With little more than a week to go before the Bank of England considers its next interest rate move, it has become clear that the Old Lady of Threadneedle Street has missed the boat. Its governor, Mark Carney, hinted as much in comments earlier this month when he spoke about the weakening of the economy since the start of the year.
“I don’t want to get too focused on the precise timing – it is more about the general path,” Carney told the BBC. In particular, he said the turmoil on Britain’s high streets, which has seen a worrying number of businesses go to the wall, was a matter of interest to the bank’s interest-rate-setting committee.
He could see what was coming in the latest GDP figures, which came out on Friday and revealed a miserable 0.1% increase in the first quarter of the year.
Carney’s gloomy stance is in sharp contrast with his bullish comments in February. Back then, he was keen to follow the US Federal Reserve and signal several increases to head off what he saw as a booming economy that was feeding rapidly into higher wages.
In the simplest of monetary policy calculations, higher wages mean demand outstripping supply for goods and services, which in turn leads to rising prices. Carney said that with wages set to soar and inflation to remain stubbornly high, calm could only be restored by jacking up interest rates.
But persistently high inflation perpetuated by strong wage rises was always a mirage shimmering on the horizon. It was never going to happen – at least not in the sustained fashion that might worry a central bank.
A report last week by the labour market economists David Bell and David Blanchflower explains how the long-term trend for wage rises is no more than 2%, and that this is not going to be enough to put pressure on prices.
The inflation rise seen in Britain was always a temporary blip driven by the fall in the pound, which provided a one-off rise in import prices. It was prolonged by an unexpected rise in the oil price to $70 a barrel.
So the question must be, why did Carney and his rate-setting committee make such a big deal of the need to raise rates when the case was always weak?
There are several reasons, and they link together. The first is that they want to have some ammunition when the next recession hits. Building up an armoury involves raising interest rates, in order to cut them in the future, and winding down the quantitative easing (QE) programme to afford officials the opportunity to give it a boost at a later date. At the moment, with rates at 0.5% and the total spent on buying government debt under QE standing at £435bn, there is little room to add any extra fizz should the economy start to slide.
There is also the problem of how to justify tighter monetary policy during a long and modest recovery. Three years ago, when the UK economy appeared to be bouncing back from the crash, several Bank officials said the time was right to raise rates. The departed Kristin Forbes was one. Ian McCafferty, who is still in place, was another. Judging by the standards of today, they were right. The money supply was expanding at its fastest rate since the crash, GDP growth was hitting 2% and unemployment was low and falling.
Carney was one of the chief naysayers, arguing that the economy remained weak by historical standards and, crucially, that low productivity was restricting the possibility of high and sustained wage rises. Looking back, 2014 and 2015 were high points in a long struggle for recovery.
Is Carney kicking himself for inaction now that there is an even weaker case for re-arming monetary policy? He shouldn’t be. The responsibility for acting always lay with the government, and particularly George Osborne’s Treasury. All the time Osborne was promising more austerity, the Bank’s hands were tied. While the Treasury was withdrawing money from the economy by spending less – and businesses, nervous about the future, were doing the same – it was a suicide mission for the Bank to pursue a similar goal. It was only the Bank that stood between the UK and a full-blown, 1930s-style depression.
It is still possible the Bank of England will raise rates in a bloody-minded show of strength. Yet by its own standards, the case for it could only have been made three years ago. Now it’s much too late. Austerity remains firmly in place. The current chancellor, Philip Hammond, worries about Brexit and business follows suit – limiting investment and wages growth, and leaving hard-pressed households to survive as best they can.