The Governor of the Bank grabbed the headlines on Thursday night for hinting that official interest rates may go up earlier than markets expect. As markets expect a rate rise by the second quarter of 2015, that could bring it forward to later this year.
The Governor’s speech was more balanced and careful than the headlines suggested. It is true he said rates may go up “sooner” than anticipated. He also said “there remains scope for spare capacity to be used up before policy is tightened”. He went out of his way to remind us the Bank wants to see a good recovery and does not wish to take action which is too early or too tough which could damage the progress being made.
He drew attention to fast rises in house prices. He said the Financial Policy Committee of the Bank and the banking regulators would seek to prevent a mortgage inspired house price bubble. New rules have already come in making it more difficult for people to obtain a mortgage, and further action is planned to prevent banks being too expansionary in the mortgage market and to prevent people borrowing too much money to buy a property. He does not think the interest rate weapon is the right one to tackle this issue.
The Governor’s speech also drew attention to two longer term weaknesses of the UK economy. He pointed to the large balance of payments deficit, and to the need for more business investment spurring productivity growth. He inclined to an optimistic view of how the UK will respond to these challenges. He thinks in due course as the rest of the advanced world recovery gathers pace there will be more opportunity for UK exports. He also hinted that the current strong pound may reverse at some stage if the current account does not correct naturally. Business investment is now picking up and may in due course raise productivity. As I have commented before, the decline in North Sea oil output and the movement of high earning people in financial services to lower tax jurisdictions has of course hit the productivity figures.
He did not comment on one obvious reason for a poor balance of payments performance – high energy prices and shortage of domestic energy. The UK is importing increasing quantities of high energy using products, and is importing more electricity from France and other energy from abroad. Cement, for example, is often now imported despite the high transport costs because UK production is so expensive given energy prices here.