Let’s give Mervyn King, governor of the Bank of England, credit where it’s due. He voted against the move. Sometimes, though, disagreeing with something is not enough. He was the boss, and the organisation he headed made a mistake; the buck stops with him, even if the man said no.
Back in August 2005, the Bank of England lowered the rate of interest. It was a move that had been expected by just about the entire community of economists, and it was warmly welcomed by organisations such as the CBI, British Retail Consortium and Unions across the land. Many argued it did not go far enough. Capital Economics, whose top man Roger Bootle is currently arguing rates may hit six percent soon, said at the time that the rate of interest would keep falling, eventually hitting 3.5 percent. And yet it was a mistake, or so says the National Institute of Economic and Social Research (NIESR). On Friday, it claimed that if the UK’s central banks had upped the rate of interest back then instead of lowering it, inflation would now be a tenth of a percentage point lower, and there would have been no need for the bank to have written a letter to Gordon Brown two weeks ago.
It’s easy to be wise in hindsight, but, in fairness, Mr King and three of his colleagues Rachel Lomax, Andrew Large and Paul Tucker voted against the drop. In fact, it was the first time the Bank of England’s Monetary Policy had voted against the chairman.
At the time, some members of the press argued against the move too. For example, writing in the Business Paper, Alistair Heath said: “Mervyn King#133; has also taken a potentially serious gamble.”
To put the rate drop of August 2005 in historical context, the UK was struggling at the time. Growth in the previous quarter was at the lowest level since 1993, the high street was in crisis, and the voices calling out for a fall in rates had risen to a deafening roar.
It was as if the bank had forgotten its job was to keep a lid on inflation, and it temporarily succumbed to trying to boost the economy – something it was not supposed to do. At the time we headlined: “rates dilemma between the devil and the deep blue sea”, and it seems we had a point. The economy needed to see a fall in rates, but inflation was far from licked, and there were dangers implicit in the move.
And what lessons can be learnt for today? Aside from the obvious conclusion that the Bank of England is not infallible, it also perhaps shows how many have been underestimating the dangers of inflation.
Government and consumer borrowing has been too high for some time. In any other era, inflation would have been much more serious by now. But today – thanks to globalisation and the internet – prices on the high street have stayed muted, and we have seen prices pick up elsewhere instead. One type of product, whose price is less sensitive to the forces of global competition, has seen inflation soar – we refer of course to the property market.
The idea that house prices could have enjoyed such extraordinary growth without other parts of the economy seeing inflation occurring eventually, is absurd.
On Friday, the NIESR predicted CPI inflation will top two percent, that’s the Bank of England’s target level, for at least a year.
Elsewhere there seems to a growing feeling that CPI is too narrow a target for the Bank of England. This morning Bloomberg quoted Tim Drayson, an economist at ABN Amro, as saying: “In a few years’ time, people will find that inflation targeting is flawed,” he added: “The Bank of England’s inflation focus has been too narrow. It’s too late to engineer a soft landing now.’‘
But it seems to us that with the money supply growing and many consumers still spending more than they earn, the big danger is that the UK economy will start behaving the way it always used to – and then inflation will continue northwards, but over the longer term.
© Investment & Business News 2013