Yesterday the Bank of England voted to hold interest rates at 5.25 per cent. Andrew Bailey warned rates would remain high – only compared to the last decade or so – for an “extended” period of time amid fears the war between Israel and Hamas could drive energy prices and inflation up again.
Threadneedle Street forecast that rates would not start falling until the summer. This is bleak news for the 1.6 million homeowners set to come off fixed-rate mortgages, and for Rishi Sunak, since those most likely to be hit by higher repayments are disproportionately in Conservative constituencies.
He will be cheered to hear the Bank predicts inflation will reach 4.6 per cent by the year’s end, meaning the Prime Minister is on track to hit his pledge to halve inflation. But he will be less pleased to hear Bailey suggest there is a 50-50 chance we are heading for a recession in an election year.
Higher interest rates are the price one pays for reducing inflation. Yet Sunak has also pledged to get the economy growing. This year it has done so, barely, with growth in Q1 and Q2 at 0.3 per cent and 0.2 per cent respectively. The Bank expects it to flatline in Q3 and hit only 0.1 per cent in Q4.
The Bank expects it to flatline for the all of next year, down from the 0.5 per cent growth predicted in August. The Eurozone has seen inflation fall to 2.9 per cent, but at the expense of an average 0.1 per cent contraction between July and September. Will Sunak accept a recession to reduce inflation?
One expects yes, and not only since growth is already sluggish. Inflation is the more unusual, pressing, and politically painful phenomenon – the mugger, robber, and hit man of Ronald Reagan’s imagination. But as a recession becomes nearer, the conversation around trade-offs will start to change.
Company insolvencies are now at their highest level since 2009, with 18,000 companies declared insolvent in the months up to September. Property prices are declining at their fastest pace since 2009 – cry me a river – whilst unemployment has risen unexpectedly quickly to 4.2 per cent.
The money supply has also contracted sharply. One imagines this is not something the Bank has paid much attention to, based on Bailey’s previous attempts to downplay the monetary role in our current inflation. My calls for the Bank to invest in all-monetarist short-lists for hiring have fallen on deaf ears.
Hence why some have started to suggest the Bank should not focus on holding rates, but on cutting them. With inflation already falling, prioritising bringing it down is backward-looking. A recession is now the bigger issue, since the full impact of pre-existing rate rises has yet to be felt. Julian Brazier and Maggie Pagano both provide good summaries of the case for.
It would certainly further weaken the public finances, further reducing Jeremy Hunt’s (or Clare Coutinho’s!) room for tax cuts next spring. We could have the worst of all worlds: inflation lower but still above target, a recession, rising mortgages, growing unemployment, no tax cuts, and an election.
If the Bank was too slow to raise rates, is it now being too slow to reduce them? I wouldn’t be so sure. The Bank’s forecasts are consistently inaccurate; international conditions are increasingly volatile. A little recession might be no bad thing in an economy as zombified as ours.
That’s not a line with which CCHQ is likely to agree. But having chastised Bailey for being too sluggish in raising rates, I’m hesitant to let him fall back on bad habits too soon – especially if a looming war in the Middle East sends inflation spiraling once again.