Why the Bank of England won’t raise interest rates any time soon

Rate-setter Kristin Forbes, who wanted borrowing costs higher, never felt she could vote for an increase. That’s because the economy can’t really take it

Savers lost one of their last hopes for an interest rate rise when Bank of England rate-setter Kristin Forbes announced she would be heading back to her home in Massachusetts in June.

Forbes, a US academic who craves a return to the “economic normality” of 4%-5% base rates, has consistently called for an increase, though never actually voted for one. After the summer, it could be that only Ian McCafferty is still inclined to raise rates among the Bank’s nine monetary policy committee members.

Mortgage-payers, on the other hand, will be throwing their hats in the air. And why not when the departure of Forbes, and the economic realities that always prevented her acting on instinct, means interest rates are going to stay low this year, next year and most likely for the rest of the decade?

This prediction is not some finger-in-the-air exercise allied to Brexit gloomery, but an assessment of Britain’s ingrained economic weakness, something Forbes understood and railed against.

This fragility may not be obvious from the most recent economic figures. These show the UK outperformed the rest of the developed world last year: employment is near record highs and unemployment at an 11-year low.

The concern – and anyone can see it in the Bank of England’s own reports – lies beneath the veneer of impressive data Philip Hammond understandably flashes around to justify his steady-as-she-goes approach. That picture of boom-boom Britain is not entirely an illusion, but the figures don’t really add up.

Firstly, wage rises are stuck in first gear. The Bank of England expects pay packets to rise in response to increasing inflation over the next year. Yet the agents it employs around the country talked to 340 businesses and were told those employers planned to scale down increases from 2.7% to 2.2%.

Several reasons were put forward for the reduction, most of them relating to increased labour costs from the new apprenticeship levy, due to take effect in April at a cost of £3bn to businesses, and the rollout of the Nest occupational pension to small employers. The theory here is that while labour costs are rising, there is less money available to boost wages.

Last week, the Office for National Statistics said annual wage rises had already started to dip, albeit slightly, from 2.7% to 2.6% in December.

Exhibit two is the lack of business investment. A separate survey by Threadneedle Street found that ultra-low interest rates had failed to persuade companies to prioritise investment above handing out profits to shareholders. A third of companies complained that their banks were still tight with their money, and many others said the outlook was too uncertain.

None of these companies are going to increase investment if the cost of borrowing rises, even if they were somehow to interpret higher rates as a sign that the economy was looking rosier.

Then there is consumer spending. It is well known that the economy has expanded since 2010 largely due to a mania for mobile phones, cars, short hotel breaks and eating out.

In the last year, this high street splurge was mostly due to households spending their wages, which increased by around 2.5% on average while inflation was virtually zero. Consumer credit is at levels not seen since the crash. Yet retail sales have declined for the last three months.

In the last year households have also borrowed heavily and run down their savings. One industry shines out from the rest: figures from the Finance and Leasing Association show that British households borrowed a record £31.6bn in 2016 to buy cars, up 12% on the year before.

To give a measure of the way credit has become embedded in the purchase of a car, nine out of 10 private car buyers are now using personal contract plans that effectively provide a lease.

These finance plans are all priced from the ultra-low interest rates and would become unattractive in a “normal” interest-rate world. Moreover, savings have tumbled as a proportion of gross domestic product – and, worse, savers have been stealing not only from their deposit accounts but also from their pensions.

George Osborne’s reforms allowed people aged 55 or older to empty their pensions, turn long-term savings into cash and splash it about like champagne-spraying Formula One drivers. Around £9bn has been extracted and spent in this way, giving the economy a boost akin to a 1p cut in the basic rate of income tax.

By no means last on the list are the government and its finances, which are shot.

The latest figures from the Institute for Fiscal Studies prepare the nation for at least another 10 years of austerity. There will be room for a little extra cash to be spent in this area or that. But with health costs rising, and tax receipts stagnant, there will be little room for manoeuvre.

In short, there is very little left in the tank of the private sector or the government to boost a flagging economy, let alone overheat it. And the economy will need to be overheating, or look like it will, before the MPC even considers higher rates.

Contributor

Phillip Inman

The GuardianTramp

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