Sterling took a pounding yesterday.
The pound slid after the Bank of England kept interest rates on hold yet again. It fell from as high as near $1.54 to just below $1.52 this morning.
The rate freeze was entirely expected of course. But what was more surprising was the accompanying inflation report.
It now looks as though – despite Britain’s apparently improving economy – the Bank could be keeping rates on hold for perhaps the whole of next year.
More misery for savers ahead then.
The Bank of England and the currency Cold War
Wages in the UK are rising pretty strongly. Employment is high. Retail spending is healthy too – the money from rising wages and falling petrol prices is starting to make its way onto the high street.
There are plenty of problems and general ‘weirdnesses’ about our underlying economy. The usual dysfunctional property market. The fact that the Bank of England owns a huge chunk of government debt.
But regardless of how healthy or otherwise you think the UK economy really is, it’s very hard to make the argument that it’s in intensive care, or in an emergency situation right at this precise moment.
Which begs the question – why do we still have an emergency interest rate policy?
Put simply, central bankers have got pretty lucky. The crashing oil price is actually hugely stimulatory for an economy like the UK’s. But at the same time, it keeps the inflation figures down. So it provides plenty of cover for inaction.
It’s increasingly clear that central bankers actively want to be ‘behind the curve’. We’ve heard a lot of theoretical talk in recent years about how central banks should raise their inflation targets to get out of the economic slump.
In other words, they should be willing to tolerate more inflation (something closer to 4%, say, rather than 2%) to make up for the years when inflation was weak.
Now as I said, this is all in the realms of academic theory rather than official policy at the moment. But I wouldn’t be at all surprised if this is the broad game plan that central banks are now unofficially following. It’s always worth remembering the one thing that really terrifies the likes of Janet Yellen or Mark Carney – the spectre of Japan.
They’ll do anything to avoid ending up in Japan’s situation. And as far as they’re concerned, Japan’s basic problem (not to mention the Great Depression of the 1930s) boiled down to overly tight monetary policy.
It’s important to keep this in mind. Central banks – certainly in the US and the UK – will very strongly err on the side of caution. They would rather make an error of omission (failing to raise rates in good time to prevent inflation) than one of commission (being too early with raising rates).
This is the main reason why I still don’t expect the Fed to raise rates next month, despite the rapid back-pedalling we’ve seen in recent weeks. In fact, I suspect that Yellen is praying for a weak US payrolls report today in order to make justifying a continued hold at 0% easier.
It’s also pretty clear that central banks the world over are monitoring their currencies closely. We’re engaged in a ‘currency Cold War’. There’s no outright targeting of any given exchange rate. That would be politically unacceptable.
But the last thing the Bank of England wants is to be seen as being the only developed world central bank that’s close to raising interest rates. Manufacturers are already feeling the bite of the pound’s strength against the euro.
The financial repression will continue until morale improves
What does it all add up to? Apart from anything else, savers can’t expect to get decent returns on their money any time soon. At least, not via a ‘safe’ option like a bank account.
This is one reason why we’ve been talking about income a lot recently. In a world that promises ongoing financial repression as far as the eye can see, you need to know how to generate it.