Was the Base Rate increase an overreaction?

by Neil Patterson

8 months ago

Was the Base Rate increase an overreaction?

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Was the Base Rate increase an overreaction?

Was the Bank of England’s decision to increase the Base Rate from 0.25% to 0.5% and overreaction to artificially high inflation figures or can we anticipate potential future adjustments upwards?

One of they key factors expressed several times by Mark Carney and his team for the increase in Base Rate is the erosion of slack within the economy with  unemployment falling to a 42 year low and global growth at a much higher overall level than the UK’s. This then raises concerns of wage lead inflation adding to the external price lead inflation caused mainly by the fall in the exchange rate since the Brexit vote.

However, this is against the backdrop of very weak productivity growth in the UK which is a problem for many Western economies, but our output per worker is particularly low compared to the US and the bigger European countries.

The Bank of England November inflation report said: “The increase in inflation to above the MPC’s 2% target over the past year reflects the effects of the continued rise in import prices following sterling’s depreciation. Over this period, inflation has picked up most in those components that tend to have the greatest imported content, such as food, energy and other goods . The rise in global oil prices in recent months has added somewhat to external cost pressures and is likely to feed through to retail fuel prices, and therefore to CPI inflation, relatively quickly.”

This does tend to indicate that inflation is lead by external cost factors that are very difficult to influence with domestic interest rates dampening demand.

Even worse you would normally expect any increase in interest rates to strengthen Sterling by attracting more money into the UK, but the Foreign Exchange markets instantly reacted badly and the pound fell against the Dollar and the Euro thus adding to even more inflationary pressure on prices.

Analysts have speculated that the easily justifiable rate increase considering a 3% inflation figure is more of an attempt to give the bank some wiggle room up or down depending on the outcome of Brexit negotiations. Mark Carny did indeed stress in his press conference that there could be adjustments either way depending on future negotiations and that this would not reflect on the current decision or mean that it was a mistake.

The Chart 1.6 shows for interest the future projected rise in interest rates for the UK against other countries, but predicted future rises have been pushed out almost every quarter for the last five years and do show only small predicted increases. Therefore there is definitely nothing in the figures for mortgage borrowers to panic over yet.



Comments

Gromit

8 months ago

Inflation due to the falling exchange rate post-Brexit referendum will work its way out of the system over the next few months as the Pound/Dollar has is anything strengthened a little since the vote. So this is not a valid reason - but it could make the BoE look good as they can say "we increased BBR and inflation has come down give a nice pat on the back". Of course, the BoE (aka UK Govt) could have another hidden motive.
All the doom and gloom is misplaced as it only takes us back to were we were 15 months ago i.e. 0.5%

steve p

8 months ago

I think the cut from 0.5% to 0.25% was an overreaction after the brexit vote, Carney predicted carnage with massive job losses straight away. That never happened and now is a convenient time to undo that mistake. Also they will want somewhere to go down to if the brexit deal is not so good.

Old Mrs Landlord

8 months ago

Couldn't agree more, Steve. It was the drop to 2.5% which was the panic over-reaction and has done harm to the economy in stimulating borrowing. The sums owed on credit cards, overdrafts personal and car loans are staggering. However, Carney can now claim he staved off a recession, plus, as you say, he now has scope to drop rates should it really become necessary.

David Price

8 months ago

As a scientist I laugh when I see these self styled experts pretending that they can control the economy by varying one of the many thousands of parameters in the equation, not that is that they even know what the equation is.

H B

7 months ago

Reply to the comment left by David Price at 04/11/2017 - 09:07
And it's very hard to control inflation wroth interest rates anyway.

Ian Muir

7 months ago

It will be interesting to see how their projected international interest rates compares to reality. Do they really believe that interest rates will be pushed up when Gvmts are so massively in debt, and cannot afford current repayments?

As for the rise in global oil prices, the reality is that petrol prices have hardly moved.
Productivity? Well that's another set of obscure statistics that Ive enquired about and failed to get an answer to; exactly how they are actually calculated, what is a working day, hours worked, who is included (part-time?), what industries, holidays etc and are the stats produced exactly the same way for each country?

Statistics appear to be little more than a justification for Gvmts to hide the real problem - debt. I would like to see stats for anticipated interest rates if Deutsche Bank crashed (it apparently has derivative exposure that is 20 times Germanys GDP), or the Italian banks, or another Greece crisis (a certainty). In these events, Gvmts can only react to the markets and currently risk of sovereign default is not factored into interest rates (Greece is a 100% certainty of default, so why does anyone lend at 7%?). Once risk is factored in (its a certainty that Europe, UK, USA, Japan cannot repay their debts and will have to default) then interest rates will shoot up, irrespective of what Gvmts and central bankers say.

Personally I wouldn't rely on Gvmt statistics or central bankers/"economists" projections for making decisions on affordability. Being able to raise money at very short notice will be crucial in order to avoid a business-crushing spike in interest rates, even just to the long-term mean of 6-7%, let alone to the 15% rates we suffered in the late 80's-90's .

terry sullivan

7 months ago

carney is no friend to GB--he should be removed


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