An article by Douglas McWilliams for Reaction
There is one subject on which both the hawks and doves who disagree over interest rates do agree on: that the Bank of England is making a horlicks of its communications with the outside world, and more pertinently, the financial markets.
Over the last week we have heard the Governor, Andrew Bailey, hint at an early rate rise overturning earlier hints that interest rates rises were on the cards for next year, while MPC member, Silvana Tenreyro, has argued that there was no need to raise rates because the markets had already anticipated a rise.
This lack of a clear communication from the Governor leaves the markets with mixed messages, leaving traders and investors to scratch their heads over what to expect.
At least with the previous Governor, Mark Carney, they knew what to anticipate: his statements were treated as contra-indicators, so far off beam was his understanding of the UK economy. Today the markets only think the Bank is confused – under Carney they would routinely bet he was badly wrong.
Underlying all this confusion of what to do next is that the Bank doesn’t understand what is happening to the UK economy. It has routinely failed to understand that in the modern tech based economy, the economic relationships have changed dramatically.
Because so many of the parts of the economy which are growing are in sectors that get badly measured by the statisticians, you need to build in the likelihood of statistical understatement into your understanding of what is actually happening.
At the same time, the labour market is rapidly changing shape too. Many older people, having got used to not commuting over the last 18 months, are not likely to get back into the rat race as they now know they do not have to spend four hours a day commuting.
It also seems as though the Bank doesn’t want to know what is happening on the ground. When I offered to help the previous BoE Chief Economist Andy Haldane, for free, to bring him up to speed with the modern economy and suggested that some of my commercial rivals would probably also be happy to do so, his response was arrogantly dismissive of a few decades worth of economic understanding.
With the current bout of inflation the Bank has told us first that it was a blip, then that it was temporary. Now the new chief economist has claimed that the temporary period might be extended, temporarily maybe. Or not. No one knows.
There seems little realisation that against a background of huge monetary and fiscal expansion during the lockdown period to stave off many of the secondary impacts of the pandemic (where at the time the authorities played a blinder in my view), it was likely that the response might be an inflation overshoot that would then need to be reined back in.
The effect is doubled up by the fact that the US economy is also in bubble territory and even the Eurozone, which conventionally lags behind, is picking up. The Chinese have deliberately acted to burst their property bubble, for both political and economic reasons. But in the West the authorities have so far done little.
We are so far into uncharted territory that anyone who is certain about what might happen next is making it up. But my guess is that the rise in price inflation and the shortages of many goods, combined with labour shortages, will create a pay price spiral.
There is plenty of monetary kindling out there to keep the inflationary fire burning. And so rates will probably rise much more than anyone currently thinks to create a recession to bring down this spiral.
Which is why it would make sense, and would reduce the total requirement for interest rate rises, if the process of raising rates were to start when the MPC next presents its findings on Thursday 4th November, the day before bonfire night.