On Thursday, the Bank of England’s MPC voted to hold Bank Rate at four per cent. Given that inflation is well above target this came as a surprise to nobody. It also voted to slow the rate of QT. As I wrote last week, the Bank’s approach to QT has been problematic and so it is good that it has recognised this (although I would have paused it rather than scaled it back). As an aside, it was interesting to see that it was Catherine Mann who wanted to be more radical on QT and scale it back even further despite voting to hold interest rates this time. Dr Mann does see herself as an activist member of the MPC and so it does mean you can never know quite what to expect which means following monetary policy is a bit more exciting (and gives bloggers something to blog about).
Although it should have been bolder on QT, I think that the MPC probably made the right decision on interest rates. I myself voted the same way on City AM’s Shadow MPC last week. I was asked to cast my vote by the close of play on the Friday before the MPC met. As I wrote a few weeks ago, although I felt that we should not be too worried about inflation, I’d want to see signs that inflation was on a downward trajectory and/or the labour market was in serious trouble. It wasn’t quite a 50:50 decision in my mind when I voted to hold but it wasn't clear cut. The most recent data on the labour market did concern me.
If the most recent data had been available to me then I still would have voted the same way. However, it would have been a much closer call and I would have been more tempted to vote for a 25 basis points cut to Bank Rate.
On a related note, I was also asked by City AM to say where I thought that interest rates would settle. I stated that they would drop to three per cent by the end of 2026. This is considerably lower than where the market currently thinks they will end up (around 3.5 per cent). It’s also lower than where many of my fellow Shadow MPC members think they will land. So, why do I think this?
The Bank expects inflation to peak at around four per cent before returning to target. I agree with this, I just think this will happen more quickly than the Bank has forecast. Inflation has remained sticky in the UK in recent months but this has been largely driven by government policies. The hike to Employers’ National Insurance coupled with the increase to the minimum wage have meant that costs have risen for firms. This has been passed onto consumers in the form of higher prices. Moreover, money supply growth is nowhere near where it would have to be to become a problem. As such, it is reasonable to assume that inflation is going to return to target.
What is more, the deeply unwise increases to Employers’ NI and the minimum wage are starting to pass through to the labour market. We have already seen unemployment creep up while the number of vacancies decreases. As I’ve written before, we should all be very concerned about the state of the labour market.
Unfortunately, things look set to get even worse. There is no sign that the Chancellor will change course and reverse her damaging policies. We have the workers’ rights legislation which will act as a massive disincentive for hiring people – especially the young. There is also the prospect of more tax hikes in the autumn. All of this will destroy business confidence and mean that firms are more reluctant to hire workers and may even be forced to start letting workers go. At the very least we would expect to not see any salary increases for workers.
This will not just be a disaster for workers in the industries most impacted, it will have ramifications for the economy as a whole. As Simon French pointed out, the latest data reveal that the UK equivalent of the Sahm Rule has been breached. This of course does not necessarily mean that we are going to go into a recession, but things are certainly not looking good. Economic growth is pretty much non-existent as it is and so it seems very likely that the UK will be entering a period of negative growth.
All of this is likely to be disinflationary. Therefore, we should again expect inflation to return to target more quickly than the Bank and other analysts think. Now, it could be that inflation remains stubbornly high for whatever reason. However, even if this is the case then I can still see a path for interest rates being cut. If the labour market does continue to cool and if there is a recession then this will force the MPC’s hand and it will have very little option but to keep cutting rates.
There is, of course, the possibility that I’m completely wrong (it’s happened before). While three of my fellow Shadow MPC members agree with me, five do not. I tend to agree with Julian Jessop on most things but he believes that rates will settle at 3.5 per cent. Professor Jonathan Haskel – who served on the MPC and so has a much better understanding of how his former colleagues make decisions – also thinks that the terminal rate will be 3.5 per cent.
This does give me reason to doubt my own forecast. Moreover, given that my position is based on the assumption that even more young people will be unable to find work and have their life chances diminish while the country experiences another deeply damaging recession, I hope that I’m wrong.
However, I just cannot see how the labour market and the economy as a whole can withstand the pain to come and so even if inflation does not return to target, the Bank will still be forced to act.
International Trade
It’s been a very gloomy post so far - but remember this blog is called ‘Opportunity Lost’ so you can hardly have expected it to be a barrel of laughs when you signed up. Anyway, I spent Wednesday and Thursday at the WTO’s annual Forum. While I’ve been to the WTO before, that was for work purposes and job interviews, so it was nice to attend as a punter.
I will probably write something on my reflections of attending (maybe even tomorrow) but just to say that I thought it was great. The future of the rules based trading system is in jeopardy, but the fact that the event was so well attended and that there were so many smart and energetic people with solutions on how to fix it does fill me with hope. I also ate a lot of waffles and cheese.
Thanks as ever for reading. Enjoy your weekend!