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Even A Small Rate Rise Could Be Fatal

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Last week saw yet another horrific inflation figure and further rises are still to come. CPI (Berlin: CEJ.BE - news) inflation looks set to push through 4pc.

I do not propose to rehearse again the arguments for the inflation surge being temporary. Rather, I am concerned to discuss the issue of credibility. According to one view, gaining credence in both the media and in the markets, the MPC (050540.KQ - news) is guilty of a dereliction of duty and the credibility of the whole regime is at risk. Is this right?

The Committee's remit is "to maintain price stability; and subject to that, to support the economic policy of Her Majesty's Government, including its objectives for growth and employment." The operational target is a 12-month increase in the CPI of 2pc "at all times."

Right from the outset, this remit was ambiguous, as the recent strength of inflation and the weakness of the economy has laid bare. What weight should the MPC place on its secondary objective? "Subject to" has no operational meaning. There may be no trade-off between inflation and the level of economic activity in the long-run, but in the short-run, there most certainly is. What is the yardstick for weighing up 0.1pc off the inflation rate against a drop in GDP?

And what does it mean to aim for 2pc inflation "at all times"? On that score, the MPC has recently appeared to be a blatant failure. Yet it would be impossible for the Committee to keep CPI inflation at 2pc every month, even if it were prepared to play yo-yo with interest rates. Inflation shocks can affect the CPI very quickly. By contrast, the effects of interest rate changes on the CPI usually build up slowly over two or three years. So "at all times" is part of the remit simply to commit the MPC to aim for a future CPI inflation rate of 2pc, regardless of whether the target has recently been overshot or undershot.

The MPC's experience in 2008 is instructive. CPI inflation peaked at 5.2pc, reflecting a surge in the price of oil and food and the start of sterling's depreciation. (Plus ca change!) Instead of hiking interest rates, the MPC cut them, amid signs that economic growth had slowed considerably. What happened to "credibility"? The Bank came in for vigorous criticism but because it did not cut rates fast enough to counter the recession! By the way, inflation fell like a stone, reaching 1.1pc just a year after its 5.2pc peak.

But what about the current argument that if the MPC doesn't act soon then expectations of inflation will pick up and become the basis of ingrained higher inflation? The way people respond to price pressures is subtle and variable. Price expectations often follow what happens to prices, rather than the other way round. In 2008, households' inflation expectations first rose sharply, but then fell to a low of 0.8pc, mirroring the collapse in actual inflation.

You might expect that expectations in the bond markets were more robustly formed. In 2008, however, they also rose in response to higher reported inflation, and then plunged as the economy weakened and inflation collapsed.

Despite the hysteria of some commentators, there is no evidence that the gilt market is currently getting alarmed about the MPC's lack of grip. Similar rises in inflation expectations have been seen in both the American and the French bond markets, reflecting global factors.

Nevertheless, there is a view that the Bank could raise interest rates by a token ¼pc or ½pc and thereby act to retain its credibility as an inflation fighter without damaging the economic recovery. This is bunkum. If it raised rates now it would seem to be admitting that it had been wrong about inflationary prospects. But if it is wrong, rates would have to go much higher. It would be like paying Danegeld. The hawks would soon be back for more. The result would be that in both the markets and the real economy people would assume that this was the beginning of a huge turn in the interest rate cycle. This could derail the recovery altogether. The Japanese experience urges caution. In 2000, the Bank of Japan (NYSE: MCO - news) raised official interest rates prematurely but was soon forced to cut them.

The upshot is clear. If the Governor and like-minded MPC members feel that their analysis of inflation has been wrong then they must admit it and change tack. But if they still believe it, as I do, then they should stop up their ears. If they were to give in and raise rates and then the recovery weakened and their views about inflation next year were vindicated, they and we would really be in the soup. And those who are now screaming at the Bank for letting inflation rise would be lambasting it for being over-zealous on inflation and killing the recovery. By contrast, if Mr King and his allies stick to their last, next year may see them looking both resolute and foresightful.

• Roger Bootle is managing director of Capital Economics and economic adviser to Deloitte.

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......

Nevertheless, there is a view that the Bank could raise interest rates by a token ¼pc or ½pc and thereby act to retain its credibility as an inflation fighter without damaging the economic recovery. This is bunkum. If it raised rates now it would seem to be admitting that it had been wrong about inflationary prospects. But if it is wrong, rates would have to go much higher. ....

I read this article earlier and it was this bit that caught my eye. I think its a valid point (whether they are in fact wrong or right is another matter).

CPI-CT is still below 2% I don't see a rate rise "just around the corner".

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Last week saw yet another horrific inflation figure and further rises are still to come. CPI (Berlin: CEJ.BE - news) inflation looks set to push through 4pc.

