It’s never a foregone conclusion, but the Bank of England is highly likely to hold interest rates unchanged this week, thanks to a recent steady flow of weak economic data over – only partly excused by the March snow. If that happens it would be the 101st time in the last 103 meetings of the Monetary Policy Committee that it has taken that view. Whatever criticism can be levelled at the Bank’s handling of the UK economy, frequent policy changes is not one of them. The Bank’s increasingly vocal critics should be taken with a pinch of salt. Many are economic forecasters who have been repeatedly wrong-footed. Rather than address their own shortcomings, some have chosen to label the Bank as an unreliable partner. I doubt that Bank Governor Mark Carney and his colleagues care. They are not in the business of providing post-dated promises.
One fact is undeniable. The Bank of England, like most major central banks, is finding it hard to return interest rates to a level most Britons would consider normal. Having cut the Bank’s headline interest rate to emergency levels in 2009, subsequent guidance towards higher rates have been a series of aborted missions. First came the rapid fall in UK unemployment that failed to generate rising wages. Second was the dramatic fall in the global oil price. Most recently the Brexit referendum instilled a level of economic uncertainty with few precedents. On each occasion I believe the Bank chose the correct path; however there are others who see these as missed opportunities to rebalance the incentives faced by borrowers and savers.
So perhaps the Bank of England needs to look again at how it starts the process of normalising monetary policy – perhaps interest rates are not the best place to start.
The Bank has also bought £425 billion of UK government debt since the global financial crisis. These purchases have been designed to maintain low borrowing costs at a time when there were limits to ever lower interest rates. The Bank still holds that entire amount today and has committed to owning this stock of debt until interest rate “normalisation” is well under way.
However this £425 billion of debt is not static. The debt matures at regular intervals – at which point the Government pays back the Bank the amount it had initially borrowed. Currently the Bank simply reinvests these payments to buy replacement government debt. One of the ways in which the Bank could begin to gradually tighten monetary policy outside the glare of quarterly inflation reports is to manage these reinvestments using a pre-announced rule. An example would be where reinvestments would cease as long as the interest rate on 10-year government debt remained below a certain level – say 2 per cent. Should interest rates rise above that level then reinvestments could restart to ensure borrowing costs did not rise too abruptly. There are similar policies already in place in other countries, most obviously in Japan.
The Bank, which has resisted the idea, says it wants the headroom to cut interest rates ahead of the downturn. This argument is flawed, as it assumes consumers and businesses respond more to interest rates than a change in the Bank’s debt holdings. While the very mention of quantitative easing leads most people to glaze over, if the psychological impact of a rate cut is greater than changes to QE then it follows that a rate increase has similarly larger impacts. When policy is struggling to flow it would be better to attempt a trickle rather than a torrent.
What UK businesses and consumers really care about is the commercial borrowing rate. For many borrowers, despite November’s rate increase, heightened competition has brought down the cost of available mortgages. Managing quoted interest rates through the Bank’s sale of debt rather than interest rate policy moves the Bank’s actions closer to what businesses and consumers actually pay on their debt.
By holding rates this week the Bank risks reconvening during the most fractious of Brexit negotiations later in the year. If the next crisis arrives before Brexit has been completed then the Bank is unlikely to be thanked for its previous caution. It is time to look again at how the first step is taken.
A version of this piece was published in The Times.