If it isn’t hurting it isn’t working. That was the message from John Major, then chancellor, in 1989 during a previous period when interest rates were being used to combat high inflation. And it was the message rammed home by the Bank of England on Thursday.
Any hard-pressed households or struggling business looking for comfort from Threadneedle Street would have been disappointed by news that the pain will continue and is likely to intensify. Interest rates may not yet have peaked.
In one sense, the latest decision by the Bank’s monetary policy committee (MPC) came as little surprise. As expected, it raised the official cost of borrowing for a 14th time in a row, and by 0.25 percentage points to 5.25% as anticipated by the City.
What will have raised a few eyebrows is the Bank’s language, which has noticeably toughened up. Previous increases in rates were already slowing the economy but the MPC said it would “ensure that Bank rate is sufficiently restrictive for sufficiently long to return inflation to the 2% sustainably in the medium term”.
Financial markets will see that not just as a sign that there may be further increases in interest rates to come, but also that they will stay high. Anybody thinking about whether to go on to a variable rate mortgage should factor in that there may be no cut in interest rates until well into 2024.
That, though, assumes that the Bank is right in assuming the UK will avoid a recession in the coming months. That’s a moot point. Threadneedle Street’s recent forecasting record has been so bad that it has asked the former head of the US Federal Reserve, Ben Bernanke, to conduct a review of what has gone wrong.
For what it’s worth, the Bank now thinks inflation will continue to fall and will be at or just below its 2% target by early 2025. Meanwhile, the economy will continue to grow sluggishly, by 0.5% in 2023 and 2024, and by 0.25% in 2025.
Andrew Bailey, the Bank’s governor, was one of six MPC members voting for the quarter-point increase. There were two votes for a repeat of June’s half-point rise, while one committee member, Swati Dhingra, said rates should be left unchanged.
“Inflation is falling and that’s good news,” Bailey said. “We know that inflation hits the least well off hardest and we need to make absolutely sure that it falls all the way back to the 2% target. That’s why we’ve raised rates to 5.25% today.”
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Recent history suggests the MPC’s forecasts could prove wrong. What’s more, the higher rates go, and the longer they remain high, the greater the risk of policy overkill.
That is the point being made by Dhingra, who thinks the risks of overtightening have continued to build, increasing the risks of a recession that would require an eventual policy U-turn. According to the minutes of the MPC meeting, the lone dove on the committee said: “Lags in the effects of monetary policy meant that sizeable impacts from past and recent increases were still to come through, particularly from cumulative impacts on housing costs.”
The future path of interest rates will depend on what happens to the economy over the coming months. Currently, the Bank thinks there will be a soft landing, but borrowing costs are now at their highest in 15 years and each ratcheting up of interest rates makes the avoidance of recession less likely.
