In the United States, the Federal Reserve raised interest rates 0.5pc to 1pc Wednesday. Markets anticipate further increases of more than 2 percentage points this year and further increases next year as well.
But while the Fed has shown it can at least reduce quantitative easing and raise rates if needed (albeit very slowly and not to “normal” levels), the Bank of England has yet to pull off the same test.
The Fed, after all, went through the “tantrum” of 2013, when then-Chairman Ben Bernanke warned markets that it would at some point begin to scale back its quantitative easing program and triggered a huge sell-off in Treasuries and emerging market assets. After some delay, the Fed did cut and raised rates.
The Bank of England, preoccupied with Brexit during the same period, never really lowered rates. And while the Fed has now announced a plan to cut QE – and at a faster pace than in 2014-15 – the Bank has yet to do any such thing, despite a balance sheet now worth almost half of British GDP. .
Already, last summer, the Bank’s lethargy had begun to arouse strong criticism.
A report by the House of Lords Economic Affairs Committee (which includes ex-Governor Mervyn King among its members) concluded in 68 politely written pages that the Bank does not know what the effect of QE has been, cannot not say whether he helped fulfill his term, will not discuss how and when he will complete it, produces research that is significantly more positive about EQ than independent work, and has been “defensive” about discussing his negative effects.
With another supply chain crunch underway as China shuts down and back on much of its economy, the effect of QE’s big hangover on prices will only get worse, but none of these issues have not been resolved since the publication of the report.
Instead, the Bank’s mandate, which is theoretically fair to keep inflation at 2%, seems to get more complicated every year. The latest task given by the Treasury in recent years was to determine how to force financial markets to go green, thus helping to increase the cost of capital for fossil fuel investments, a project likely to further increase costs for consumers.
This is in addition to the obligation created after 2008 to maintain financial stability, in the name of which the Bank intervenes directly in all kinds of decisions that private banks used to take, such as the risk assessment of their customers. .
In that vein, in 2014 the Bank began telling mortgage lenders to check whether aspiring buyers would still be able to pay their mortgage payments if bank interest rates increased by 3 percentage points. This, as you will notice, is only slightly more than the amount the markets expect rates to rise.
In government, as the Prime Minister indicated in a TV interview this week when he said benefits could not be increased because of the risk of stoking inflation and rising unemployment rates interest, there is a visceral fear at the prospect of a spike in mortgage payments.
Not only would this slow down the economy as a whole, because the most spared households would see their costs increase the most. This would particularly affect those most likely to vote Conservative.
So I’m sure it’s a complete coincidence that a few months ago the Bank of England announced a consultation plan on scrapping the 3pc stress test requirement for mortgage lenders. An announcement easing the rules is expected this week, just as interest rates are expected to rise.
In other words, the Bank may be taking monetary slack with one hand, but letting it out with the other. It does so at a time when house prices have risen 10% in a year, a pace last seen in 2007.
Meanwhile, there is the gilt market to consider. The Office for Budget Responsibility pointed out last year that one of the perverse effects of QE is to make public finances much more exposed to rising interest rates, meaning that for every 1 point increase in percentage of rates, interest payments on the debt increase by 20.8 billion pounds sterling, or 0.8 pc of GDP.
There’s also the question of who’s going to buy all those gilts if the Bank starts selling them, and what that means for fiscal policy. As last year’s Lords Report noted, markets have widely interpreted the vast post-Covid expansion of QE almost explicitly as a move to fund the government’s huge fiscal stimulus – which would go directly to against the Bank’s mandate if that were true. The Bank, of course, denies this.
I am not suggesting the existence of some nefarious conspiracy between politicians and economists to ignore inflation. But the more you look, the clearer it becomes that the Bank has wandered deep into difficult political territory.
Its mandate to control inflation could well force it to trigger a recession by tightening its monetary policy sharply. But all sorts of other priorities are pushing in the other direction.
Is it any wonder that policymakers still cling hopefully to the idea that inflation will simply go away without too much painful action on their part? Isn’t that curious, though? This is precisely the phenomenon that central bank independence was designed to avoid.