Interest rates and inflation

 

              Worldwide inflation is quite rapid. Food prices have been especially lively in recent months. China has hoisted interest rates to 5.81%, Brazil to  10.75% and India 6.25%. Australia and Canada too have started to increase theirs. In the UK mortgage rates and lending rates to small business are nothing like the official 0.56% base rate. Mortgage rates have been going up recently.  Only the Bank of England keeps on driving by looking in the rear view mirror. It remains more worried by the past recession than the looming inflation.

                    Yesterday the Chancellor advised the EU to get its house in order by stress testing banks more strenuously and doing more to deal with the problems of Euroland. He said “The affirmation of the UK’s triple A credit rating and the fall in market interest rates shows that it is possible to earn credibility with a convincing deficit reduction plan.” 

                   He is right to remind us that the UK’s top credit status was at risk on the previous policy. Lenders have taken some heart from the goverment’s expressed intention to cut the rate of increase in borrowing. However, his comments on the movement of interest rates are now a little dated. The 3.4% yield on ten year government bonds at the time of the budget did fall below 3% at its best. Today the rate has gone back up to 3.57%.  There has been a general shift up in EU government  bond rates, including Germany’s, as a result of the Euro crisis of late autumn. Some modest contamination did rub off on the UK, despite our non membership of the Euro.

            It makes it more important than ever that the UK should decline any future involvement in financial bail outs and show it  can now earn a dividend from staying outside the Euro. Meanwhile, we await decisive leadership from France and Germany from within the Euro area, as they move to sort out the problems of their currency. Chancellor Kohl always saw political union as an important complement to monetary union. The present German government both wants there to be more discipline over the other member states, and for the union to remain a union of independent countries where each one takes responsibility alone for its own budget and borrowing.

              Senior Germans do not like the idea of bigger transfer payments around the union to allow the rich and successful to help the poorer and less enterprising. They do not want to pool their sovereignty over budgetary matters. They do, however, wish to impose substantial controls over the budget freedom of other states. This could prove to be a sticking point when it comes to hammering out practical proposals to put a sovereign behind the currency.

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24 Comments

  1. norman
    Posted January 7, 2011 at 7:06 am | Permalink

    I worry that with interest rates at such an artificially (for the private sector, anyway) low level for so long that when the do start to creep up again banks will maintain the current formula.

    As an example, if a bank is currently offering mortgages at base rate + 3.5% that when rates go up to, for example, 2% then they will offer mortgages at 5.5% rather than take the attitude that the government / BoE are finally waking up to reality and moving the official rate more in line with the real world rate.

    It may be a little cynical of me to think this way, and I’m one of the tiny minority in the UK who don’t think all bankers should either be strung up from lamp posts or forcibly emigrated to Geneva, but I really believe there is a strong chance this will happen the longer the rates fail to reflect reality.

  2. lifelogic
    Posted January 7, 2011 at 7:21 am | Permalink

    If they want tax receipts to ever recover business has to become competitive – it cannot be so with a big 50%+ of government, high regulation, and expensive “green” energy as balls and chain round its limbs. It will also take time to adjust so can they please just get a move on. First step limit redundancy to a maximum of say £10,000 or similar then start getting rid of the pointless or actively damaging parts of the state sector – there is no shortage of candidates. Just this action alone will uplift businesses spirits and strengthen the pound somewhat and reduce inflation too. Also get some competition in banking and some lending to sound business going again.

    It certainly looks as though Cameron would much rather be a Ted Heath type taking us over the cliff while concentrating just on spin and PR rather than action and a true sense of direction.

  3. Jay Currie
    Posted January 7, 2011 at 7:36 am | Permalink

    Things are shifting. Inflation on commodities and food, deflation on property.

    Meanwhile..

    “advised the EU to get its house in order by stress testing backs”

    While my back is sore tested, I suspect you want “banks”.

    • lifelogic
      Posted January 7, 2011 at 5:52 pm | Permalink

      Houses are built of the inflating commodities and many house prices are below building costs already.

  4. A.Sedgwick
    Posted January 7, 2011 at 9:05 am | Permalink

    Re Britain’s inflation rates – my council tax in the same house has gone up 55% in 8 years – that rate to me reflects a more accurate measure of our overall inflation in the real world.

  5. George Rowley
    Posted January 7, 2011 at 9:33 am | Permalink

    This year is very worrying with the VAT increase and worries about job losses I would like to see an economy of growth and wealth for everyone where we could enjoy the money we have instead of wondering if we can afford to live because of interest rates increasing.

  6. English Pensioner
    Posted January 7, 2011 at 9:38 am | Permalink

    Politicians are very good at talking about “cutting the rate” at which something is increasing, it sounds good except when you really think about it!
    To cut the rate at which a deficit is increasing still gets us further into debt; to cut the rate at which crime is increasing still means there is more crime than previously – the list is endless. No doubt with inflation seemingly increasing all the time, we will soon hear that the government is cutting the rate at which inflation is increasing. I’m waiting for the day when they claim they are increasing the rate at which something is decreasing!

