The Bank of England Risks Forgetting its History

The prospect of accelerating inflation is persuading some Bank of England policy makers, including Chief Economist Andrew Haldane, to consider raising interest rates. It’s reminiscent of what happened six years ago, when faster inflation prompted some officials to call for tighter policy. The history of what happened then, though, should restrain them from being too quick to act today.

By February of 2011, three members of the bank’s Monetary Policy Committee — Chief Economist Spencer Dale, along with external members Andrew Sentance and Martin Weale — were calling for higher borrowing costs to damp inflation. The benchmark interest rate had been cut to a then record low of 0.5 percent in 2009; Dale and Weale voted to hike it to 0.75 percent, while Sentance by then was calling for it to double to 1 percent.

At the time, the U.K. economy had been on a roll for several quarters, with gross domestic product growing by more than 2 percent for three consecutive quarters. Annual inflation had passed the Bank of England’s 2 percent target in November 2009, and continued to accelerate. By the start of 2011, it was running at double the target rate, a pace it maintained and even exceeded for much of the rest of the year.

Then and Now

Faster inflation is prompting some MPC members to call for rate hikes — as it did in 2011

Source: Bloomberg

It didn’t last. By the middle of 2012, GDP growth had slowed to just 1 percent. Inflation, meantime, peaked at 5.2 percent in September 2011, dropped below target in January 2014, and was down to just 0.5 percent by the end of 2014.

Luckily for the British economy, higher borrowing costs that might have exacerbated the slowdown were avoided; Sentance’s stint as a policy maker ended in May 2011, while both Dale and Weale fell back into line with the rest of the MPC and were voting for unchanged interest rates by August.

A Policy Error Dodged

Annual Change in GDP

In a speech this week, Haldane said that he considered voting for a rate hike at this month’s policy meeting, at which three other members of the MPC did call for higher rates. “Provided the data are still on track, I do think that beginning the process of withdrawing some of the incremental stimulus provided last August would be prudent moving into the second half of the year,” he said.

In the past month, traders have ratcheted up their expectations for how likely a policy change is at the MPC’s forthcoming policy meetings.

What a Difference a Month Makes

Percentage chance of a Bank of England interest rate increase

Source: Bloomberg’s WIRP function

The U.K. economic backdrop, however, should give policy makers pause for thought. Haldane said it is a “strong assumption” that Brexit will proceed smoothly, repeatedly warning in his speech of the risk of a “Brexit break” hurting the economy. The bulk of his comments were on anemic wage growth, which continues to confound the Bank of England. He pointed to a growth slowdown later this year and said that sterling’s depreciation effect on inflation is temporary. In other words, he made a clear economic case for leaving rates alone.

It is his analysis for hiking rates that causes head-scratching. He cites reduced global political and policy uncertainty, which even he admits is an odd comment in the light of recent domestic events.

But the key point is that he argues reversing the post-referendum 25 basis-point rate cut would only dial back one quarter of the extra stimulus the central bank injected last August, with the extra 70 billion pounds ($88.6 billion) of quantitative easing staying in place to do the heavy lifting. Haldane argues that tweaking rates higher first, before reducing QE, is the correct policy procedure.

That is likely to be lost on the bulk of U.K mortgage and debt holders who will see a real-time jump in their cost-of-living — just as the gap between wages and inflation widens against them.

Wage Slave

Wage Growth is pointing down which should enable the BoE to look through rising inflation

Source: Bloomberg Intelligence, ONS

The bank runs the risk of a PR disaster if it were to hike — as Governor Mark Carney put it expressly this week, “now is not yet the right time.” More to the point, the damage to the economy could be substantial, which is surely a mistake worth avoiding. His hawkish colleagues should channel their inner historian and look back on the bank’s successes in looking through inflation to avoid potential policy errors. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Mark Gilbert in London at magilbert@bloomberg.net
Marcus Ashworth in London at mashworth4@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net

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