AS I SEE IT: TERRY MURDEN says there is no certainty that rate rises will solve the inflation problem
Just as the country has been basking in heatwaves and enjoying medal-winning sporting success, Bank of England governor Andrew Bailey has been doing his best to ruin everyone’s summer. He’s put the economy on a recession footing and joined his fellow committee members in deciding that jacking up interest rates is the key to tackling rampant inflation.
But it’s a highly questionable strategy and may just make the situation worse, unless the incoming Prime Minister has a cunning plan to get us back on the road to recovery.
Inflation is forecast to hit 13% early next year and could reach an eye-watering 15%. This is new territory for a whole generation of businesses and consumers, as is the new 1.75% interest rate, a 27-year high.
But is raising interest rates the appropriate solution? The governor himself admits that high inflation is partly a result of rising energy and commodity prices caused by the Ukraine war. Increasing credit card and mortgage payments for British consumers will do nothing to alter that equation.
Dr Tony Syme, macroeconomic expert at the University of Salford Business School, goes so far as to describe the policy of raising rates as “an inept tool”.
He notes that in his Mansion House speech, Mr Bailey outlined the three big supply disturbances of the last year or so that has caused the inflationary rise: supply chain pressures post-Covid, a declining UK labour force, and the Russian invasion of Ukraine.
“None of these supply-side problems can be addressed by increases in interest rates,” he says. “They are trying to carry water in a sieve. The intention may be reasonable, but the tools are wrong. The answer lies in international diplomacy and an end to the war in Ukraine, not interest rate rises.”
A number of analysts are blaming the Bank itself for being too slow to tackle prices as they began to rise. There are always time lags for an interest rate rise to have any effect, as much as 18 months, and prices of some commodities are already beginning to fall, so the impact of the rate rise may be muted.
Oliver Chapman, CEO of supply chain firm OCI, says it will take time before recent falls in commodity prices show up in the inflation data, “but bear in mind that for inflation to persist year on year, prices must continue to rise. Instead, commodity prices are now falling.”
Brent Crude oil is 20% down down on the year high, the wheat price is down by a third from the level three or so months ago, and corn is down by around a quarter. Copper prices have also fallen sharply in recent weeks.
There is concern that raising the cost of borrowing merely fuels price increases all round as firms decide they have to pass on higher costs, and that this dampens demand, thereby hastening recession.
Liz Cameron, chief executive of the Scottish Chambers of Commerce, worries that higher interest rates will cause demand growth to weaken further in the coming months and that firms are deferring investment plans that would help the recovery.
So, is the Bank’s interest rate policy bringing on the recession it is trying to avoid?
One of Dr Syme’s colleagues at Salford Business School, economics specialist Zeeshan Syed, disagrees and rather than focus on Ukraine and rising food and energy prices, he blames a consumer boom led by the cash-rich middle class, who accumulated substantial cash savings during the pandemic and are “refusing to back down”.
He says their “unwavering tendency to spend more” is forcing up prices and refers to record demand for foreign holidays despite a 10% devaluation of the pound against the dollar. Simple economics does not explain this behaviour, he says.
So what should be the new Prime Minister’s solution? Following the above argument, any plans to cut income taxes would be highly risky as they would fuel more spending by the middle classes, keeping prices high and potentially nullifying any benefits of tax cuts for the less well off.
The higher paid are also most able to withstand increases in the cost of credit cards, mortgages and petrol, which means that once again it is those lower down the pay grades who feel the brunt of the interest rate rises. It’s this group who are struggling with energy and food bills, and are cutting back on hospitality and spending in the shops.
This points to the Bank adopting a policy aimed at calming down an exuberant middle class, but unable to tackle underlying supply-side causes of the current inflation, described by one property investor as like treating a sprained ankle by breaking a finger.
For the government, there needs to be more focus on easing the business rates burden, while tax changes need to be targeted around those that keep down costs, such as relief on energy bills, and encourage investment.
Terry Murden held senior positions at The Sunday Times, The Scotsman, Scotland on Sunday and The Northern Echo and is now editor of Daily Business