The Bank of England is always fighting the last war


                  Most agree that fighting the last war often leaves you wrongly equipped for what might come next. There is also a futility about trying to refight the last war if you have already lost it. However much you try, the past result remains.

                  The Bank of England specialise in doing too much too late. The Bank recommended membership of the Exchange Rate Mechanism, which gave us boom and bust and ended with the ignominious exit of the UK from the Mechanism.  Our interest rates were treble the level needed and were throttling the UK economy.

           The Bank in 2004-7 encouraged and allowed a massive explosion of credit, failing to raise interest rates soon enough or fast enough to restrain the banks. It ignored both opposition political parties who warned that credit was out of control.

                  In 2007 to early 2009 the Bank kept rates too high for too long, starved the markets of liquidity, and helped bring the banks into the Credit Crunch. The Bank ignored those of us who told them to slash rates and make more money available to the money markets. At one point the politicians rightly took the decision out of the Bank’s hands by reaching international agreement for lower rates. In 2010 the Bank failed to raise rates to prevent the inflation which is now very predictably hitting us. I called for higher rates more than a year ago to head off the inflation we now have.  

                So now the Bank is in a difficult place. Most people read the G0vernor’s letter on inflation to mean two or three increases in rates this year, starting in May. It is difficult to see the logic of these, given all that the Bank has said about why it didn’t bother to raise rates a year ago when the inflation was a forecast, not a reality. Higher sterling is the only way to bring current inflation down a bit, and that requires monetary action yesterday, not in May.

                  The problem is greater now, because the strong worldwide recovery which we have been experiencing is about to be slowed by tougher monetary action elsewhere. Brazil has a 11% interest rate. India and China have raised their rates to 6% and may go higher.  China is seeking to cut the rate of growth of money and bank credit. Even the USA will probably stop printing money by misdsummer and will be thinking of interest rate rises.  The world monetary climate will get cooler later this year, which will in due course take some of the heat out of commodity prices. It will also come at the price of slower worldwide growth.

                 UK money growth remains low. There is the chance that higher prices will not lead to substantially higher wages, particularly if the public sector sticks to its stated policy of a two year pay freeze. The recovery which should resume this quarter after the poor end to 2010 will encounter more headwinds from the global position, and from the sensible decision to slow the rate of growth of public borrowing.

                  The answer is that you cannot mend the UK economy just by moving interest rates. If the Bank is eventually going to raise rates, help savers and have a stronger pound, at the same time it needs to sort out the commercial banks. It becomes their regulator shortly. It needs to understand that current banking regulation is pro cyclical. It is making recovery more difficult, just as surely as it stoked the credit boom by reinforcing that destructive cycle. If it wants lower inflation and more growth it cannot just raise interest rates.

                  The Bank’s latest forecast is for inflation to stay well above target for 2011. The Bank rightly reminds us that commercial banks need to refinance around £400-500 billion of  their borrowings this year. Official rates are well out of line with market rates. The Bank shows us that the typical personal loan costs 10% and a 90% mortgage 6%. Meanwhile money growth is sluggish, credit restricted for small and medium sized companies according to the Bank, and GDP still around 5% below early 2008 levels.


  1. lifelogic
    February 17, 2011

    Perfect analysis we are still waiting for a proper Tory party after Major and the ERM buried it.

    Borrowing money at all is the problem after the bank stopped lending 75% loan to value and now on developments it is hard to get up to 50%. With very high fees and margins too. The rules need to change to allow them lend more freely. A higher base rate is less of a problem. The real problem is the huge margins fees and often a total lack of lending.

    1. lifelogic
      February 17, 2011

      People always fight the last war, it is perhaps human nature, even people buying a new house over compensate for say a small garden or kitchen or a busy road by buying one with an absurdly large one next time or in the middle of no where.

      In government there is also the problem of a group (or a sort of this year fashion) think even when everyone knows that something is daft such as CAP, EU, ERM, the excess green agenda, pointless wind mills, big tax & big state. Still no one can turn round until they all agree too. Usually like major they all fall over the cliff together and have to all climb back up before this happens.

      I would not mind but these proven fools still lecture us from the house of lords. Indeed being proved wrong now seems to be one of the main criteria for entry to the lords…..

