Inflation up – so cut interest rates!

The Monetary Policy Committee of the Bank of England (MPC) failed to control inflation on the way up, allowing interest rates that were too low for too long. The Uk made its own contribution to the world credit bubble, and has its own high inflation as a result. Expect more bad figures today.
Now the MPC is determined to get it wrong the other way, keeping rates far too high for too long. They can’t stop inflation rising this year by keeping rates up – they caused the inflation by errors in previous years. What they can do is to start ameliorating the downturn. Instead, the MPC seem determined to make it as bad as possible.

In recent weeks we have seen

Oil prices fall by one third!
House prices continue to fall – now down by more than a tenth in a year
Commercial property prices fall by one fifth in a year
Share prices falls by more than one quarter from peaks
Northern Rock and Lehman have crashed
Some other banks and financial institutions are in a difficult situaiton, strapped for cash

How much more deflation will it take before the MPC can get the message? INTEREST RATES ARE FAR TOO HIGH. THE ECONOMY IS BEING THROTTLED.

The MPC should wake up, meet in emergency session, and announce a reduction in interest rates to 3% in the first instance.

The markets are in a very fragile state. The US has cut interest rates to 2% only, and may take them down further. Why is the UK out to lunch in the middle of this nasty financial crisis? Why are they always looking backwards to past mistakes, instead of seeing that inflaiton will fall sharply next year, along with economic activity.

They seem to want more people to lose their jobs, more people to lose their homes, and more people to lose their businesses. Can someone tell me why?

At the same time the UK governemnt should publish a new and sensible forecast for its own spending and borrowing this year and next, and take action to cotnrol its ballooning deficit.


  1. ken from glos
    September 16, 2008

    Rubbish!! What about us savers we are always ignored and i need the income from savings.

  2. Stuart Fairney
    September 16, 2008

    I can only agree ~ it's as if they have learned nothing form the whole Montagu Norman tragi-farce of the 1930's.

  3. Johnny Norfolk
    September 16, 2008

    We have a Labour Prime Minister who was supposed the be the best chancellor ( not my view) we have ever had. In fact he is the worst as you can now see by the lack of action.

    Where is the cut in rates.

    Where is the cut in government spending ( needs to be massive)

    Where is the cut in taxes for the lower paid. ( not complicated government handouts)

    What of course he will do is the cowards option of borrowing even more. That will make it even worse in the long run. The Labour governments past and present have never faced up to economic reality.

  4. Alistair
    September 16, 2008

    I don't understand why if oil prices have fallen by a third why petrol/diesel prices have not fallen at least somewhat. The petrol/diesel sellers did not waste any time putting up prices but are very tardy at dropping them!

    1. Johnny Norfolk
      September 16, 2008

      Because of the falling value of the pound

      1. Andrew Forbes
        September 16, 2008

        And the fall in the pound (back to John) is why they can't cut interest rates

        Reply: The US slashed interest rates and the dollar rose. The danger is the UK gets into a vicious cycle of high interest rates, big downturn, lack of confidence, falling pound, high interest rates, lower growth etc

        1. Andrew Forbes
          September 16, 2008

          The dollar rose because the US govt haven't made a complete arse of everything they've been meddling with for the last 10 years. We don't have that luxury here, so interest rates must protect the exchange rate.

        2. Robert
          September 16, 2008

          That was because the dollar was already weak – not the case with sterling!

          reply: Sterling has been weak most of this year.

  5. mikestallard
    September 16, 2008

    John, I think you are being unfair here. The authorities are, in fact, walking a tightrope between inflation and credit crunch.
    There is a huge case for avoiding inflation: the government is broke, searching for money and tempted to pump more "liquidity" into the system. The Trades Unions are finding their feet. The cost of living is soaring. The pound is sinking too – so the price of oil appears to be rising, along with all the other imports. Finally, of course, house prices love inflation – that is how you seem to make money!
    As I see it, the credit crunch is like winter: it kills of the weak, the people without foresight and purges. So it is not all bad.

    Reply: I am not keen on killing off the weak if that means people losing their jobs and their homes. I don't mind if bad busiensses have to go through the Receiver, but see no need to force more to do that by creating a big general downturn.

