If it isn’t hurting it isn’t working. That was the message from John Major, then chancellor, in 1989 during a previous period when interest rates were being used to combat high inflation. And it was the message rammed home by the Bank of England on Thursday.
Any hard-pressed households or struggling business looking for comfort from Threadneedle Street would have been disappointed by news that the pain will continue and is likely to intensify. Interest rates are unlikely to have peaked, and the only real question is how much further they have to rise.
So while Jeremy Hunt took comfort from the fact that the Bank thinks Rishi Sunak will meet its target of halving inflation during the course of 2023, in truth there was precious little else for the government to cheer.
If the Bank is right, the next election will take place with the economy barely growing, unemployment rising and mortgage payments increasing by about £3,000 for the average household. As vote-winning strategies go, that leaves something to be desired.
Privately, Hunt and Sunak may well have some sympathy for those analysts who think the Bank has already done enough and should call a halt now before any more damage is caused to the economy. Previous rate rises are certainly hurting (as the Bank itself admits), but the feeling in the financial markets is that there will be at least one, and perhaps two, more quarter-point increases before the Bank’s monetary policy committee (MPC) hits the pause button.
Of itself, the August rate decision was mildly doveish. After raising rates by a half point in June, there had been some speculation of a repeat performance this month. In the end, the MPC’s 14th rate increase in a row was limited to a quarter point rise to 5.25%.
What did raise a few eyebrows was the Bank’s language, which has toughened up. The MPC expressed concern about the level of wage increases and said it would “ensure that Bank rate is sufficiently restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term”.
Financial markets saw that not just as a sign that there may be further increases in interest rates to come, but also that rates will stay high. Anybody thinking about whether to go on to a variable rate mortgage should factor in that there may be no cut in interest rates until well into 2024.
That, though, assumes that the Bank is right in assuming the UK will avoid a recession in the coming months. That’s a moot point, because there are already signs that the economy is weakening: falling house prices, weak credit growth and rising unemployment among them. The former MPC member David Blanchflower says attention should be paid to sharply higher youth unemployment, because younger workers tend to be the first to suffer in a recession.
Threadneedle Street thinks there will be a soft landing rather than a recession, but its recent forecasting record has been so bad that it has asked the former head of the US Federal Reserve, Ben Bernanke, to conduct a review of what has gone wrong. For what it’s worth, the Bank now thinks the economy will go sideways next year as inflation continues to fall.
Andrew Bailey, the Bank’s governor, was one of six MPC members voting for the quarter-point increase. There were two votes for a repeat of June’s half-point rise, while one committee member, Swati Dhingra, said rates should be left unchanged.
Bailey was keen to accentuate the positive and repeatedly talked about the economy’s resilience. Yet, the higher rates go, and the longer they remain high, the greater the risk of overkill.
That’s the point made by Dhingra, who thinks the risks of overtightening have continued to build, increasing the risks of a recession that would require an eventual policy U-turn. According to the minutes of the MPC meeting, the lone dove on the committee said: “Lags in the effects of monetary policy meant that sizeable impacts from past and recent increases were still to come through, particularly from cumulative impacts on housing costs.”
The future path of interest rates will depend on what happens to the economy over the coming months, but borrowing costs are now at their highest in 15 years and each ratcheting up of interest rates makes the avoidance of recession less likely. As one economist noted, the economy is like a frog in a slowly boiling pan of water: it can only remain resilient for so long.