I do not propose to rehearse again the arguments for the inflation surge being temporary. Rather, I am concerned to discuss the issue of credibility. According to one view, gaining credence in both the media and in the markets, the MPC (050540.KQ - news) is guilty of a dereliction of duty and the credibility of the whole regime is at risk. Is this right?

The Committee's remit is "to maintain price stability; and subject to that, to support the economic policy of Her Majesty's Government, including its objectives for growth and employment." The operational target is a 12-month increase in the CPI of 2pc "at all times."

Right from the outset, this remit was ambiguous, as the recent strength of inflation and the weakness of the economy has laid bare. What weight should the MPC place on its secondary objective? "Subject to" has no operational meaning. There may be no trade-off between inflation and the level of economic activity in the long-run, but in the short-run, there most certainly is. What is the yardstick for weighing up 0.1pc off the inflation rate against a drop in GDP?

And what does it mean to aim for 2pc inflation "at all times"? On that score, the MPC has recently appeared to be a blatant failure. Yet it would be impossible for the Committee to keep CPI inflation at 2pc every month, even if it were prepared to play yo-yo with interest rates. Inflation shocks can affect the CPI very quickly. By contrast, the effects of interest rate changes on the CPI usually build up slowly over two or three years. So "at all times" is part of the remit simply to commit the MPC to aim for a future CPI inflation rate of 2pc, regardless of whether the target has recently been overshot or undershot.

The MPC's experience in 2008 is instructive. CPI inflation peaked at 5.2pc, reflecting a surge in the price of oil and food and the start of sterling's depreciation. (Plus ca change!) Instead of hiking interest rates, the MPC cut them, amid signs that economic growth had slowed considerably. What happened to "credibility"? The Bank came in for vigorous criticism but because it did not cut rates fast enough to counter the recession! By the way, inflation fell like a stone, reaching 1.1pc just a year after its 5.2pc peak.

But what about the current argument that if the MPC doesn't act soon then expectations of inflation will pick up and become the basis of ingrained higher inflation? The way people respond to price pressures is subtle and variable. Price expectations often follow what happens to prices, rather than the other way round. In 2008, households' inflation expectations first rose sharply, but then fell to a low of 0.8pc, mirroring the collapse in actual inflation.

You might expect that expectations in the bond markets were more robustly formed. In 2008, however, they also rose in response to higher reported inflation, and then plunged as the economy weakened and inflation collapsed.

Despite the hysteria of some commentators, there is no evidence that the gilt market is currently getting alarmed about the MPC's lack of grip. Similar rises in inflation expectations have been seen in both the American and the French bond markets, reflecting global factors.

Nevertheless, there is a view that the Bank could raise interest rates by a token ¼pc or ½pc and thereby act to retain its credibility as an inflation fighter without damaging the economic recovery. This is bunkum. If it raised rates now it would seem to be admitting that it had been wrong about inflationary prospects. But if it is wrong, rates would have to go much higher. It would be like paying Danegeld. The hawks would soon be back for more. The result would be that in both the markets and the real economy people would assume that this was the beginning of a huge turn in the interest rate cycle. This could derail the recovery altogether. The Japanese experience urges caution. In 2000, the Bank of Japan (NYSE: MCO - news) raised official interest rates prematurely but was soon forced to cut them.

The upshot is clear. If the Governor and like-minded MPC members feel that their analysis of inflation has been wrong then they must admit it and change tack. But if they still believe it, as I do, then they should stop up their ears. If they were to give in and raise rates and then the recovery weakened and their views about inflation next year were vindicated, they and we would really be in the soup. And those who are now screaming at the Bank for letting inflation rise would be lambasting it for being over-zealous on inflation and killing the recovery. By contrast, if Mr King and his allies stick to their last, next year may see them looking both resolute and foresightful.

• Roger Bootle is managing director of Capital Economics and economic adviser to Deloitte.

IMHO the economy will not recover from this current suspension until the real economy can stand on firm ground and invest, in reference; Small Is Beautiful: Economics As If People Mattered is a collection of essays by British economist E. F. Schumacher.

The trouble with the lack of balls or kicking the can down the road stupidity, is we must feel the pain to move on, alas!

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The BoE have no credibility, interest rate policy has been a complete failure.

As soon as the BoE under Eddie George decided to go for a consumer debt funded boom to avoid a recession all credibility was lost. Long term stability was sacrificed at the alter of political short termism, once you've got down that road you have no way to recover and worse still you've put yourself in a between a rock and a hard place.

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CPI-CT is still below 2% I don't see a rate rise "just around the corner".

I keep hearing this.. it's as if people don't like the figures they're hearing so go looking for another stat.. RPI ? No, that's toast.. CPI ? No.. that's toast too.. um, lets use CPI-CT, not least because nobody knows what it is and we look clever.