    1. Robert
      September 16, 2008

      It is inevitable I am afraid – you can't have one without the other be realistic

  6. Kit
    September 16, 2008

    I know the instinct of every politician is to meddle but please leave well alone. Let the financial markets work through this themselves. The MPC has a job to do so do not move the goal posts in the middle of a crisis. Meddling will only lead to greater instability and uncertainty.

  7. Tony Makara
    September 16, 2008

    The Bank of England must set its focus on maintaining the stability of Sterling over any transient gains that may come from cutting interest rates. Price stability has to be the base for all economic strategy. If rates are cut it will undermine Sterling and our over dependence on imported food and fuel will be reflected in high street inflation, leading to pressure on wages and a fall in living standards. Once we have rampant inflation in the system it will be very difficult to iron out. As a nation that imports so much, we are literally forced to have a strong Pound policy and the higher interest rates needed to support our currency. The way out of this conundrum is to develop more by way of an internal market, especially in the production of food and fuel, that will require a radical tax-cutting agenda aimed at those producers who want to supply the domestic market. Until we begin to dominate and supply our own market, we shall always need higher interest rates to stop us importing inflation.

  8. Matthew Reynolds
    September 16, 2008

    Cutting regulation in the mortgage market & construction industry will help if it boosts liquidity while tackling scams and reducing costs . Taking an ax to QUANGOS's & tax credits so that the basic personal allowance can be £14,000 p/a for everyone would disproportionately benefit those likely to spend the extra cash while reforming Job Seekers Allowance & Incapacity Benefit so that all those previously eligible for those handouts now get one payment designed to slash economic inactivity so that public spending cuts do not add to the dole queues and thus welfare budgets . That simple program would aid the economy as would a more credible inflation target and greater powers & independence for the Bank of England as John Redwood and George Osborne have suggested . Greater economic stability would aid a recovery by encouraging long term investment . The poorer you are the worse high inflation & rising taxes affect you – tackling this surely is what modern compassionate conservatism is all about is combines social justice & economic liberalism ?

  9. Nick
    September 16, 2008

    I disagree.

    Inflation is rising. The only tool of the BoE is rates.

    If you want to get the economy moving, first you need to clear the deficit between taxation and spending.

    Then you can start cutting taxes.

    The problem is that cutting spending means cutting jobs, and very hard. We are talking about huge swathes of public sector workers.

    For the reason of making sure my NI record was kept up to date, I signed on the other day. In the Jobcenter there were about 15 staff doing job center work, but there were 10 who were working as people hanging around. It's make work, all on pensions to boot.

    Get rid of lots like these. Cut back on politicians. Cut back on quangos. Whole departments need to go. DTI? Get rid of it. Enterprise zones? Can.

    The tax cuts first must go on raising the tax allowances at the bottom. If necessary other rates get raised to claw back the gains for the better off.

  10. Martin Day
    September 16, 2008

    I quite agree on this issue John!

    This is when B of E independence from the treasury becomes a problem. Part of the roadblock to recovery comes from the mandate the Labour party gave the Bank of England on Independence in 1997.

    The Government should be raising taxes at this times and slashing interest rates, rather like in 1981! Whilst no tax increase is ever welcome, my opinion is the Labour party have lost anyway – so there is no point Brown wasting money on gimmicks that do nothing for the country or from his point of view his standing in the polls. All Brown seems to be doing is choking private sector economic activity for ill-thought out public expenditure.

    A tax increase now would ensure that Government borrowing does not become uncontrolable. A mild Tax increase now may be painful but the Labour party is currently saving up much pain for the future along with the current problems. The Cut in interest rates would help consumers, Businesses and ultimatly Financial Institutions who could re-build there margins/ profitability whilst passing on some of the interest rate cuts.

    Tax increase and rate cuts today – lower taxes in the future. This policy would also ensure that the proceeds of Interest rate reductions would also be shared.

