WHY DO CENTRAL BANKS KEEP GETTING IT WRONG?

August 5th 2021 - Financial Times

"The Bank of England has warned that inflation will, in the short-term, be more "pronounced" than expected but?still expects it to be transitory.

Transitory inflation - this was a new term to me at the time, and it became pretty familiar to many of us who were paying attention, trying to figure out what was going on, as prices continued to rise/rocket from 2020.?

The Bank of England, Federal Reserve in the US, and the equivalent in the EU, all came out, month after month through 2021/2022, to tell the world, as they continued to loosen monetary policy, that all was well, and that the inflation issue at that time, would begin to settle down, and return to 2%, as quick as it came - more or less!

However as we all now know in Q2 2023, this was clearly wholly incorrect, as prices have continued to rise, and all of these people have had to come out in recent months to retire the rhetoric of "transitory" when discussing inflation, and admit/apologise, that it was in fact, a serious issue, one that could only be solved, in their eyes, (another stroke of genius) through eye watering, and steady increases in interest rates.?

I have been an agent for the Bank of England now for some fifteen years in NI, which really means I get to attend their presentations a few times a year, and get an opportunity to speak to their thought leaders, and economists, on some of these issues.

I have to add it is an experience I enjoy, and with the next one coming up in a couple of weeks time, you can rest assured, I have my questions at the ready.?

In last week's monetary policy committee, the BOE decided to raise interest rates for a record-breaking 12th successive time, lifting the cost of borrowing to 4.5% and warning that inflation would be higher this year than it previously anticipated.??

The outworkings of this being that by a further stroke of a pen, millions of people across the UK, who have a loan, residential or commercial, could see their repayments increase the following month (for the 12 consecutive time).?

Again for anyone really paying attention to this, clearly with a cost of living crisis ongoing, and much of the disposable income in households, now "disposed off", things are starting to break for many people, homes and businesses right across the country and further afield.?

The Bank of Englnads rationale for this of course is all in the hope that by doing this, it will reduce inflation.

HOW DOES RAISING INTEREST RATES LOWER INFLATION?

According to the BOE -?"Higher interest rates work by making it more expensive for people to borrow money to buy things. Higher interest rates also encourage people who can save to save rather than spend. Together, these things mean there will be less spending in the economy overall"

I took the above from the BOE's own website, and for me it kind of misses a couple of key points funnily enough, namely;

1. higher interest rates means that people who have loans that are pegged to the BOE base rate, will see their monthly repayments increase.?This could lead to defaults, business going bust, residential home loans going into default, and assets coming to the market as values become quite quickly suppressed.

2. higher interest rates mean that people will be unlikely to save as they were already struggling to make ends meet, when interest rates were lower than they are today.?

THE REAL REASON WE HAVE INFLATION

In my view, and for those people who understand this topic a lot better than myself, including one of the world's most famous former hedge fund manager's, Mr Hugh Henry (whom I had on my podcast Money & Plants) the issue that has been going on now for some time, which has led to rapid inflation is SUPPLY Led, NOT DEMAND led.?

For example, let me ask you a question;?Are you and your family buying more / consuming more goods and services, than you were this time two years ago??

If you are like myself and people I know, the answer is NO, definitely not.?

This inflation problem is predominantly a supply led problem, with major issues around supply chains throughout and post the pandemic, and also geopolitical matters, like a war in Europe, problems in China, and uncertainty right across the globe, which continues to be the case unfortunately.

If I and others are correct with this conclusion, then it would appear to me that increasing the burden on businesses and households, through raising interest rates is utterly the wrong thing to do, and also incredibly unfair.

The only glimmer of hope and good news in all of this, is that these geniuses in the Bank of England are projecting inflation to continue to drop shortly this year, and even projecting it to be down to closer to 2% come Q4 of 2023 - therefor rates should quickly follow.?

I bet you a ￡1 they are wrong about that too.

WHAT DOES THIS MEAN FOR YOU?

It means that if you have a mortgage of any sort, you need to be paying attention.?

I have written on this platform only a matter of weeks ago, how we are all now in new territory as the repricing of money is well underway.?

You need to figure out how this impacts the financial wellbeing of yourself, that of your family and your business.?

At GDP we have seen client engagement increase 25% in the last two months, as this wrecking ball of mortgage increases starts to take hold on those impacted.?

We are speaking to people who are now at the coal face, as a direct result of the monetary policy of the Bank of England, who have seen their mortgages increase, on occasions, up to three to four times, what they have been paying previously.?

Businesses are also caught when they need to refinance into new facilities, as the repayment capacity at the new cost of funds, is simply not there.?

These scenarios are major issues for most people, who are caught in this unfortunate turn of events.?

Early engagement, being proactive, dealing with matters head on, getting in touch with people who might be able to help, are ways in which you might be able to navigate a way through the coming weeks and months.?

As ever, If I can help any of my network, feel free to get in touch.?

Have a great week,

CD

Conor Devine MRICS,?has been working across the property, debt and funding markets for over twenty years, and is passionate about helping others in the industry overcome challenges and to reach their business goals.?