  2. Peter van Leeuwen
    February 17, 2011

    I always believed that there was very close coordination between central bankers, e.g. between Mr King and Trichet. They often seem to move together. How then come that the expected inflation rate for the eurozone in 2011 is not yet 2%?

  3. Stuart Fairney
    February 17, 2011

    I never quite understood why people said it was sustainable for a governments to spend at about 103% of income when this would bankrupt an ordinary person after a while. Of course it is because they know that the quite deliberate inflation of 2-3% pa will monetise the debts and the policy of debasement (and crypto-theft from people) allows the apparent largesse. I feel somewhat foolish for not realising this sooner.

  4. Doppelganger
    February 17, 2011

    I lost my faith in the BofE (and others) during the Lawson boom.

    I am a firm believer that lending and investment banking activities should be separated a la Glass Steagall. It would be interesting to know how much capital (in terms of debt and equity) the commercial banks split between their lending and investment banking functions. I also wonder if it might not worth be considering treating debt finance the same as equity finance ie removing debt’s the tax shield advantage. Do you have any views on that Mr Redwood?

  5. Antisthenes
    February 17, 2011

    The UK is highly uncompetitive and it’s economy has most of its eggs in the wrong basket, the financial and services sectors. Joe Public want’s it’s cake and eat it, spend and borrow today and let the next generation pay for it. Vested interests and the feckless, selfish and greedy are stubbornly resisting the necessary medicine to rectify the economic and social ills that are dragging the UK deeper and deeper into terminal decline. Corruption and incompetence is now endemic particularly in the public sector, the private sector is not totally immune either. The best that the coalition can do is slow the rate of decline but not stop it. So when the Labour party resume control of the country as it inevitably will because the decline cannot be reversed because the coalition dare not take the necessary actions to do so for fear of public reaction. Then the final nail in the coffin will be hammer home and everyone will get their comeuppance, the left will have won and everyone will be equally poor and miserable.

  6. Euan
    February 17, 2011

    It’s about time Cameron and Osborne got some gumption and dealt with the Bank of England, the EU and made some real cuts in spending.
    I see reports that Mr Pickles can find savings of 50% plus in his department, why can’t the other ministers do the same? What we have got is a weak willed government shackled by Lib Dems and a general lack of conviction that back away from the smallest battle (forests for one). The promised reforms are constantly watered down so as not to offend the BBC, Guardian and public sector unions leaving us with “New Labour Lite” – the worst of all worlds.
    Start by giving Merv the Swerve the push and move swiftly on with all the other very pressing problems the country is facing.

  7. Brian Tomkinson
    February 17, 2011

    Given such a litany of failure, I ask again why has your government decided to give more powers to the BoE? You cannot mend the economy just by moving interest rates but that is the only tool the MPC has for achieving their CPI target of 2%. This they have consistently failed to do and consistently been wrong with their forecasting. Is it really credible to believe that such a body of people could have been so incompetent for so long or is the truth that they have been encouraged by their political masters to do what they always do in times of economic crisis – devalue and inflate?

  8. Mr J Leslie Smith
    February 17, 2011

    It appears that inflation is the tool deliberately being used by this Government with the clandestine help of the BOE to diminish Public Debt. This is a false policy and utterly deceitful to Pensioners and Savers alike. Althuogh the Head of the BOE has a maassive ego it seems, even he knows the difference between having a mandate from Government to hold inflation under 2% and simply noticing when it hits 5%!! When will these people ever learn that trust from the people will never return until a little honesty returns first from their actions – not thier words.

  9. acorn
    February 17, 2011

    Does not bode well for breaking up the FSA and giving the job to the BoE. I think Merv is looking a little tired; time for the House of Lords? Mind you, he did put the BoE pension fund into index linked bonds, so he can’t say he didn’t see the “temporary” – ie: 5 to 10 years – inflation problem coming.

    Thought for the Day. There are 30,000 lottery terminals conveniently scattered across the nation. Camelot tends to plant them where they will attract most customers. There will be about 44 million potential voters for the next election; that’s about 1,500 for each terminal. The Electoral quango allows up to 2,500 voters per polling station. I bet Camelot techs could easily mod’ them for elections. How about a million pound payout to some lucky voters?

  10. sm
    February 17, 2011

    Just a thought.

