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I want to find the weather for in .

Rates on the Rise … How far will they go in the years ahead …

Posted by Isabel Riley on 9th November 2017

Based on the data for the first three quarters of the year, we now expect growth of 1.6% in 2017. A similar level of output is expected in 2018. Fears over Brexit are overshadowing activity in the economy. Business investment decisions are haunted by uncertainty about life following the referendum implementation. Household real incomes are affected by the modest rise in earnings and the increase in headline inflation.

Against this backdrop, the Bank of England increased base rate last week. It was the first rate hike in a decade. More of a nudge than a hike, the decision to increase base rate to 0.5% merely returned interest rates to the “status quo ante referendum”.

So why has the bank acted now? Growth has softened into the third quarter, concerns about Brexit persist. The Bank of England is seriously concerned about jobs, incomes and investment as a result of the Brexit decision.

“In many respects the decision was straightforward” explained the Governor, “With inflation high and slack disappearing, the economy is growing at rates above it’s speed limit. Inflation is unlikely to return to the 2% rate without some increase in interest rates.”

Was it really so straightforward? Not all MPC members were convinced. Sir Jon Cunliffe, Deputy Governor for Financial Stability and Dave Ramsden, Deputy Governor for Markets voted against the rate rise. Two out of three deputies were doves. Just one was a hawk. Ben Broadbent, Deputy Governor for Monetary Policy voted for the rate rise.

So what about inflation? Inflation CPI basis hit 3% in September. The Bank of England expects inflation to increase slightly in October, before falling back to the 2% target within the forecast period. The rise in prices is largely explained by the drop in Sterling values and the rise in oil prices last year. The Governor is quick to blame the Brexit decision for the drop in Sterling. The decision to cut rates in August last year is excluded from the analysis. The reduction in base rates to 25 basis points, undoubtedly compounded the challenge for the currency.

In every Inflation Report, headline inflation is always forecast to return to target within the forecast period. One day perhaps it will. But not in this scenario. The short term pressure on prices is set to dissipate as the 2016 effects wash out of the annualised data.

More generally inflationary pressures are set to increase. World growth is set to be over 3.5% this year. Strong growth in China, is supported by recovery in North America and in Europe. World trade increased by over 5% in the third quarter. Commodity prices are rising. Oil prices are spiking as geo-political pressures increase in the Middle East.

In the UK, unemployment is low. Vacancies are high. Recruitment difficulties are increasing in the public and private sector. Earnings are forecast to rise in the months and years ahead. The anomaly of high employment and low earnings must surely be eliminated in the next phase of UK growth.

So what of interest rates? Inflation pressures will not be confined by two further increases in base rates over a three year period as the Governor would have us believe. The Fed is setting the pace in the US. The Bank of England will inevitably have to follow with a more aggressive rate stance in response.

For the moment, the UK is in the slow lane with a speed limit imposed by factors as yet unknown or ill defined. The Governor places great weight on the absence of productivity growth and investment. The private sector bears the burden of accusation for failure according to the Bank.

Low growth is also a function of low Public Sector spending generally, the lack of infrastructure spending specifically and the yawning deficit on the balance of payments trade account. Sluggish  Investment may inhibit growth but the lack of Public Sector spending, infrastructure investment and a growing net trade deficit don’t help.

And what of the external deficit? In 2016, the current account deficit was almost 7% off GDP. A record for UK data. Levels have been high before but not to this extent. In 1974 and again in 1979, deficits were almost 5% of GDP. Interest rates were hiked to 15% to contain domestic demand and avoid foreign capital flight. So what does this mean for rates?

Interest rates are set to rise again despite growth in the slow lane. It is unlikely two further increases over the next three years will be enough to return inflation to target. It will not be enough to satisfy the “kindness of strangers” in foreign capital markets on which the funding of deficits both external and internal depend.

Dr John Ashcroft is CEO of pro-manchester and author of The Saturday Economist.

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