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.