  7. alan jutson
    Posted January 7, 2011 at 10:28 am | Permalink

    John

    We HAD a convincing deficit reduction plan, but it seems no longer is this to be actioned.

    All we have seen so far are tax increases, and little control or reduction in Government expenditure.

    All the promises of control on housing benefit and the like seem to have been sidelined for future years.

    We may yet have our AAA rating compromised if nothing is done to actually IMPOSE PROMISED EXPENDITURE CUTS which were to be 80% of the planned solution.

    • Winston Smith
      Posted January 7, 2011 at 4:56 pm | Permalink

      The Government has done little to reduce State expenditure, but has managed to attract excessive publicity for its “cuts”, with the help of the unofficial opposition; the BBC. Yet another strategy and communication failure from Cameron’s clique will see their attempt to fool the markets backfire. The public is mostly fooled, thanks to the constant rhetoric of the BBC and other left-wing outlets, into thinking there will be savage cuts everywhere. So Cameron has managed to not make the hard choices for the future of the Country, yet still gain the unpopularity.

      • lifelogic
        Posted January 9, 2011 at 8:16 am | Permalink

        How do the BBC manage to recruit only people with this genetic “Guardian think”?

        Always in favour of an ever bigger state, pro EU, pro public support for “the Arts” and open borders to all the World and irrational and unswerving support for the “proven science” of global warming and green energy (usually despite having few science O levels to rub between them). Every problem always began with Mrs Thatcher (even the recent banking crisis due to city deregulation under her charge!)

        Indeed are there any people left who think like this who do not work for the Labour/Liberal parties, the Arts, the state sector or the BBC luckily I never have to meet many.

  8. Alte Fritz
    Posted January 7, 2011 at 12:14 pm | Permalink

    One of the many good things about this blog is that the posts regularly look out into the great wide world where the script is being written. It is an interesting departure that we now have to take account not only of what China thinks but also India and Brazil. And why not? These countries are not there to do things convenient to us.

    Meanwhile, what Mr R says about Germany sounds all too true, yet this is the country in the EU which matters above all others. France seemed happy to cede leadership to Germany throughout 2010.

    Maybe I have been brainwashed by Liam Halligan in the Sunday Telegraph, but there seems no way to cut the gordian knot other than the split retail and investment banking to contain future risk, and for banks finally to ‘fess up’ to their losses to define and address current risk. This must be better than to stumble through the fog, and, as Mr R observes in another post, spin away to avoid setting off another crisis.

  9. waramess
    Posted January 7, 2011 at 12:24 pm | Permalink

    Be quite certain that the very next time the EU wants Britain to contribute to a bail-out, Cameron will consent. Do not place serious money on anything else happening because it is a foregone conclusion and it will not matter whether we are obliged to do so, simply a nudge from the Germans and French will do the trick.

    The Germans are of course very happy to reap the benefits associated with the Euro as it represents a rough average of all the member economies and as such it feeds the German exporters with an opportunity to expand their markets and volumes at a much faster rate than they experienced with the DM,

    The effect is that the Germans are bleeding the weaker members of the EU who find conversely that the strength of the Euro against their weaker economies to be immensely damaging.

    Whilst the EU allows an inadequate return of some wealth to poorer countries the Germans are not at all happy for a large proportion their ill gotten benefits to be returned to the weaker economies and view possession as being nine tenths of their claim to the riches accrued.

    So we should be quite clear that the next time Cameron exercises largess with our money, in favour of a bail-out what in fact is happening is that we are allowing the Germans to continue avoiding a liability that should be their own.

  10. stred
    Posted January 7, 2011 at 2:04 pm | Permalink

    The BoE committee looking after interest rates may be ‘driving while looking in the rear view mirror’ and helping the banks rebuild their bonuses-sorry reserves.

    However, it was reported that the committee for their own pensions have been investing in inflation linked products. Perhaps this is why a friend was delighted to find that, by organising their lavish banquets for 5 years in the 80s, he had collected a pension at 60 of £20k and a lump sum.

    Contrast that with a SERPS transfer pension paying £900pa on an capital sum of £20k total (Standard Life) and a savings plan (AXA – Sun Life) that paid £11k after a cash investment of £9k over 20 years received by other friends and family.

    Personally, I don’t see why banks can’t be told to behave or else they are not allowed to trade here or use our money to, as for instance with the Royal Bank of S…., they lent taxpayer’s money to Kraft to take over Cadburys and move it abroad.

  11. David Hearnshaw
    Posted January 7, 2011 at 2:45 pm | Permalink

    Let us nor forget the continuing pain being felt by savers, who have been prudent and tried to do the `right thing.’ It is patently unfair that they are being, forgive the expression, `royally screwed’ by the banks and building societies with derisory interest rates based on the 0.5% base rate whilst lending rates bear little relation to it. It can’t go on!

