Here is a conundrum. At noon on Thursday, the Bank of England will most likely increase interest rates for the sixth time in a row. Analysts are generally expecting a rise of a half of a percentage point– the biggest single hike since before the Bank was made independent, when monetary policy was ultimately the responsibility of a chancellor called Ken Clarke.
Yet this week’s rate rise is not intended to cool an overheating economy – far from it. Both the IMF and the OECD forecast that the UK will endure the weakest growth of any rich country next year, while the well-respected National Institute of Economic and Social Research (Niesr) believes that the country will enter a recession this summer and stay there until well into next year. So why, then, is the Bank pushing up interest rates?
To listen to its governor, Andrew Bailey, this is about signalling his commitment to keeping inflation at 2% – as he is mandated to do by the government. “Let me be quite clear: there are no ifs or buts in our commitment to the 2% inflation target,” he said at the Mansion House dinner last month. Yet pushing up interest rates in the UK will achieve precisely zero in bringing down the price of wheat or oil on global markets. It is the shortage of commodities around the world that is raising prices. That is why the Niesr expects inflation to soar to “astronomical” levels next year.
If wages aren’t rising to keep pace, then what we currently label inflation is really a form of rationing – rationing by price, so that the wealthiest can afford to keep their houses warm this winter and their cars filled with petrol, while those with less money have to make some stark choices. Freezing or starving? New uniforms for the kids, or toys for Christmas? All higher rates do in this scenario is add to the economic pain by making mortgages and credit card bills another worry for families already stressed about paying for energy and food.
This mess is not Mr Bailey’s creation. He might more fairly be viewed as the unluckiest Bank governor since it was cut loose in 1997. Mervyn King enjoyed what he dubbed a “Nice” decade (10 years of non-inflationary constant expansion); his successor, Mark Carney, was an astute politician basking in the support of George Osborne. Mr Bailey has faced a once-in-a-century pandemic, a global commodity shortage and constant sniping from senior Conservatives. Some think he should have raised rates far sooner and far higher – which would most likely have turned a recession into a depression. The frontrunner to be the next prime minister, Liz Truss, wants to rewrite the governor’s job description so that he is even tougher on inflation.
Where Ms Truss has a point is that, since 2010, the Tory government has relied on the Bank to keep interest rates as generously low as possible so that successive chancellors could be zealously tight on spending. The result of this regime has been to leave the Bank with precious little room for manoeuvre and to encourage a surge in the prices of houses, artwork and other assets. It was a dangerous economic policy that did nothing to channel money to where it is most needed (such as council housing, public services and the incomes of the lowest paid). It should be reversed – but not in this haphazard fashion, which will hurt businesses and harm households.