Bank of England governor Mervyn King was on good form over the weekend.
In an interview with The Daily Telegraph’s Charles Moore, he took the finance industry and the banks to task. Among other criticisms, he noted that the attitude has too often been that “if it’s possible to make money out of gullible or unsuspecting customers, particularly institutional customers, that is perfectly acceptable”.
It’s a good read. I’ve always felt that Mr King’s heart is in the right place. And I couldn’t agree more with his assertion that “the concept of being too important to fail should have no place in a market economy”.
But while I hope he gets his way with the banks, he has more pressing issues to deal with. Such as what to do about inflation and interest rates.
Mervyn King has a fight on his hands
Judging by his take on the banks at the weekend, Mervyn King must like a fight. And it’s a good thing too. Because over the next few months, he’s going to have a job convincing other members of the Monetary Policy Committee (MPC) that he’s right on interest rates.
It’s possible to defend Mr King’s view that hiking rates would be “a futile gesture”. From next month, we’re all going to feel the pinch quite sharply. The point at which you start to pay income tax at 40% is being lowered. National Insurance contributions are going up. A swathe of benefits and tax credits are being altered. That won’t be good for the consumer.
Soaring oil prices are a nightmare too. Petrol prices are hitting record levels. And Alan Duncan, the Overseas Development Minister, took the shine off our weekends by noting that if oil hits $200 a barrel then “£1.30 at the pump could look like a luxury”. If petrol hits £2 a litre, a double-dip recession would be a foregone conclusion. So you can see why the idea of hiking rates seems risky to Mr King.
But not hiking rates might be risky too. And more and more members of the MPC seem to be coming round to that idea. As Andrew Sentance, the member most keen to raise rates has noted, the Bank does have some power to offset the impact of rising commodity prices. Higher rates would mean a stronger pound, which would reduce some of the pain.
Also, we’ve got the European Central Bank (ECB) threatening to raise rates now, even in the face of an unresolved debt crisis in Europe. That would put pressure on the UK, as Deborah Hyde notes on Citywire, because it would likely weaken sterling, and increase inflationary pressures further.
Obviously, European monetary policy is even more entangled in twisted political machinations than our own. More than anything else, Europe needs to keep the euro strong. As long as the continent is stuck in this debt crisis, any sign of a run on the euro could cause more panic in the periphery. By keeping the euro shored up, the ECB buys time for politicians to get some sort of lasting deal on the table. So I suspect that the threat of a rate hike is just bluff for now.
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What really matters for UK interest rates
What’s more interesting – and what should probably be worrying the Bank more – is that even the Confederation of British Industry (CBI) is starting to push harder for higher interest rates in the UK.
More often you find business lobby groups calling for lower rates. After all, low rates traditionally mean more consumer spending and cheaper borrowing. But it seems that the CBI is more worried about inflation than rate rises. John Cridland, the CBI’s director-general, said: “I don’t think a modest increase in interest rates would destabilise an export-led recovery… We must not allow inflation to get back into the national psyche as a given”.
This suggests to me that manufacturers – who are feeling the rebound in the economy most powerfully – are increasingly worried that their wage bills are going to be driven higher this year as staff expect life to keep getting more expensive. According to recent pay data, a significant proportion of the sector is seeing wage deals of 4%, well above the national average. It’s this concern about rising wages, far more than oil prices or what the ECB decides to do, that will decide how rapidly rates are hiked in the UK.
There are no easy choices left
But whatever happens, it’s unlikely to be pleasant for the UK economy. If rates go up, it could be painful. But if inflation gets any further out of control, it’ll also be painful. The problem is that we’ve got too used to the idea that there’s a ‘magic’ interest rate that will make everyone happy and keep the economy ticking along. That’s not the case anymore. The best the MPC can hope for now is to make the ‘least-bad’ choice.
People hail ex-Federal Reserve chairman Paul Volcker as a hero now. But his cure for inflation in the early 1980s drove the US economy into a painful double-dip recession. And he wasn’t very popular at the time. Our own central bankers are already getting a taste of that, and it’ll only get worse for them.
As we’ve noted before, it all points to keeping your portfolio positioned defensively. And if you want some protection from inflation, then looking at the energy and food sectors is worth doing. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
Oh, and I thoroughly recommend you read the interview with King in The Telegraph if you haven’t done so already: Mervyn King interview: We prevented a Great Depression… but people have the right to be angry
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