The elephant (not) in the room
At the time of the Bank of England’s interest rate decision, no-one in the room knew who was going to be Britain’s new Chancellor. This might seem like an odd thing to mention, given right now the main story people will be obsessing with is the element of shock – that the Monetary Policy Committee decided not to cut rates. But it matters.
But before we get to that, let’s consider the decision itself, and why so many investors and economists got it wrong.
In the run-up to the Bank of England’s interest rate announcement today, investors were placing an 80% probability on the Bank’s Monetary Policy Committee cutting interest rates. Instead, not only did it leave Bank rate on hold at 0.5%, only one of its nine members voted to cut them to 0.25%.
As I tweeted this morning, the market’s apparent confidence that rates would be reduced to their lowest level in history was always misplaced – for four reasons.
First, we don’t yet know the full impact of Brexit on the economy – and the Bank only very rarely makes big call on rates without at least checking the data or updating its forecasts.
Second, the fall in the pound is likely to push up inflation – perhaps even beyond the Bank’s target.
Third, when Mark Carney hinted about rates being cut a couple of weeks ago, he was actually rather vague about how soon it would happen – but he mentioned August a few more times than July.
Finally, back to that point I made at the beginning: at the time it made its decision, the Bank did not know who would be Chancellor. This might seem like an odd, pedantic point, but it is significant.
It is an under-appreciated fact that these days the MPC decides interest rates the day before the official announcement. And, as I understand it, the MPC voted to hold rates yesterday afternoon, before Theresa May was appointed Prime Minister – and before she made Philip Hammond her Chancellor.
Now, on the one hand, the MPC is independent to decide rates as it sees fit. On the other hand, it cannot ignore the government entirely. For one thing, if there was to be an emergency Budget (we suspected there wasn’t but that has only been confirmed this morning), the MPC might have considered it prudent to wait and see whether the Government was planning a major splurge. There is less point, after all, in loosening monetary policy radically if fiscal policy is also going in the same direction.
Moreover, were the Bank going to do more quantitative easing, it would have needed the Chancellor’s approval. Which would have been difficult since, at the time, there was no Chancellor. George Osborne was on the way out and Hammond on the way in.
Such considerations don’t surface explicitly in the minutes – and why would they? There are enough reasons above for the Bank to pause this month rather than cutting. But it underlines the fact that these decisions are a bit more complicated, and involve a little bit more second-guessing, than you might have thought.
Anyway, the expectation now is that rates get cut next month. But will it actually happen? Probably, but these days you never know.