    1. mikestallard
      September 16, 2008

      If you increase taxes, don't you make already poor people poorer?
      Why should most people be poorer while public servants get a huge pension, cast iron wages and employment in non-jobs? Some of them are on well over £100,000 p.a. Why? What do they give to the economy? (see Nick above).
      Isn't it much better if the government stops being wasteful? If you have been reading this blog for some time, you will know that there are certain things which everyone agrees should be cut, starting with quangos.
      Rather than soak the non public sector or the client state, we need a government which will pull in its own belt before asking us to tighten ours.

      1. Martin Day
        September 17, 2008

        Whilst I agree with you – I don't think it is going to happen at this time as Labour will not cut anything but the defence budget!

        It also depends what you tax! A short term hike timed with lower interest rates may work. You have to deal with the here and now, not what we would like to do! If quangos were to be cut etc, I have no doubt that a six month review would be instigated first. The economy needs rapid action not vacilation!

  11. David Eyles
    September 16, 2008

    In your list of bad things that have happened just recently, you mentioned that oil prices have dropped by one third, as if the reduction in price is what is contributing to the economic downturn. I beg to differ. High oil prices are a big factor in raising inflation, reducing cash available to industry and increasing demands upon borrowing. The reduction is extremely welcome. I have just ordered red diesel at £0.57/litre, which is down, thank heavens, from £0.70/litre earlier on in the year. But it's still too high. Last year when I bought red diesel, it was £0.45/litre and that was too much.

    I suggest that the hot money moving out of oil and into gold and other things is cause for a little celebration – it's one thing we have to pay less for, borrow for and otherwise scrape the piggy bank for.

    Reply: I am delighted oil prices are falling – I put it in my list to show there is no prospective inflationary problem.

  12. Ben
    September 16, 2008

    Interesting, John. Your colleague, Douglas Carswell, has said the opposite this morning – and he thinks you are a neanderthal.

    Sort it out amongst yourselves, please, then let us know what the Tories would do.


  13. Brian Tomkinson
    September 16, 2008

    You certainly don't give up on your crusade to see a cut in interest rates. However, it is clear that some of your colleagues do not agree with you. I noted Ben's reference to Douglas Carwell and last week I heard Michael Fallon speaking out strongly against an early cut in interest rates, which is the view that I share. Are you being totally objective about this subject or are you perhaps also being influenced by the wishes of those companies in which you hold directorships?

    Reply: I am being objective. I always think of the public good in statements on this blog.

  14. Matthew Reynolds
    September 16, 2008

    We could opt out of EU rules on VAT and bring in a far simpler US style Sales Tax that would reduce regulation and bring in enough revenue to fund cutting basic rate income tax by 1p to 19p , cutting top rate tax by say 2p to 38p and raising the top rate tax threshold by £10,000 p/a over and above prices . A shift from direct to indirect taxation was a positive pro-growth move in 1979 and can be so again . Ending tax credits for the rich & middle classes and using the money to fund a bigger basic personal allowance would move money from the rich to the poor . That would simplify taxes and would make things fairer. By stressing a right-turn on Europe & lower income tax and a pro-redistribution line would impress the left the Tories would pick up support across the board via a radical tax policy .

  15. Eddie Allen
    September 16, 2008

    All bank executives should be taken out in the streets, tarred and feathered, pulled along cobbles at the back of a cart and dangled off London Bridge for a week whilst their assets are being stripped and returned to the people !!!

    Government Ministers who let them have our tax money so they could make a fortune out of lending us it all back again should also have their homes taken off them ( all of them ), and they should be exiled for life to John O'Groats along with all their do-goody creepy supporters !!!

    That's what I reckon anyroad !

    By the way HBOS shares have tumbled 34% today.

  16. mikestallard
    September 16, 2008

    And now, with banks crashing all round, the poor old broke government is rapidly losing its golden goose which is dying on its feet.
    This will mean that there is bound to be a serious shortfall next year.

  17. Cliff
    September 16, 2008

    I do not understand economics or high finance however, one thing strikes me about the weakness of the Pound and Labour's love of further integration into the EUSSR…..Is it possible that this Labour Government, is actually happy to see the pound fall against the Euro, as once it becomes equal in value, the government could say we should join the Euro to protect our economy?

  18. savonarola
    September 16, 2008

    Its financial/economic management by numbers.