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I read this article earlier and it was this bit that caught my eye. I think its a valid point (whether they are in fact wrong or right is another matter).

CPI-CT is still below 2% I don't see a rate rise "just around the corner".

The cost of government services is going up -- ergo, remove the cost of government services from the inflation figure.

The need to raise taxes is going up, in part, because the Bank of England is creating a wage/price spiral, with state-sector unions demanding higher pay, and the government conceding increases in pay in the face of high inflation. Unions might be weaker than the 1970's in the private sector, but they're plenty strong enough in the public sector to keep real wages up in an inflationary environment.

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If all that's holding the rises back is a face saving exercise for the MPC, then I believe the Japanese have a neat solution for the shame.

being bankers though, they would deserve £5m antique ceremonial swords though. A rusty dagger just wont do.

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Why is raising rates 'giving in' and lowering them not ?

Surely they both have their merits depending on the moment - and therefore there is no such thing as 'giving in'.

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About a week ago when the latest terrifyingly well off target CPI figures came through someone from the CBI was saying that if it weren't for the inflationary items that took CPI upto 3.7% then CPI would be on target at 2%.

That someone said that the inflationary items that took the CPI upto 3.7% should be stripped out so the BoE would be correct about interest rates and CPI would actually be 2% so then there really would be nothing to be concerned about.

That's after them exceeding the 2% target for most of the past 5 years at least - and for a lot of that time exceeding the target a lot.

The UK and its economy have come to a very sad position when they start to claim even a small rate rise would derail the recovery when inflation is out of control. Inflation that people were told was the main enemy that must be defeated not so long ago. Now when they had the opportunity it's no it's really deflation that's the problem. Ok then they say maybe there's a balance but that's why people were told that the 2% was needed to meet that balance but no not anymore. Not too hot not too cold - that's what they said :lol:

They've got everything just so badly wrong.

As for their credibility :lol::lol:

Edited by billybong

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If all that's holding the rises back is a face saving exercise for the MPC, then I believe the Japanese have a neat solution for the shame.

being bankers though, they would deserve £5m antique ceremonial swords though. A rusty dagger just wont do.

A rusty dagger?

No self respecting samurai is going to do themselves in with a rusty dagger, ffs. Oiled and gleaming, with a friend standing by to apply the coup de gras if it goes embarrassingly wrong. How else will you be able to face your ancestors? Bankers do not have the sense of shame required to act in such an honourable manner.

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The BoE have no credibility, interest rate policy has been a complete failure.

...

Nope.

The interest rate has been a remarkable success. Despite the biggest financial fraud in history giving rise to the biggest collapse of banking in history the UK is still going. Most people have survived so far without too much hardship. My friends have just been off skiing in Japan for their hols and their mortgage has never been lower. Despite the catastrophic failure of the US, Irish, Spanish and Dubai housing markets the UK has held up well. Few repos and most people still able to move about although some NE is starting to show.

What you (or I for that matter) might want is not the point. You might want to buy a house at 20% off peak (are there really none next to the new sewage plant near you?) but that puts you in the minority.

If Toff and Toffer can just manage to kick the can down the road until the next election they can blame it all on Brown and the following year's collapse on Milliband or his replacement.

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Nope.

The interest rate has been a remarkable success. Despite the biggest financial fraud in history giving rise to the biggest collapse of banking in history the UK is still going. Most people have survived so far without too much hardship. My friends have just been off skiing in Japan for their hols and their mortgage has never been lower. Despite the catastrophic failure of the US, Irish, Spanish and Dubai housing markets the UK has held up well. Few repos and most people still able to move about although some NE is starting to show.

What you (or I for that matter) might want is not the point. You might want to buy a house at 20% off peak (are there really none next to the new sewage plant near you?) but that puts you in the minority.

If Toff and Toffer can just manage to kick the can down the road until the next election they can blame it all on Brown and the following year's collapse on Milliband or his replacement.

luving those international food riots and £1.30 petrol...

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Why is raising rates 'giving in' and lowering them not ?

Surely they both have their merits depending on the moment - and therefore there is no such thing as 'giving in'.

raising the BOE rate means that our debt holders would require a greater % being paid in interest. It would cost more in interest payments to service the same debt with our bond holders and could quickly spiral.

Playing the game, pumping out bs reports every quarter, saying that inflation will be within 2% within the next 2 years and constantly pushing that date out keeps the masses quiet.

Keeping rates down allows savers to service the debt and be stolen from in the form of inflation along with having them keep their cash in the banks which not only benefits the banks but interest being paid net is another earner for uk plc.

Real inflation is over 6% but so long as people are still listening to deflationist crap or holding cash then they are getting screwed. The base rate is not going to rise any time soon because......it cant.