    If its illegal to steal. Is it not illegal to encourage inflation which in effect is akin to a tax and a transfer of resources.Surely any transfers should be done openly and democratically. Doing things by stealth, missing targets and passing soothing comment may not be the best way.

    Perhaps the ECHR should pontificate on this and ensuring we have proper checks and balances. It would be a better use of hot air.

    I note one of the blog links dropped from the last inflation post but the source can be googled for those that wish from the authors name.

  11. Conrad Jones (Cheam)
    February 17, 2011

    “The Bank in 2004-7 encouraged and allowed a massive explosion of credit, failing to raise interest rates soon enough or fast enough to restrain the banks. It ignored both opposition political parties who warned that credit was out of control.”

    From what you are saying, you are blaming the Bank of England for the instability in the System. Labour’s decision to hand over more power to the Bank of England effectively caused this mess that we are now in.

    If credit had been restricted, the Housing Bubble would not have formed making it easier for first time buyers, Banks would not have had the additional credit to gamble on the World Equity markets and therefore, the economy would not have risen so much, but would not have stalled.

    As it is acknowledged that the Bank of England is not managing the economy correctly, should the Conservative and Liberal Democrat Government rectify Labour’s mistake by removing the powers granted to it in the last Government?

    Far better to have an elected body making decisions about interest rates than a non elected one. This is a third rate system – as you know; as the Markets themselves should adjust Interest Rates to either attract money in or allow more borrowing depending on market conditions. This self adjusting Interst Rate mechanism would reduce the Booms and Busts. Refusing to Bail Out Banks would eliminate them altogether. Therefore there would not be a need for a lender of last resort.

    Reply: The crash was also brought about by excessive borrowing by the government and the excesses of some mega merger banks.

    1. Conrad Jones (Cheam)
      February 20, 2011

      The merger of Banks is a big concern. The monopolisation of the Banking System is already starting to hold the Country to ransom.

      Is there anything the Bank of England can do to help attract new Banks into the System and reduce the size of the largest Banks?

  12. StrongholdBarricades
    February 17, 2011

    If the “Third Way” was to use the markets to inflate assets, and then allow the population to use the value of these assets for their own welfare, where are the commentators knocking the fiscal policy of the last government? Where are the investigations to point the fingers and ascribe blame and responsability so that those people who have been let down can actually take legal action?

    Why are we having to await the BoE taking over regulatory affairs before we even get to the stage where the new regulations are considered?

    Are the delays simply a political and practical acceptance of the fact that as “free traders” we can not impose restrictions on capital flows without capital repatriation, and also the crash was really a huge “fraud” (madoff style) on western banks carried through with the connivance of the Balls fiscal policy?

  13. Javelin
    February 17, 2011

    Great analysis.

    My friend works at a credit rating agency and he tells me there is increasing pessimism about the economy. “Something has got to give, cuts must get deeper, taxes have to up on people and down on business. We need growth to get, but all the growth has gone [abroad]”.

    1. Javelin
      February 17, 2011

      Just want to relay a story from a cab I too from Waterloo to Victoria (to a Hedge Fund where I may work next). The cabbie was basically saying “London is empty .. Look around you where is every one? … The hotels are empty … Business people just aren’t coming here in the week … People don’t get cabs during midday or Friday because of video conferences and working from home … Just look the streets are empty.” He then went in to say “young people aren’t stupid there are no jobs … His daughter was an A* pupil but could only get a job flipping burgers … (allegation left out ed) … young people were completely demotivated”

      Makes you think.

      1. Conrad Jones (Cheam)
        February 19, 2011

        Of course they are – because if they go to University, they are going to be forced into debt while remembering that their Parents went for FREE.

        When they finally get a Job, they will be forced into even more debt if they wish to purchase a House – a corner stone of Margaret Thatcher’s home ownership democracy.

        If they do not go to University – they will be regarded as second class citizens – as Tony Blair said “Education, Education, Education”.

        They will see their wages decline as the number of graduates has increased – market forces acting correctly here flooding the market with more qualified people giving rise to over supply. Should happen in the so called Housing “Market”. Gordon Berown’s manipulation carried on pumping money into to Housing market right up to the election. A month later – it started to fall again. Is the Bank of England really independent? Independent from WHAT?

