The Case for Cutting

31 July 2024

Will they, or won’t they? It’s the perennial question that financial markets, economists, and the housing market are in thrall to. The ‘they’ I’m referring to is the Bank of England (BoE) Monetary Policy Committee (MPC). The matter in question being a cut in official interest rates.

In case you need reminding, the cash rate currently sits at 5.25%. In truth, it’s more squatting like an unwelcome house guest than sitting, having been stagnant for the past 12 months. This after 14 consecutive hikes gave us the highest interest rates in 16 years.

Back in December, 2021, when the BoE began their quest to tame inflation, interest rates were a paltry 0.1%. Mind you, they hadn’t risen above 0.75% in the previous decade. Any time that the MPC might have considered ‘normalizing’ rates, a fresh crisis emerged that required quantitative easing, economic jargon for pumping cheap money into the real economy. Think GFC, Brexit and Covid-19.

Therein lies part of the problem. For the best part of a generation the BoE conditioned homeowners to think that rates hovering near zero were the norm. Homebuyers borrowed to the hilt, with no hint of the crippling increase in mortgage payments to come. On top of which the cost of pretty much everything went through the roof in 2021/22. Inflation or greed-flation? Take your pick, officially designated a ‘Cost of Living Crisis.’

When the BoE kick-started this tightening cycle, inflation was already galloping along at 5.4%. Like most central banks, the BoE was caught ‘unawares’ by the inflation genie escaping, which beggars belief. Post lockdown, consumers were sitting on billions of pounds in savings, eager to get out and spend money. Supply chains were in tatters. An economics student at GCSE level would have seen the looming inflationary cliff. But, somehow, not Governor Bailey and his cohort of central bankers.

So, when these experts bang on about sifting through a whole bunch of economic data to plot the course of inflation, you could be excused for being a little cynical. Especially when you consider the state some of their tools are in. Specifically, the Office for National Statistics (ONS) labour force survey which the BoE relies upon for data on unemployment and economic inactivity (those not working or looking for a job). It’s so banged up that they are currently deploying two variants until the new version is fit for purpose.

Headline inflation has been back in sync with the BoE target of 2% since May. Yet, underlying inflationary pressures are apparently still furrowing brows in Threadneedle Street. The principal culprit being services inflation, which has been coming in marginally above market forecasts, casting a pall over the timing of the first rate cut. Interesting that we’re tying ourselves in knots about minor variations between actual and forecast calculations, yet the BoE didn’t start to tighten the cash rate until inflation was a full 3.5% above its target. What might have been?

Of course, the bigger question is what impact higher interest rates had on the economy and consumers? A report from the respected think-tank, the Institute for Fiscal Studies (IFS), funded by the Joseph Rowntree Foundation and released several days ago, claims that higher housing costs associated with the spike in interest rates pushed 320,000 people in the UK into poverty by the end of 2023. It also claims that “official data do not measure mortgage interest payments properly, so official poverty statistics will only capture about two-thirds of this effect.”

Headline inflation or CPI officially peaked at 11.1% in October, 2022. Yet the IFS calculates that those in the bottom decile for income experienced a crippling rate of 14.3% at its peak. Which makes you wonder about the efficacy of pushing interest rates up. The BoE tells us that it was necessary to cool an overheating economy. Yet, the fact is that higher income earners who dedicate a lower proportion of their income to housing costs continued to have discretionary purchasing power for travel and other consumables. Those on lower incomes buckling under the cost of higher mortgages or rental costs, not so much.

Joseph Stiglitz, a Nobel laureate in economics and former chief economist of the World Bank (1997-2000), argues that raising interest rates is a blunt tool in tackling inflation. In 2022 he posited the questions: “Will higher interest rates increase the supply of chips for cars, or the supply of oil? Will they lower the price of food, other than by reducing global incomes so much that people pare their diets?” Instead, he argues that “well-directed fiscal policies and other, more finely tuned measures have a better chance of taming today’s inflation than do blunt, potentially counter-productive monetary policies.”(1)

So, please, Governor Bailey. It’s time. When the MPC meets on 1 August, give some relief for homeowners and renters who have been financially bludgeoned by high interest rates for the past two and a half years. Enough of the nuanced language that you have been trotting out since March hinting at interest rate cuts. In the same week when the newly minted government is raising the specter of cutting services and raising taxes, it’s time to act.?

(1) Project Syndicate: All Pain and No Gain from Higher Interest Rates, Joseph E. Stiglitz, December 8, 2022.