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raising the BOE rate means that our debt holders would require a greater % being paid in interest. It would cost more in interest payments to service the same debt with our bond holders and could quickly spiral.

Playing the game, pumping out bs reports every quarter, saying that inflation will be within 2% within the next 2 years and constantly pushing that date out keeps the masses quiet.

Keeping rates down allows savers to service the debt and be stolen from in the form of inflation along with having them keep their cash in the banks which not only benefits the banks but interest being paid net is another earner for uk plc.

Real inflation is over 6% but so long as people are still listening to deflationist crap or holding cash then they are getting screwed. The base rate is not going to rise any time soon because......it cant.

deflation is the natural state at this stage of the cycle.

the crap is coming from the PTB.

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deflation is the natural state at this stage of the cycle.

the crap is coming from the PTB.

deflation in house prices maybe but not anywhere else.

Look at the rpi and cpi then bear in mind that they are fudged, look at your receipt when you have been shopping or filled the car, look at your energy bills.

Deflation is a myth, there isnt any, inflation is the plan and always is.

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deflation in house prices maybe but not anywhere else.

Look at the rpi and cpi then bear in mind that they are fudged, look at your receipt when you have been shopping or filled the car, look at your energy bills.

Deflation is a myth, there isnt any, inflation is the plan and always is.

exactly...Inflation is manufactured at this point.....but, the BUST hasnt been allowed to happen...we have a very wasteful banking sector that needs to die.

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About a week ago when the latest terrifyingly well off target CPI figures came through someone from the CBI was saying that if it weren't for the inflationary items that took CPI upto 3.7% then CPI would be on target at 2%.

That someone said that the inflationary items that took the CPI upto 3.7% should be stripped out so the BoE would be correct about interest rates and CPI would actually be 2% so then there really would be nothing to be concerned about.

That's after them exceeding the 2% target for most of the past 5 years at least - and for a lot of that time exceeding the target a lot.

The UK and its economy have come to a very sad position when they start to claim even a small rate rise would derail the recovery when inflation is out of control. Inflation that people were told was the main enemy that must be defeated not so long ago. Now when they had the opportunity it's no it's really deflation that's the problem. Ok then they say maybe there's a balance but that's why people were told that the 2% was needed to meet that balance but no not anymore. Not too hot not too cold - that's what they said :lol:

They've got everything just so badly wrong.

As for their credibility :lol::lol:

...And when you think about it, Brown changed to the CPI because it made inflation look lower, not because it was more accurate. In addition, he made sure housing costs were removed from the inflation figure. Imagine if inflation figures properly reflected housing costs and we had retained the RPI! Then from 1998 onwards inflation would have been massively higher. Interest rates would have been put up AND NOT DOWN in the critical period from 2001. That way, homes would not have reached the nutty values we see today. Imagine if the banks/mortgage market had been propery regulated to avoid stupid lending. Well, our kids could have been looking forward to buying their first flat or small house, just as they should. It all proves that people will borrow whatever they are allowed to and the price will spiral if that lending turns out to be stupid.

INTEREST RATES SHOULD BE BACK TO 5% NOW. THE RECOVERY IS NOT REAL AND IS DERAILING ITSELF ANYWAY. WE LIVE BY GOVT AND WORLD DELLUSION. AVOIDING THE PAIN IS GOING TO COST IN SLOW OR NO GROWTH. STRIKES COMETH..

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Nope.

The interest rate has been a remarkable success. Despite the biggest financial fraud in history giving rise to the biggest collapse of banking in history the UK is still going. Most people have survived so far without too much hardship. My friends have just been off skiing in Japan for their hols and their mortgage has never been lower. Despite the catastrophic failure of the US, Irish, Spanish and Dubai housing markets the UK has held up well. Few repos and most people still able to move about although some NE is starting to show.

What you (or I for that matter) might want is not the point. You might want to buy a house at 20% off peak (are there really none next to the new sewage plant near you?) but that puts you in the minority.

If Toff and Toffer can just manage to kick the can down the road until the next election they can blame it all on Brown and the following year's collapse on Milliband or his replacement.

Yes this is probably true. Something I muse over, is that the overnight rate was cut to 0.5% in post-lehman financial panic where it looked like the banking sector was melting down. Before that it was about 5%. That would suggest to me that a sensible level, now that things are more stable, is somewhere in the middle. It irks me that BoE are adopting this "do nothing / sit and wait" strategy, without seemingly adressing the fact that the base rate is currently parked at an emergency level.

This is highlighted by the fact that 10 to 15 year rates are 3.5% to 4.0%. For me a yield curve of 0.5% at overnight and 3.5% at 10 years doesn't make sense.

I will completely arbitrarily say that maybe 2 to 2.5% seems about right, at this point.

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  • 312 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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