        They also see their Government talking about; North Korea, Iran, Pakistan and the threat from China. At the same time they remember the lack of evidence found in Iraq for WMD – the basis of the invasion which cost 100s of thousands of lives and cost Trillions of Dollars.

        They see Barack Obama stoking the fires of War off the Coast of North Korea in endless military exersices designed only to antaganonise the North Koreans into an attack with the South to spark yet another War which tax payers will be expected to pay for – cuts or no cuts.

        They see their parents hard earned savings losing purchasing power, making it more difficult for parents to help their children.

        They now see David Cameron arguing the case for cuts in public services while maintaining the support for the Banking Services allowing publicly funded Bank salaries and Bonuses for the richest members of the Banks while lower ranks of the Banking staff are thrown onto the lines of unemployment.

        “Tuition fee increases will be capped, says Nick Clegg”

        Many voted for Nick Clegg – based on what he said about “No Increases of Tuition Fees” – they see him as a key member of the Government and cannot understand why he didn’t make this policy a key part of the coalition agreement. He says that he regrets signing the pledge.

        Yes, I can see why the young are demotivated. They have no representation in Parliament. What usually happens when their is Taxation without Representation?

    2. Max Van Horn
      February 18, 2011

      Finding it hard not to use expletives to answer your friends comment on ‘increasing tax on the people.’ Just where exactly,in a country that makes nothing but depends on a service sector for growth does he expect people will get the money to spend to stimulate the economy. It’s rubbish. This government is all about managed decline and monetising the debt. The banks are up to their ears in CDS and spagetti derivatives . Kings hands are tied.One false move and the whole lot comes tumbling down.

  14. Bernard Otway
    February 17, 2011

    We truly are lions led by donkeys,yet we continue to put these people in their positions,or vote in politicians who do it on our behalf .We fall for the photogenic ie blair and then get the opposite [Brown],the Tories vote in Cameron when they should have backed Davis or preferably for me you John,when you favour style over substance as the British seem to do I despair,especially as when this backfires everyone then winges,it is like complaining halfway down having jumped off a cliff.

    1. Mr J Leslie Smith
      February 17, 2011

      A good post!! I also dispair at the low level of real experience and any common sence from so many of these Politicos. The BOE is possibly one of the worst cases of Mass Ego and poor vision, since we have had 13 years of Blair and Brown, to turn their heads. All these top civil servants who were cosy with New Labour should go and go now. They are simply unable to change……

  15. Bernard Otway
    February 17, 2011

    Apropos the AV debate,if there were fair constituencies there wouldn’t be the need as with 10.7 million votes on may 6 the party would have got a good working majority,WHY the party and the right wing press weren’t complaining LOUDLY about this from long ago,I don’t
    understand,if the shoe was on the LIEBOUR foot you can bet it would have been Screamed from the rooftops.

  16. Steve Cox
    February 17, 2011

    Andrew Sentance is on message again today:

    Is there anything stopping Mr Osborne from getting rid of Brown’s (I will never address him as Mr!) (words left out ed) appointees to the MPC and replacing them with more sensible folk like Mr Sentance? Or doesn’t Mr Osborne care? And if so, why not?

    Speaking of Brown’s (appointees-ed) on the MPC, I see that (words left out) Blanchflower is on his hobby horse again. The current MPC members would do well to remember that their reputations are on the line here. Do they really wish to be remembered in the future as the (stupid ones -ed) who failed utterly to act against the coming hyperinflation that might devastate the country for 20 years or more? Unless there is a total collapse of the economy, a la Weimar Republic, of course. Blanchflower is also warning of an economic collapse in Britain, but for entirely the wrong reasons. And he doesn’t much care about his legacy, it seems, he intends going down in history as a hero (from another perspective -ed).

  17. Demetrius
    February 17, 2011

    The B of E has botched it and has been way behind the game. When the enemy appeared at the gates it invited them in for tea.

  18. Neil Craig
    February 17, 2011

    “The answer is that you cannot mend the UK economy just by moving interest rates.”

    Indeed. Most fiscal manoeuvering is rearranging the deckchairs to make it look better. The formula is – economic freedom + inexpensive evergy = growth. We have very limited economic freedom with government spending half the money & regulating more out of existence. Our energy policy is to regulate the more of the most expensive (windmills) & prevent the cheapest (nuclear) which is why we have the lowest rate of electricity use to GNP of any sizeable developed nation.

