple of years warning of the potential consequences of both the level of our interest rates and the Banks behaviour.

  5. Robert
    Posted March 29, 2008 at 9:00 pm | Permalink

    John could you please curtail my name to Robert dropping my surname please.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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