Time to start thinking about higher rates

I’m going to let you in on a little trade secret. Most of the analysis and reaction to a Bank of England rate decision is pre-written hours, sometimes days, ahead of the announcement itself. An economist will write some paragraphs in case of various different eventualities – a rate hike, a cut, more quantitative easing and so on – and the PR department or tech people will press the button on the relevant one as soon as the decision is announced.

Except that, in the past few months there hasn’t been much point – after all, there’s only one likely outcome from each month’s Monetary Policy Committee meeting: the Bank will leave interest rates on hold at 0.5%. It’s the longest period of unchanged official borrowing costs in Britain since the 1930s and World War Two, when they were left at 2% for a couple of decades.


Which is why I am taking the conscious decision today to break with tradition. Not only have I written my post-decision analysis before the move happens, I’ve decided to post it up online beforehand as well. The Bank of England will not/did not change interest rates today. The economy may be recovering at a fair clip, but it opted to leave the cost of borrowing unchanged this month – and will probably do so in the coming months as well.

Whether it should be doing so is another matter. For the past six months, the Bank has been saying that, under its forward guidance policy, it will not even consider raising rates until the unemployment rate drops beneath 7%. Its initial expectation had been that this moment would not arrive until 2016. However, since then the labour market has proved peskily more resilient than expected. No sooner had the Bank Governor made his announcement than the jobless rate, which had hung stubbornly close to 8% since 2009, started to come down. According to some economists, new figures may even show it dropping to 7% by the end of last year.


In other words, the key condition which the Bank has said would mean it could actively start considering whether to lift rates is about to be fulfilled. There are two primary avenues they could take now (yes I know there are other permutations, but I’m simplifying, ok?):

  1. The Bank starts considering lifting interest rates. It begins actively debating doing this at its monthly meetings. This, in turn, will push up the actual rates many pay on some mortgages and loans (after all, markets often try to pre-empt the Bank’s moves). After some time (and it may be a year or more beyond that 7% moment), the Bank decides to lift borrowing costs. Another way of putting this would be as follows: Bank ditches forward guidance altogether. Back to good old inflation targeting.
  2. The Bank redefines forward guidance. It changes the threshold at which it says it will consider raising rates from 7% to 6.5%. Many economists think this is quite possible. After all, as they see it, forward guidance was really just a tool to allow the Bank to leave rates on hold longer than the inflation target itself would have merited. The fact that the statistic at its very heart has moved more than expected should not detract from that key purpose. In other words, 7% unemployment was only ever a means to an end (lower rates for longer).

To my mind, the first of these options is the most attractive for everyone concerned. After all, let’s say, for the sake of argument, that the Bank of England is determined to leave interest rates unchanged for a while. Forward guidance was a policy clobbered together when inflation was well above its target of 2%, leaving many to wonder why the Bank wasn’t acting sooner to bring it under control. Well, it so happens that right now, inflation is back down to 2.1% – a level that hardly bespeaks imminent inflationary shock.

This won’t be the case forever, of course. As the economy gets back into gear, the cost of living will start to increase, and in due course, perhaps towards the end of the year, perhaps next year, it will be appropriate to lift borrowing costs.

And a good thing too: there is only so long that you can run an economy on the most accommodative monetary policy in history. I was one of the commentators who supported the thrust of the Bank’s policy all the way back in 2009, but always couched my approval with one key proviso: the MPC had to be ready to withdraw that policy before it caused another boom, and a spike in inflation. With each month that goes by, that moment is drawing closer, as is the time to act.

Of course, the only problem with choosing option one is that the Governor, Mark Carney, would have to acknowledge tacitly that there wasn’t much point to his forward guidance policy in the first place. Given how proud he was of it when he unveiled this “ground-breaking” innovation last summer, that may be too much to expect.