Criticism of the Bank of England’s back-to-front interest rate policy over the last few years has clearly rattled a few of the pillars in Threadneedle Street.
Remember how the Bank forecast that rising inflation during the Covid era and the outbreak of the Ukrainian war was deemed to be ‘transitory’ – and started raising rates too late?
And then how the Bank’s all-powerful Monetary Policy Committee (MPC) in its wisdom missed a trick again not to cut rates once the inflation genie was back in the bottle and the economy was recovering ahead of the 2024 election?
Its timings couldn’t have been more skew-whiff. Yet we should be grateful if those past errors have jolted the MPC’s ill-judged groupthink.
Rather than give one magical central forecast as it usually does, its nine members have mapped out three potential scenarios for the next few years because of the unpredictability of the Iran war on the global economy.
This is a more sensible approach. If you were being cynical, you might say that a bruised MPC is hedging its bets. Those with knowledge are rarely foolish enough to predict the future.
On hold: The Bank of England’s Monetary Policy Committee members voted eight to one to keep the base rate at 3.75%
Which is why, apart from one dissenter –the Bank’s own hawkish chief economist – the MPC was also sensible in holding rates at 3.75 per cent.
But the bad news is that in all three ‘thought experiments’ – call them the goodish, the bad and the ugly – inflation is likely to rise, interest rates will go higher and so will unemployment, to at least 5.5 per cent.
Let’s look at A, the more benign outcome. In this scenario, the Strait of Hormuz is reopened, oil peaks at $108 a barrel this year before falling to below $80 at the start of next and to $72 by the end of 2028.
Inflation would rise to 3.6 per cent, above the latest 3.3 per cent. This would suggest a couple of increases later this year.
In the second mapping, B, oil prices peak at $108 but stay higher for longer and inflation would be slightly higher at 3.7 per cent. Add to this food inflation, triggering several rate hikes.
In both A and B, the Bank has revised down its GDP growth forecast to 0.5 per cent.
Now the ugly outcome, C. Oil prices peak and stay at $130 a barrel, forcing inflation up to 6.2 per cent next year.
This, says the Bank, would push interest rates up to 5.25 per cent, which will wallop homeowners and small businesses as well as pushing up the Government’s borrowing costs, already on steroids.
Unquestionably, such an outcome would tip the country into recession.
What is puzzling, however, is whether the MPC has fully taken into account how much demand is already being squeezed because of higher petrol and diesel costs, rising holiday prices and higher energy prices still to come.
These rises are, de facto, doing the Bank’s work for it without putting up rates. It’s highly unlikely that we will see fresh demands for pay rises in this troubling climate with thousands of businesses closing and unemployment rising.
Then you have to factor in growing fears that food prices are set to soar later this year because of fertiliser shortages.
Columnist and author of ‘Prisoners of Geography’ Tim Marshall points out that the closing of Hormuz hasn’t hit only 20 per cent of the world’s oil and gas supplies but is cutting off up to 30 per cent of fertiliser stocks from Qatar, Saudi Arabia and Iran.
Fertiliser will be needed for the planting seasons later this year and, if it’s not available, farmers will be unable to plant, leading to shortages, driving up food prices.
Even countries which make their own fertilisers need natural gas, which in turn comes mainly from the Middle East.
Interest rates are a crude instrument at the best of times, often too late or too little. It may be that Bank Governor Andrew Bailey hopes he is being clever by warning rates are on their way up – whatever the scenario – by borrowing the ‘Maradona theory’ from predecessor Mervyn King.
Well-known for his sporting analogies, King used Diego Maradona’s magnificent goal for Argentina against England in 1986, when he ran straight while defenders were expecting him to swerve, to show that central banks can manage expectations and move rates by signalling future actions without taking them.
In which case, the MPC has done a great job by scaring us.
Not the way to run a country, though.