Britain’s monetary policymakers put on a good show of toughness on Thursday, telling the nation that people have become far too complacent about interest rates staying at rock bottom for ever.
“Some withdrawal of monetary stimulus is likely to be appropriate over the coming months in order to return inflation sustainably to target,” the MPC said as it sought to copy the US Federal Reserve and European Central Bank’s telegraphing of decisions to come.
The words jolted financial markets, but the long tradition in the UK is that these movements soon wane as people realise the Bank of England’s bark might be loud, but there is no bite at all.
Soon after Mark Carney became governor, the bank declared it would begin to consider raising rates when unemployment fell below 7 per cent. That level of joblessness, the BoE thought, was consistent with stable inflation. Since then, it has fallen to 4.3 per cent, yet interest rates are lower now than in 2013.
A year later, the governor said interest rates were likely to rise “sooner than markets currently expect”. At the time, markets expected interest rates to be 2.25 per cent by now. Since interest rates are only 0.25 per cent, markets were wrong and the governor even more so.
In 2015 he repeated the open mouth operations saying the rates decision would come into “sharper relief” around the turn of the year, but they did not.
When the BoE has cried wolf so many times, the question is whether people should place weight on its words today. Scepticism is understandable. In the past four years, the BoE has not seen fit to tighten monetary policy in all conditions: when growth has been high, when inflation was projected to rise above the 2 per cent target, and when inflation has already exceeded that mark and is expected to remain there. The Monetary Policy Committee has always found reasons for delay.
MPC members deserve pity rather than contempt. Their job is to control inflation, but the traditional sensors telling them when is best to change interest rates have stopped working. The link between unemployment and wages has broken down completely, not just in the UK. However tight the labour market appears to get, wages seem stuck at growth rates of about 2 per cent.
Leaving rates at 0.25 per cent risks allowing imbalances and vulnerabilities in the economy to build even if inflation remains under control
Growth rates also no longer appear to drive inflation with sufficient certainty to make a big decision to raise rates for the first time in a decade. It is not even remotely clear what effect interest rates have on growth and jobs, and therefore ultimately on inflation.
Even taking a risk-based approach does not give a clear steer on the right path for interest rates. Raising rates when there appears little inflationary pressure risks denying households and companies income and prosperity.
Leaving rates at 0.25 per cent risks allowing imbalances and vulnerabilities in the economy to build even if inflation remains under control. Think of the problems of the 2000s, not the 1970s. We do not know which risk is greater and nor does the MPC.
With a majority on the committee committed to a rate rise in the months ahead (so long as the economic data does not dive), the MPC has put its credibility on the line. Increasing rates just to prove there is value in listening to central bankers’ words would be the worst possible justification for a change in monetary policy.
That said, if the BoE waits much longer, a rate rise becomes even more difficult because inflation, currently at 2.9 per cent, will dip in the new year as the effects of sterling’s depreciation wear off. November might be the only time the committee will feel able to justify a move into the unknown, which might, or might not, be warranted.
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