    The good news is this means government could allow us a fast growing economy any time it was willing to get out of the way.

  19. rose
    February 17, 2011

    Not only is it fighting the last war, but it is as usual underestimating the evil of inflation: seeing cheap credit as the main end, and inflation as a cheap and easy way to cancel debts; not understanding how destructive debasing the currency actually is, morally, economically, and politically. For the British establishment it is as if the seventies had never been, yet the Germans remembered their lesson from 1922/3 for much longer. A bad experience needs to be truly drastic and far-reaching for people to remember not to repeat it. What has gone into the folk memory here, fostered by the media, is the unemployment of the 1930s, not the frightening anarchy of the seventies.

  20. grahams
    February 17, 2011

    Strongly agree on the gist of your post. It really is Sunshades in October.

    I recently had one of those long-winded formula letters from my high street bank renewing my unwanted at unused overdraft facility at 11.3 per cent. Don’t think Bank Rate has much effect on this, likewise loan rates to small business. Santander has vacuumed up a lot of the mortgage competitors but I suspect that competition for new loans is still sufficient there to stop rise in Bank Rate to 1 per cent having much impact on average mortgage rates.
    By contrast, a 1 per cent Bank Rate might well claw back 5 per cent of the sterling depreciation, significantly reducing CPI inflation (ex VAT).

    By the way, I read that transfer of bank supervision back to the Bank of England will not happen until 2013, coinciding with the end of Mervyn King’s term. If so, and without any malice to Mr King, who has done good work and tried his best, might it not be better if both were brought forward under a new Bank leadership?

  21. BobE
    February 17, 2011

    No public servant should earn more than the PM. This should include Councils.

  22. John Ward
    February 17, 2011

    It’s true that, at times, the Bank’s behaviour looks wilful.
    But looked at in the context of the derivatives problem, it makes a sort of insane sense.

  23. Electro-Kevin
    February 17, 2011

    Much of the inflation is foreign, out of our control and here to stay, I’m afraid.

    This is what it feels like to live in a country which is getting poorer and less resourceful. Labour and the BBC are, unfortunately, doing a grand job of laying the blame at your door.

  24. Anoneumouse
    February 17, 2011

    Perhaps Mervyn King should read J.F.C. Fuller on Clausewitz

    1. Mark
      February 18, 2011

      Inflation is theft by other means.

  25. Palepete
    February 17, 2011

    You may be right personally, but your colleagues are continuing the shambles of Mr Blair and Mr Brown’s ponzi scheme economic boom funded by cheap money. The low interest rates are merely destroying the saving of those of us who saved for our retirement. Don’t imagine we will vote for the coalition because Labour is worse. As far as I can see it isn’t. We still have the governor of the B of E who has presided over an economic disaster, we still have the same tired FSA who presided over a regulatory disaster. We still have the aspiration to grow the population to 70m merely to pay our children pension. This is nothing but a population Ponzi scheme. At least democrat Clinton has the strength to bring in the 5 year rile for benefits scroungers in the USA, and immediately improved the social fabric. What is Cameron’s agenda for those of us who are libertarian conservatives. I am not hopeful. All I can see is the coalition listening to the public sector aristocrats who now rule the roost as much as the old landed gentry. The public sector seems to be a priviliged communist style berioska employment scheme beyond the rules that apply to those of us who are what the Aussies call “battlers”. Or maybe I’m just getting old.

  26. zorro
    February 17, 2011

    ‘The Bank’s latest forecast is for inflation to stay well above target for 2011.’…..John, when did the MPC BoE last get anything right? If we’d paid someone to stand there tossing a coin every month (or employed that very clever octopus of World Cup fame – now sadly deceased – he showed great promise, and earned me some cash :-)) he’d have had more success than the BoE in doing their stated job (keeping inflation at 2%) and would have been a lot cheaper – definitely more for less!!
    To be quite honest, in these days of inflation and declining salaries, one of the few things that brings a smile to my face is all these wizard of Oz moments in political life, when we see what really lies behind the curtains.


