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The Global Squeeze On Monetary Conditions May Not Be Over Quickly

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Guest wrongmove

The global squeeze on monetary conditions may not be over quickly

" At some stage, Chinese consumers will want to enjoy more of the fruits of their own labour

Published: 21 June 2007

So, the next rise in UK interest rates to 5.75 per cent is certain, and it is very much odds-on that they will go to 6 per cent, maybe more, before the end of the year. We know this from the tone of the minutes of the Bank's monetary committee and, in particular, the narrow margin of the rejection of another rise last month. My own view at the time was that they had made a mistake not to go up. That view is shared by four of the members, including the Governor.

We need to figure out what a world of 6 per cent interest rates will be like. What will be the direct consequences on, most obviously, the housing market, but also on investment, economic growth and inflation expectations? We also need to think beyond the UK because this gradual monetary squeeze that the Bank is imposing is merely one element of a global shift towards dearer money: the end of a period of excess liquidity. Small point: yesterday the Swedish central bank increased interest rates there. No country is an island, not even the US.

I think the first thing to be clear about is that this is something that will last two or three years. There will be two or three years, maybe a bit longer, of real interest rates around the world being quite strongly positive. Translated to the UK, that will mean 3 per cent real rates: if inflation on the retail price index, adjusted to exclude mortgage rates, stays about 3 per cent, we will have 6 per cent base rates. If it goes higher, we will have higher rates. When it comes down to 2 per cent, then rates can come down.

Why do I say the RPIX and not the CPI? Because it is a better measure of inflation - it was the one the Bank used before it was obliged to switch to the common European measure, which does not include housing costs. No one really trusts the CPI because it does not square with their own experiences, but even the CPI on a long view looks alarming. As you can see from the first graph, it has come back a bit but is still very high by the standards of the past decade. ......"

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Guest wrongmove

Also in The Independent

Jeremy Warner's Outlook: Rates are going higher. Get used to it

" The Governor of the Bank of England, Mervyn King, seemed strangely more concerned in his Mansion House speech last night with an apparent dearth of £5 notes than the future of monetary policy. Yet for financial markets, it was rather the situation on interest rates as revealed by the latest MPC minutes that was the main focus of interest.

The last time Mr King was outvoted on the Monetary Policy Committee - in the summer of 2005 - it was ultimately he who was proved to have had the better judgement. With the benefit of hindsight, the majority were in the wrong in voting for a cut in rates.

Now the Governor has again found himself in the minority - this time in voting for a further quarter-point rate rise at the meeting of a couple of weeks back. Is he likely to be proved right again? My hunch is that he is, and not just because inflation has been running at well above target for more than a year now.

The majority took the view that, with inflation now abating as expected with lower energy prices, there was little immediate need to move further on rates. Time needed to be taken to assess what effect the previous tightening in rates would have on consumption.

This is no doubt a perfectly reasonable point of view, yet, if we look through the distorting effect of energy prices, most of the risks to the inflationary outlook seem still to be on the upside. The key ingredient here is the present strength of the world economy, which shows no sign of abating. To the contrary, once US growth begins to revive again, as it may already have done, the world economy is likely to become stronger still.

This makes the situation much more like the late 1990s - when bank base rate rose as high as 7.5 per cent - than the era of poor world growth which has instructed the low interest rate environment we have become so used to.

The British population may now be so in debt that consumption would indeed fall off a cliff if the tightening cycle proceeded much further. Yet beyond warnings from both Tesco and yesterday J Sainsbury that sales growth has started to slow, there is not much evidence yet of a significant change in consumer behaviour. We are still at that stage in the cycle where most people's idea of economising is to swap champagne for prosecco in the weekly shop. ........"

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