    Brown-Darling do not understand either economics or financial markets. The inflation imported from gas/food prices is unavoidable. Essential items.

    It doesn't take an economics for dummies student to twig that in current deflationary environment cutting interest rates will not cause inflation. We are spending our money on food and fuel to stay alive and get to work.


  19. Julian White
    September 17, 2008

    An interesting article, but this would repeat the failures of the Thatcher administration. If you put down interest rates, you will never control inflation.

    Indeed only one Prime Minister has ever really understood the requirement for low inflation to build a successful long-term economic recovery with sustained growth. That Prime Minister delivered low inflation, and was light years ahead of his Cabinet colleagues, indeed, including Mr Redwood judging by his above willingness to let inflation creep back. That Prime Minister was of course John Major, who left a golden economic legacy.

    Reply: Of course controlling inflation is crucial. John Major's ERM policy first put inflation up, then after we came out of the ERM he controlled it. Where exactly do you think next year's inflation is coming from? Can't you see the downward moves in commodity prices and the intense competition emerging on the High Street?

    1. Julian White
      September 17, 2008

      Inflation came down during, and because of our membership of the ERM. Thatcher left it at 10.9%, two years later when we left the ERM it was 3.6%. Thatcher's decision to join the inflation reducing ERM was one of her most inspired moments.

      Credit must be due to John Major though, his pressure on Thatcher to join the ERM, and his inspired economic policy and delivery of economic success arguably make him Britain's most competent administrator of the economy.

      Inflationary pressures are all around, whether it be food prices or indeed oil prices bouncing back up again as they are not predictable. Inflation can still creep up on an economy, even when it is in, or near, recession.

      Now is not the time to reduce interest rates. It's a crude instrument anyway as previous Prime Ministers have discovered. Fiscal policy is an alternative should the Government feel the need to intervene in the market. But Conservatives in my view should put low inflation foremost in their thoughts.

      Reply: Inflation went up in the late 1980s because we shadowed the DM, the preparation to enter the ERM. It was a disastrous policy which led to the downfall of Major's government.

      1. Julian White
        September 17, 2008

        Whilst we were in the ERM, our inflation rate fell in just two years for the lowest in 30 years. As John Major pointed out, our economic recovery did not start after we left the ERM, it started whilst we were in it. Major wrote in his auto-biography that "Britain's membership of the ERM turned Britain into a low-inflation economy" and he's absolutely right.

        Economic growth can be wiped out by the effects of inflation, and controlling inflation has to be paramount. If you put interest rates down, you'll create a false growth, and then have to deal with the consequences of rising inflation. Despite a near economic recession our inflation rate is currently well above the Government's targets, and frankly, it's not clear that the Bank of England have any confidence in where the inflation rate is going.

        Now that the Conservative party has returned to Majorite values in large areas of policy making, I am hopeful that Cameron will stand just as firm.

  20. Gareth
    September 17, 2008

    While cutting interest rates sounds good, are we out of the woods on inflation?

    One thing to remember is interest rates have been historically low. Lower then they should have been in fact, due to the fiddling of the CPI figure. Real inflation in the real world for real things real people buy with real (or borrowed) money has been higher, for longer, than the measure of inflation adopted by Gordon Brown. Yet it is CPI that dictates interest rates.*

    Had RPI or RPI-X been used as the target for interest rates we would not be in the over indebted position we find ourselves in as interest rates would not have been artificially low. Also, had the Bank of England's remit not been so narrow we would not be in such a perilous position.

    The economy has been sacrificed so the hand of history could be on Brown's shoulder for appearing to manage a decade of apparently good times.

    * Is there method in Brown's madness? Keep interest rates low and the Government can borrow willy and indeed nilly to pay for obscene spending splurges, rather than shove up taxation by a huge amount.

  21. mart
    September 17, 2008

    Dear John, there is obviously some politics involved in “calling” for a rate cut. I don’t blame you for that.

    What’s disappointing is that in your article there is no analysis of the other side of the argument.

    We see in the news today (admittedly well after your article was written and published) that the MPC were 8-1 agreed to keep rates on hold.

