Twenty-four hours on and we’re still trying to work out why the Bank of England hiked rates.
A meagre 15 basis point rise to 0.25 per cent will be too small to have any impact on the economy. It hardly compensates for the fall in real rates that’s resulted from the recent dramatic rise in inflation. Though for owners and workers in the UK’s services sector, fearing for their livelihoods in the face of the latest spike of Covid cases, it might feel like a kick in the teeth.
The decision is driven instead by a desire to anchor inflation expectations around the Monetary Policy Committee’s target of 2 per cent — some feat given that inflation is currently running at 5.1 per cent. While this hike is small, the idea is that by signalling the direction of travel (and a willingness to use interest rates as a policy tool), people will anticipate further hikes in the new year.
Yet to pull off this Jedi mind trick requires credibility.
A lack of coherence between what the MPC has said of late and what it has done — both at its November and December votes — has left markets with no clear sense of how to read policymakers’ pronouncements. The Old Lady has proven herself an unreliable boyfriend, yet again. Couple that with the climate we have right now, rife with uncertainty, and we’re not confident markets will take hints about a steady crawl up the curve that seriously. At least not on the back of a cut as small as this.
The more fundamental issue, however, is that the UK is grappling with inflation of the sort that its central bankers can do little about. The bulk of the lift in prices has come from the rise in energy costs. Another source is the disorder in global supply chains. Both are factors that Putin and spike proteins have greater say over than the Bank. We remain unconvinced that the recent surge is impacting the labour market. The UK is not the US.
Nor will the problem of supply-side driven inflation die down.
China has already identified cases of Omicron, with factory shutdowns likely to follow. Even when the pandemic becomes endemic, we’re faced with the twin threats of more frequent extreme weather events and ageing populations. Climate change threatens to have an impact on harvests of crops such as cotton. The past year has given us some insight into how labour shortages can be expected to affect production. It is reasonable to expect that the structural forces that kept a lid on prices over recent decades, such as the impact of Chinese labour and production on globalisation, to diminish too.
More volatility in output and prices is the likely result.
Monetary policy is not entirely useless in managing whipsawing inflation. But its masters ought to be more honest about the degree to which they can now be expected to deliver stability and prosperity through this channel alone. Money’s price is the only thing central bankers can truly influence. Don’t get us wrong — money clearly matters for inflation. But in a time of global outbreaks and climate change, shocks on the supply side may matter just as much. If not more.
Yet to admit this weakens policymakers’ hand. Acknowledging that influence over money — substantial though it is — may not be able to tame bouts of inflation would force them to concede that inflation may owe more to price pressures themselves than the credibility of those tasked with keeping them in check. Economist Jeremy Rudd made a strong case here for the view that it is inflation itself, not targets set by policymakers — and their influence on what people think will happen in the future — that really matter.
BoE governor Andrew Bailey, and others in the central banking priesthood, have been dismissive of Rudd’s view. Instead, they choose to stick to the textbook and claim small hikes change behaviour by shifting inflation expectations and rendering any spike in prices temporary.
Which makes sense, given that the entire intellectual framework upon which central banking has been based for the past 30 years would collapse if Rudd was proved correct. The foundations are already shaky. A global financial crisis, followed by a decade characterised by weak official inflation figures combined with surges in asset prices, has already led many to suspect that something is amiss with a system that claimed central bankers could be entrusted with delivering steady growth. If people and businesses no longer think they can control inflation, then we suspect the era of the omnipotent, independent monetary guardian is done.
So we have our answer. Thursday’s rate hike was about Threadneedle Street convincing their critics that central banks still have the power to manage the economy.
Perhaps time will prove the MPC right and we’ll look back on the hike yesterday as the first of a series of masterstrokes that reined in price pressures. We fear they’re wrong, however. They might get lucky and benefit from a fall in inflation during the second half of next year, for which they can claim credit. That’s likelier, in our view. Eventually though, we suspect they’re going to get found out.