MERVYN KING made two pledges when he took over as governor of the Bank of England in July. The first was that he would make speeches only when he had something to say. The second was that he would get out of London more, to tap into the views of the whole country.
Last week he killed two birds with one stone. More than three months after taking over he gave his first big speech, and he did it in Leicester, as the monetary policy committee and the Bank’s court of directors decamped to the East Midlands for a couple of days.
Like any actor in a new role, King will have read his notices the following morning with interest. The Financial Times gave him top billing for his warning of tough times ahead, which was also The Times’s interpretation, admittedly tucked well away inside the paper.
The Guardian saw his speech as sounding alarm bells over consumer debt, although he didn’t have much to say about that. The Independent, like the markets, thought the governor was softening us up for an early interest rate rise. This was also The Daily Telegraph’s line, at the end of a story about pensions.
And then the tabloids got hold of it almost a day later. “10 years of rate rises,” screamed the Mirror, with something similar in the Express.
The notices, one would have to conclude, were mixed. So what was King getting at? Let’s start with interest rates. It is now clear, as I argued here on September 21, that 3.5% will almost certainly represent the trough for rates in the current cycle, and that when global economic conditions permit, they will be raised.
As King pointed out: “It is over three and a half years since interest rates were last raised — the longest period since (the) Bank Rate was held constant at 2% through the 1940s. At some point reducing the present degree of monetary stimulus will be necessary in order to keep inflation on track to meet the target.” The italics are mine, to highlight the key question: when? Central banks like to keep an eye on what their counterparts elsewhere are up to. The Federal Reserve in America under Alan Greenspan has made clear its intention of keeping its main interest rate at 1% for the foreseeable future, which may mean until beyond the presidential election in November next year. In Europe, the European Central Bank (ECB) is under the new management of Jean-Claude Trichet but is unlikely to change its policy of keeping interest rates at 2% until well into next year, with an outside chance of a further cut.
The Bank of England’s monetary policy committee may well raise rates before the Fed or ECB, but it will not want to jump the gun by too much. It has the additional complication of a change in the inflation target. The new target will be announced in the chancellor’s December pre-budget report, probably to take effect in January.
Currently inflation, measured by retail prices excluding mortgage interest payments, is 2.8% and slightly above the 2.5% target. The new harmonised measure has inflation at 1.4% — only Austria, Denmark and Germany are lower in the EU — against a likely target of 2%. In the Bank’s 77 months of independence, the harmonised inflation rate has only been at 2% or above for a single month, back in 1998.
None of this precludes higher interest rates, but it does make the timing awkward. I wrote last month that the biggest risk of a hike this year was in November. It still is but, despite the release of revised data showing stronger economic growth in the first half of the year, that risk looks lower than it did.
Almost everybody expects the Bank to raise rates next year, but by how much? It says a lot that when I recently reported the consensus among analysts that rates will eventually hit 5%, the reaction was one of mild shock. Yet until two years ago rates had not been as low as 5% for 30 years. It may be they do not need to go quite as high as that, given that there are powerful disinflationary forces at work. But 4.5% or 5% is what we should think of as normal or “neutral” interest rates.
So where did all that stuff about 10 years of rising interest rates come from? Certainly not from any speech or interview given by King.
The message was intended to be a bit more subtle. The past 10 years have been the “nice” decade, he said, because of a series of favourable developments for the economy, in which inflation came under control, unemployment fell from 10% to 3% of the workforce and a strong pound — highly unusual — was of benefit to consumers through the so-called terms of trade effect: imports getting cheaper relative to exports.
Some of those things are impossible to repeat — inflation, once brought under control, can’t be brought under control again unless it first misbehaves. The same goes for unemployment. The strong pound could recur, although it would be unwise to rely on it. All that may mean the next decade will not be as nice as the last one, particularly for consumers. The Bank foresees a rebalancing of the economy away from consumer spending and in favour of exports and investment.
Is King being too gloomy? Last week Timothy Geithner was appointed head of the Federal Reserve Bank of New York at the tender age of 42. He is now a favourite to succeed Greenspan when he calls it a day. William McChesney Martin, a previous Fed chairman, gave central bankers their motto when he said their role was to take away the punchbowl just as the party gets going.
King was trying to lower expectations, to point out that we cannot go on forever with consumer spending outstripping growth in the rest of the economy. It used to be called “living beyond our means” and was reflected in a sharply rising current-account deficit. Now it is reflected more in sharply rising consumer debt.
The governor’s worry is that what goes up will come down, and that consumers will one day look down from the debt mountain, lose their balance, and fall off. The worst thing from his point of view would be getting into a position where interest rates needed to be raised, but even the slightest increase would run the risk of a collapse in the housing market and consumer spending.
He is right to worry and warn about such things, but there is another point of view. This is that, if we take the period since Bank independence in 1997, it hasn’t been plain sailing for the global economy, with the Asian crisis of 1997-98, the global recession of 2001 and a three-year bear market in equities now thankfully at an end.
You can make the case, in other words, for the coming years to be rather better for the world economy. Consumers, in that environment, might not outstrip the rest of the economy but they could still do pretty well. “Nice” need not become nasty.
PS: No space for my informal economic indicators this week, just a mention of an official one. Manufacturing employment has dropped below 3.5m, another landmark. There are now more than twice as many people employed in public administration, education and health — 7.1m — as in Britain’s factories.
Manufacturing does not seem to be benefiting much from the upturn in the global economy. Last week’s British Chambers of Commerce quarterly survey showed that the two-tier economy is alive and well, with service-sector growth healthy and industry becalmed.
Ministers, faced with a union protest, promised a new commitment to manufacturing at the recent Labour party conference in Bournemouth. If anybody spots it, let me know.