    • lifelogic
      Posted January 9, 2011 at 12:35 pm | Permalink

      Businesses have urgent need loans and capital as the banks are not lending much and they are often paying well over 10% to the robber banks. Just cut out the banks as hugely expensive middle men.

      There can even be tax advantages too if structured well just choose wisely.

  12. BobE
    Posted January 7, 2011 at 2:47 pm | Permalink

    Quote “The present German government both wants there to be more discipline over the other member states, and for the union to remain a union of independent countries where each one takes ”

    What!!!. That is total rubbish. They want a United States of Europe, as soon as possible. Controlled by Germany and France.

  13. BobE
    Posted January 7, 2011 at 3:00 pm | Permalink

    This is an interesting result.
    The Conservatives have won Park ward,Windsor & Maidenhead. (Council).
    Con 64% (+2%),
    Lab 15% (+11%),
    Lib Dems 16% (-18%),
    Ind 5% (+5%),
    The previous Lib Dem votes have been spread accross the other three parties.
    This is the price of power!! Here Labour is the big gainer. Intersting to watch as the Lib Dems vanish into history. Is this the redistribution of the student vote?
    Bob

  14. Sally C.
    Posted January 7, 2011 at 4:06 pm | Permalink

    Re inflation, this is a headline from Africa News .com today 7th January – ‘Hundreds of unemployed Algerian youths took to the streets on Thursday to protest against galloping unemployment and inflation, burning government buildings and clashing with police across several cities including the capital Algiers. The riots began on Wednesday after evening Muslim prayers, following the price hikes for milk, sugar and flour which the population had endured in recent days.’

  15. Javelin
    Posted January 7, 2011 at 6:26 pm | Permalink

    The BofE seem to treat interest rates as emotionally charged issue. Im always disconcerted at their lack of objectivity when I read their minutes. I feel that interest rates are only going to rise under duress. There IS a general upward swing in the economy and the economists live in a la la land where the economy could go either way at any time. In my mind the BofE have shot their credibility and are only in place because banks can rely on them to be consistently chicken.

  16. monty99
    Posted January 7, 2011 at 11:12 pm | Permalink

    The BoE has lost all credibility in inflation handling and Not so Mystic Merv is becoming a standing joke. Fraser Nelson is spot on in this week’s Spectator:

    http://www.spectator.co.uk/coffeehouse/6595643/kings-ransom.thtml

    High time Merv was sacked and someone brought in who actually understands the task at hand.

  17. Steve Cox
    Posted January 8, 2011 at 9:08 am | Permalink

    John,

    What can or should those of us who are deeply concerned about inflation do to let our masters know of our worries? I can write to my Lib Dem MP (who I did not vote for!), of course, but if past experience is anything to go by he will simply send me a copy of the latest BoE inflation release pretending that they have everything under control. Is it acceptable to write directly to, say, George Osborne and/or David Cameron to express my concerns and fears? Is there any other course of action open to us mere mortals to let the people who are evidently not aware, or else simply don’t care, of the financial problems facing many elderly folk? Thanks you for any suggestion
    Reply: Yes, it is worth writing to the Chancellor or the Governor – all letters have to be logged, and the more that go the more sense of people’s worries they will get.

    • Steve Cox
      Posted January 9, 2011 at 5:13 am | Permalink

      Thanks for the advice. I’ll get writing.

  18. Neil Craig
    Posted January 8, 2011 at 5:22 pm | Permalink

    Presumably few large companies or individuals, who unlike most of us have the option, will be keeping their money in sterling when they could have it in Brazilian, Swiss or Chinese money.

  19. Bernard Otway
    Posted January 9, 2011 at 4:38 pm | Permalink

    Yes John agree with you on food prices,what about the upward effect on ours because of the EU,I lived in South Africa from 1981 to 2008,and I have two good friends who farm in the Eastern Cape near Port Elizabeth,on is a Citrus farmer mainly oranges he has 1500 hectares
    and 250000 orange trees of mixed types ie navel,valencia etc,their season is may to july,ideal
    to supply us here,last june I could buy off the farm by just turning up with a truck a minimum of 500 kilos jumbles[mixed sizes] at R50 [exchange rate r10.5 to £1 ] this is 10 cents a kilo,yesterday I bought a pack of 6 Spanish oranges from ASDA for £1.50 [app 1 kilo] this is
    R15.75 a kilo ,BUT he does not export to the Uk or Eu because of prohibitive tarrifs,likewise my other friend grows pineapples a Queen pineapple sells from off the farm at 15 cents.
    Europe and it,s agricultural policies cost all of us very dearly. By the way these farmers are mechanised and labour intensive in equal measure providing work for over 150 full time
    employees who all live on the farms and are schooled and looked after.I can also take you to Wineries where a bottle of say Sauvignon Blanc sells for about R8 [75p].

  • 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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