The Bank’s big day…
Fall-out from rate rise + Podcast bonus content + Other stories that matter
The Bank of England has increased the base rate of interest in the UK by 0.75 percentage points to 3 per cent. That is the biggest increase since 1992. But that wasn’t the main story when the Bank made its announcement yesterday. The increase had widely predicted. Instead, the main story was that Andrew Bailey, governor of the Bank, suggested that financial markets are wrong to predict that interest rates in the UK will hit 5.25 per cent in the near-future (this prediction comes from the levels being priced into the value of a collection of assets).
So on the day when the Bank made a seemingly hawkish move by aggressively increasing interest rates to fight inflation, it also came over all dovish by warning about the strength of the economy. Hawks and doves, by the way, are the descriptions used in monetary policy for how economists prioritise inflation - in simple terms, hawks prioritise inflation over other concerns, doves are more likely to be concerned about unemployment or low growth.
There are lots of headlines around today about the UK facing its worst recession since the 1920s. This is because the Bank’s latest forecasts, published alongside the interest rate decision, set out a gloomy scenario where interest rates do reach 5.25 per cent. In this case, the UK economy shrinks for eight consecutive quarters, making it a two-year recession. Unemployment would almost double from 3.5 per cent at present to 6.4 per cent. Inflation would fall from 10.1 per cent to zero by 2025.
That last point is crucial, because the Bank’s mandate is to keep inflation at 2 per cent, and therefore this approach would lead to inflation falling below target, at least according to the Bank’s forecasts…
So, Bailey and the Bank laid out another scenario where interest rates stay at 3 per cent. In this case, the recession is not as long or as deep (although it still lasts for a year-and-a-quarter), unemployment peaks at 5.1 per cent and inflation is down to 2.2 per cent by 2022.
Chris Giles, the Financial Times’s economics editor, has outlined the two scenarios in more detail in a useful piece here. He notes that the first scenario, in which the economic outlook is based on the levels of interest rates that financial markets are predicting, is usually the Bank’s central forecast. However, he says that the Bank gave unusual prominence to the second scenario (3 per cent interest rates) in their report, suggesting that is more in-line with their thinking, and that interest rates therefore won’t increase by much more. Indeed, the vote to increase interest rates was 7-2 among the nine members of the Bank’s Monetary Policy Committee. The other two votes were for a 0.25 per cent and 0.5 per cent rise because there was concern that the UK economy is already in recession.
Alistair Osborne in The Times described the Bank’s approach as “self-defeating” and that it was acting like a “hawk-dove” in his column, which is here.
The Bank’s approach certainly differs from the Federal Reserve in the US, which has pledged to continue being aggressive in fighting inflation.
Much now rests on the Bank’s forecasts which, frankly, have been way off in recent times. The Telegraph has an excellent graph in this piece which shows how the Bank has consistently underestimated inflation in the last two years.
Bailey also commented on the political situation in the UK and the policies pursued by Liz Truss and Kwasi Kwarteng. “That will have some lasting effect and we have to work very hard to put that in the past,” Bailey said of the international concerns that were raised about the UK’s fiscal policies under Truss and the doubts that crept into financial markets about the state of the country. There was also this pretty remarkable quote, which sums up the absurdity of recent weeks…
Some key stories to watch now:
-Mortgage rates could fall because the Bank has indicated that interest rates may not get as high as financial markets have predicted. More here.
-The Times has done an interesting story on how homebuyers who looked to benefit from Rishi Sunak’s dramatic cuts to stamp duty during the Covid-19 crisis are now those most likely to be hit by higher interest rates on their mortgages. Story here.
-Jeremy Hunt could announce an increase in capital gains tax in the Autumn Statement on November 17 - hitting entrepreneurs and share-owners - according to The Telegraph. Story here. The Sizewell C nuclear power station could also be scrapped to save money. BBC story here.
Podcast bonus content…
Episode six of our Business Studies podcast featured an interview with Jimmy McLoughlin, a former special adviser to Theresa May when she was prime minister. We discussed what it was like working in 10 Downing Street, his role as special adviser and how the government looks to interact with businesses behind-the-scenes. There was loads of fascinating and useful detail in there, particularly for anyone interested in the machinations of government or wondering how to interact with the government themselves.
The episode is particularly relevant right now as Rishi Sunak looks to build his own team. One interesting appointment he has made this week is naming Will Tanner as his deputy chief of staff. Tanner has done some excellent work on levelling-up at his centre-right think tank Onward, which he co-founded and ran, and this appointment seems to reinforce the importance of that policy to the government. Story here. Tanner had also recently set up this Substack with Nick Timothy, who was Theresa May’s chief of staff, where they have been sharing ideas and interesting articles.
Anyway, you can listen to the latest episode of Business Studies here. Jimmy, who is the son of Conservative MP Lord Patrick McLoughlin, also has his own excellent podcast called Jimmy’s Jobs of the Future. The latest episode is with Simon Kuper, the journalist and author, on the economics of football and is well worth your time (you can listen here). Jimmy also writes a weekly newsletter here.
Another guest that Jimmy had on his podcast was Rishi Sunak while he was chancellor. Both of them studied at Stanford University in Silicon Valley, California. Jimmy did a two-month entrepreneurship and innovation course at Stanford’s graduate school of business after he left government in 2019. I was interested to know what he thought of Silicon Valley and, having worked in government and spoken to business leaders, what he thought the UK could learn. This is what he said: