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Well, the Monetary Policy Committee did exactly what the market expected.
It hiked interest rates by a quarter point – not a jot more, not a jot less.
So given that markets expected this move entirely, complacency and false confidence about the inevitable decline in inflation will continue to reign.
Once again, the commentators will start to claim that rates have now peaked, and everything will be just fine and dandy.
Until the next big inflation scare, of course…
The Bank of England’s decision to maintain a cautious course on interest rates may seem to make sense, but in fact it’s storing up disaster for the wider economy.
As MoneyWeek regular James Ferguson pointed out to us last night, since early 2002, the Bank of England has allowed “economic growth to stray above base rates.” Apparently, this has historically proved “a springboard for sustained and embedded inflation.”
“This should never have been allowed to happen and a dovish, weak-willed MPC is unlikely to get on top of it quickly enough.” He reckons that unless the MPC finds a backbone soon, interest rates of 7% or even 8% are possible.
You can find more of James’s thoughts on this topic in his regular investment email, Model Investor.
But in a way, it’s no surprise that the BoE is spineless. After all, it learned its lessons from the greatest central banker of them all – Alan Greenspan. And his legacy is still being adhered to in the US.
Interest rates in America this week stayed at 5.25%, which is where they have been since last August. As Martin Hutchinson points out on Breakingviews, at that time, there had been a global stock market ‘hiccup’ in May, and everyone broadly agreed that interest rates needed time to work through the economic system.
Now, says Hutchinson, “with the stock market up 15%, that justification has evaporated.” For all that Ben Bernanke talks about inflation being his biggest worry, he’s been doing precious little about since he took over the helm from the Maestro.
The big problem is that, as Hutchinson points out, the earlier rate hikes have slowed the US economy – first quarter GDP growth was down to 1.3% – but haven’t hit inflation. Core consumer inflation is at 2.1%, and of course if you include those pesky food and energy costs, the Fed’s favoured GDP deflator measure puts inflation at 4%.
With the US base rate at 5.25%, that makes the real interest rate around 1.25% – that’s a lot lower than the historic average of around 2% to 3%.
“The Fed may fear that a rate increase will cause it to be blamed for a recession… but in light of the growing pressures, that’s a poor reason for not raising rates,” concludes Hutchinson.
The same goes for our beleaguered bankers of the MPC. No one likes being the one to spoil the party, but unfortunately that’s a central banker’s job. And if the bulls on Wall Street, and in the City and among the estate agents want to find someone to blame for the inevitable squeeze up ahead, they’d be far better looking to Mervyn King and Ben Bernanke’s predecessors.
As former BoE governor Eddie George freely admitted, not long ago, when he slashed interest rates from 6% to 3.5% between 2001 and 2003, in the aftermath of the dotcom bubble, “we knew that we were having to stimulate consumer spending; we knew we had pushed it up to levels which couldn’t possibly be sustained into the medium and long term.” He knew it could give rise to problems in the future, but said: “My legacy to the MPC, if you like, has been ‘sort that out’”.
Unfortunately, the only way to “sort that out” is to raise rates to crush inflation, and it has now been put off for so long, it will no doubt trigger the recession that Mr George decided he didn’t want to have on his watch.
Even worse, when the hard times hit home, we’ll have had an extra four years of growing debts and soaring house prices to pay back – and inflation will be back on the menu after many thought it long dead.
Thanks Eddie.
Turning to the stock markets…
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London stocks headed lower yesterday afternoon as a weak start on Wall Street hit investor sentiment. The blue-chip FTSE 100 index closed 25 points lower, at 6,524, although the broader FTSE 250 was higher. Mining heavyweights including BHP Billiton and Xstrata were among the heaviest fallers as they retrenched Thursday’s strong gains. For a full market report, see: London market close.
Elsewhere in Europe, stocks were also hit by Wall Street weakness. The Paris CAC-40 ended the day 32 points lower, at 6,012, whilst the 60 points lower at 7,415.
On Wall Street, stocks tumbled as a bevy of retailers, including Wal-Mart, reported weaker-than-expected sales. The Dow Jones ended the day 147 points lower, at 13,215. The tech-heavy Nasdaq was 42 points lower, at 2,533. And the S&P 500 was down 21 points to 1,491.
In Asia, the Nikkei slumped 183 points to close at 17,553.
Crude oil was slightly higher, at $61.95, this morning. And Brent spot had climbed to $65.29 in London.
Spot gold was little changed overnight and was last quoted at $677.25. Silver almost hit a two-month low in Asia trading, dipping as low as 12.93, before rebounding to $13.00 this morning.
Turning to currencies, the pound was at 1.9793 against the dollar and 1.469 against the euro this morning. And the dollar had risen to 119.83 against the Japanese yen and 0.7414 against the euro.
And in London this morning, the National Institute for Economic and Social Research announced that the UK economy expanded by 0.7% in the last quarter, matching government forecasts. The report, prepared before yesterday’s interest rate announcement, also recommended a half-point hike in interest rates to counter the growing inflation threat.
And our two recommended articles for today…
Five plays on climate change fears
– Climate change fears pose a considerable risk to some stock market sectors, such as automotive stocks. But what about those that have been tipped to benefit? For Niels Jensen’s assessment of four of the most popular plays, including Moneyweek favourites Uranium and water, plus one lesser-known weather-related investment tip, click here:
Five plays on climate change fears
The best way to play the rising gold price
– There are many ways to play the rising gold price, but Doug Casey favours junior precious metals exploration companies. To find out how to incorporate gold stocks into your investment portfolio, see: The best way to play the rising gold price