  27. JimF
    February 17, 2011

    It’s not that they’re fighting the last war. They’re fighting the present one, but on the other side.
    Clearly the aim to keep inflation at 2% in the medium term cannot be helped with negative real rates, coupled with printing money. This will have the reverse effects of devaluation and inflation. In the short term these help by decreasing net costs, until folk realise they’re being conned with decreased effective wages, and conned with increased prices for goods. This process having been in ferment for 2 years or so, the con trick is about to hit. Whether this is the time to increase rates just to add insult to injury to the indebted wage slave is a mute question; it should probably have been done a year ago.
    Certainly something creative and dramatic is required to
    -move people from benefits and the public sector to the private sector
    viz remove regulation, reduce business taxes
    -decrease house and property costs for young workers with no equity
    viz increase interest rates to cap any house price increases and target maybe a 5-10% p.a. ongoing decrease in prices for 5-8 years
    This government hasn’t truly tackled these issues

  28. Bedd Gelert
    February 17, 2011

    Oh come come now Mr Redwood !! Give ‘credit’ where it is due…

    On the one hand you say..
    “Our interest rates were treble the level needed and were throttling the UK economy.”

    And on the other…
    “The Bank in 2004-7 encouraged and allowed a massive explosion of credit, failing to raise interest rates soon enough or fast enough to restrain the banks.”

    So as we can see, ‘on average’ the Bank Of England got it about right !! So make your mind up Mr Redwood. As that well-known economist who had his head in the oven and his feet in the ice-bucket once said, ‘On average, I feel fine…’

    1. zorro
      February 18, 2011

      John is correct here. Interest rates were far too high for our industrial base when the fag end Thatcher/Major government was busily shadowing the DM in the late 80’s/early 90’s during the ERM experiment. Conversely, they were too low during the credit boom period from 2003 onwards and Brown’s excess spending ran wild.
      The B of E has consistently misread economic indicators with its tactics dictated by looking in the rear view mirror.


  29. Conrad Jones (Cheam)
    February 18, 2011

    Dear Mr Redwood,

    “The basic formula for calculating the GDP is:

    Y = C + I + E + G


    Y = GDP

    C = Consumer Spending

    I = Investment made by industry

    E = Excess of Exports over Imports

    G = Government Spending

    Many of the goods and services produced are purchased by consumers. So, what consumers spend on them (C) is a measure of that component. ”

    The next component is E, or the difference between the value of all exports and the value of all imports. We can rewrite the equation, showing the components of E, using X for Exports and M for Imports:”

    Y = C + I + (X – M)+ G”

    GDP appears to go up every year (ALTHOUGH by not very much, in recent times).

    Q1: “Y” How is the apparent increase or decrease in GDP adjusted to take account of inflation?
    Q2: “C” Why is consumer spending such a large factor when considering that we are effectively adding our debt to the figure of gross domestic product.
    Q3: “G” As the Government is going to slash spending – won’t this also slash our Gross Domestic Product?

    Perhaps the way GDP is calculated should be changed. It appears to show consumers as productive members of the population rather than the people who actually produce the wealth. There are two components of GDP which relate directly to spending (or debt creation) and not production. Most consumer spending is fueled by debt creation. Perhaps GDP should be changed to GDD – Gross Domestic Debt.

  30. Lindsay McDougall
    February 18, 2011

    ‘The Bank of England specialise in doing too much too late.’ It’s not just the Bank. The whole post war (and for all I know pre war) history of UK macro-economic management, regardless of which Party was in power, has consisted of doing too much too late.

    For example, take Reginald Maudling’s ‘dash for growth’ in 1963/64. As Enoch pointed out at the time, the recovery was already under way. I think that the precise words he used were ‘The patient is up and playing golf already’.

    I have been searching the ONS website to find out what available measures of inflation come nearest to what is need for targetting. RPIY comes nearest; it excludes indirect taxes (correct) but unfortunately excludes mortgage interest payments. Would contributers to this blog believe that RPIY based annual inflation has not dipped below 2.0% in ANY month since January 2005? All the departures (errors to you and me) have been on the high side.

  31. John C
    February 18, 2011

    “The Bank rightly reminds us that commercial banks need to refinance around £400-500 million of their borrowings this year”

    I assume you meant £400-500 billion?

    If it were only £400-500 million they could refinance using their bonuses!

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