    If reducing rates is so obviously the right thing to do, why did these learned and responsible people not do so? This is not just a rhetorical question. Since you firmly believe they were mistaken, I would value reading your reasons for having that belief.

    Myself, I (going by instinct and personal observation only) still think high expectations of house price inflation are still too high. If I look at house price expectations in my area (in the South of England) – measured by the amount people are advertising their houses for – then people still have an expectation of high returns on their property investments. There have been some drops in prices advertised, but nowhere near the amount required to make them affordable again.

    So in my humble opinion, as long as expectations stay high we have, if interest rates were lowered now, the potential for inflation restarting its ugly effects on our economy.

    Kindest regards

    Reply: There was no politics in asking for a rate cut, and certainly no politics in saying public spending has to be brought under control. It is my view of what is needed. The MPC members are looking backwards, not forwards, and worrying about the current inflation (which is too high) and not understanding that it will come down quickly next year. The Bank and its friends have been wrong much of the time during my lifetime, hence the endless sterling crises, public borrowing crises, erratic inflation figures and periodic bank collapses. Probably their worst period was 2004-6, when they allowed very loose money, when most people queued up to praise them because interest rates were so low and credit was so plentiful. I have been a long term critic of Brown’s reforms and of this MPC’s boom and bust approach to monetary management. What possible evidence is there that inflation will be higher next year, when you look at commodities, shop prices,unemployment, wages and asset values?

  22. Eddie Allen
    September 17, 2008

    I don't think many get the picture here at all.
    The Free market liberalised economy where supermarkets sell insurances, loans and mortgages, banks sell mortgages and each other and building societies sell anything and everything except milk and cheese 9 thus unable to compete with supermarkets ), is at an END at least as we know it.

    The reality here is taxpayers are holding it all up otherwsie it would be BUST. The USA has all but in name nationalized its financial sector and so have we.

    It cannot operate without help from the state and no amount of shaking it will revive it…..It's DEAD.

    Go back to what it was before finance was deregulated.
    Salaries have to come back to earth, massive bonuses and the trading of imaginary financial products must be stopped, shorts must be banned and good old financial prudence must be returned to the system to allow lending to be made available from balance sheets not the taxpayers.

    Also, I think noone's noticing another couple of realities.

    a ) It matters not what the Bank of England do with interest rates because a cut would not be delivered by banks as they need to restore profits.

    b ) Noone wants to borrow money, the media are telling people banks won't lend, but the fact is noone is applying. Hence a drop of 50% or more in mortgage applications.

    Why are they not borrowing ?

    1 – People can't afford a mortgage
    2 – There's too much regulation in the mortgage market
    3 – People are jittery about employment
    4 – The banks have no money and are averse to take risk

    We need a new government, we need a new monetary system, we need to tax those who do not pay tax, tax some people less who shouldn't be paying as much, kick out quango's and take a slicer to public spending plans and to a few odd areas where Labour is basically giving money away, pull out of the Mass Trick Treaty, revalue the pound and kick start our manufacturing industries again without all the Euro nonsense wrapping the UK up in knots.

    That will then be a real "Free Market Economy" not a false one bound by red tape and lack of good old prudent financial management.

  23. mart
    September 18, 2008

    Dear John, Thank you for a sturdy reply. You asked for evidence showing that inflation will stay high. I'm afraid I have none, except the continuing high expectations shown by vendors of houses.

    For what it's worth (not much) I am not optimistic for the UK economy over the next couple of years, and maybe you are right that now is the time to lower rates in order to lower the cost of living and doing business.

    Given that the MPC was 8-1 decided in favour of keeping the rates unchanged I wanted to understand the other side of the argument. I know they are not infallible, and I know you are certainly not a lone voice in calling for rates to be cut.

    I will believe inflation is gone, and the "system" back on an even keel when people are once again advertising houses for reasonable sums. We should keep a watch on the price of basic homes, and when these are within the reach of someone on a normal wage at a 3.5 times multiplier, then I'll conclude we are OK again.

    I apologise for assuming a motive in your article that was not there.

    Kindest regards.

    Reply: Thanks. I think house prices will fall considerably over this winter, though maybe not back to 3.5 times earnings. Banks will continue to look at net income divided by interest payments.

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