The Monetary Policy Committee (MPC) had to steer between two outcomes with today’s rate rise. Raise interest rates by too little, and you court the possibility of failing to get a hold of inflation and spooking the markets. Or they could have raised rates by too much, make the recession they announced far more severe, and spook the markets.
Steering between these monetary Syclla and Charybadis meant raising rates by enough to suggest they were serious about taming the inflation tiger, but that they didn’t want to do so in a way that means our dower economic outlook is any more grim than it has to be. The markets expected a rise of 0.75 per cent. By going for 0.5 per cent, as they have, Bailey and his acolytes have made a mistake.
Personally, I would rather they leant slightly towards too high than too low. With our new Prime Minister and Chancellor pursuing a “dash for growth”, the expansionary fiscal policy is there to counteract the recession a monetary squeeze would bring. One man’s monetary squeeze is another’s return to normality. Raising rates to 2.25 per cent is only returning to them what they were in 2008. So even by conforming to market expectations, Bailey and co would hardly have been revolutionary.
Yet despite taking rates to their highest level in fourteen years and being the seventh consecutive hike, the MPC has fallen short of what the moment calls for. Across the pond, the US Federal Reserve has been opting for 0.75 per cent rises. In doing so, it has shown a determination to get inflation under control, and precipitated the current sharp rise in the dollar against the pound and Euro.
By contrast, today’s announcement saw sterling fall 0.3 per cent to a low of $1.1274. It has been falling for months, and is now at its lowest level since 1985. The reasons for it have been obvious. We have higher inflation than any other G-7 nation, and, as Bailey confirmed today, we are in a recession.
Just importantly, we have a new Prime Minister committed to borrowing record amounts and pursuing a fiscally-expansive agenda at a time of soaring inflation. The debt markets, as our Editor has pointed out, are worried. For Trussonomics to work, we need a tighter monetary policy – hence Patrick Minford suggesting rates might need to hit seven per cent during the leadership contest.
Failing to get a hold of inflation, calming the markets, and stop the pound’s slide means more deterioration in the situation in the coming months. A lower pound means higher inflation due to rising import costs. Higher inflation will mean, will all Bailey’s tardiness, higher interest rates. Higher interest rates mean higher government borrowing costs. Higher government borrowing costs, as much as Truss and Kwarteng might not want to talk about it, eventually entail tax rises and spending cuts.
None of this cannot be good for Tory fortunate at the ballot box. Hence why tomorrow’s fiscal event marks the beginning of Truss and Kwarteng’s attempts to try and cut this Gordian knot. The Government’s “Growth Plan” aims to boost growth enough to appease the markets and reduce the debt burden.
Of course, with the economic environment as volatile as it is, our new government may get lucky. Maybe the downward trend in energy prices will continue, and that inflation – which fell slightly last month – has peaked. Maybe Bailey’s rise today will be enough. But that’s a lot of maybes. The tumbling pound already shows that the debt markets are sceptical.
But it is not only the Government that the markets are wary of. Consistently, Andrew Bailey has failed to heed the warning lights on the economic dashboard, and act as he is needed to. The best announcement that the Chancellor could make tomorrow is not that he expects borrowing to be lower, or that he is reversing the National Insurance hike, or that he is a born expert at pulling rabbits out of hats.It would, frankly, be to give Bailey his P45 – and appoint someone who reconginsed the coming inflation when Bailey still believed it was transitory.
He won’t, for many good reasons. The Bank of England’s independence is long-standing enough to be difficult to compromise. The markets are more than jumpy enough as it is. And Truss has just been elected with an agenda to challenge the orthodoxies of economic thinking. Wisely, she has dropped her talk of interfering with the Bank, since it distracts from her overall agenda and makes an already tricky job even harder/
The markets haven’t give up on Bailey yet. Expectations suggest rates will peak at almost 5 per cent, which means the MPC will need to get its skates on at the next rate rise. As I mentioned this morning, history suggests lowering taxes can encourage growth and raise revenues, and end the dilemma facing the Government. The Bank spoke today. Trussonomics speaks tomorrow. Good luck to the Chancellor. He will need it.