The Monetary Policy Committee (MPC) of the Bank of England meets this week to vote on interest rates. It is widely expected that the MPC will keep Bank Rate at 5.25% and will keep it at this for at least several months. The Bank’s Governor Andrew Bailey has said that it is far too early to talk about lowering interest rates. Bailey is wrong.
While inflation is still over double the Bank’s target, the Bank’s cautious approach might seem the right one. However, the MPC is in fact being overly cautious and needs to take the bold step of cutting interest rates, starting this week.
The Bank’s restrictive monetary policy is doing what it’s supposed to: it has quashed demand in the economy and has tamed inflation. Although inflation is still higher than it should be, it continues to fall and is forecast to return to target in the medium term. What is more, pay growth has begun to slow and money supply growth has all but collapsed. All of this means that core inflation will continue to fall. We should also see headline inflation continue to fall. The Bank has less influence over this but food and energy bills falling will come as a relief to struggling households. As such, we should expect to see inflation continue to fall, and probably more quickly than the Bank’s forecasts.
Restrictive monetary policy is getting inflation under control. However, all the signs are now pointing to the fact that it is now doing more harm than good to the economy. We’ve seen a decrease in output in sectors which are particularly sensitive to interest rate moves such as manufacturing. We have also seen a decrease in retail sales as people have less money to spend on the high street. What is more, economic growth is stagnant and is forecast to be practically non-existent until at least 2025.
The labour market is still tight by historic standards, but it has been loosening for some time. Job vacancies decreased by 45,000 between September and November and have been decreasing each month, for 17 months in a row. This is the longest period of decline on record, even longer than during the Great Recession.
The government obviously needs to play its part and has been woeful in introducing policies which will stimulate the economy and bring about growth. However, the Bank also has a role to play. If we want to reverse the decline and boost the economy then the MPC needs to be bold and cut interest rates this week.
Inflation that is slightly above target is surely preferable to stagnant economic growth, higher unemployment, and a damaging recession
Cutting interest rates will likely mean that inflation will remain slightly above target for longer. While this is obviously not ideal and could further tarnish the Bank’s credibility, inflation that is slightly above target is surely preferable to stagnant economic growth, higher unemployment, and a damaging recession. The UK has already experienced 15 years of stagnation and all the signs are indicating that we will be suffering another lost decade, with young people and low income households bearing the brunt of it.
An interest rate cut would make the UK an outlier as the Federal Reserve and the European Central Bank are both unlikely to start lowering rates anytime soon. This will mean that the MPC will have to be bold. However, the UK context is very different from the US. The Fed and the Biden Administration have managed to achieve a soft landing for the US economy with inflation returning to target, jobs being created, and the economy growing. The Bank of England and the UK government most certainly have not.
The Bank was too complacent and slow to act in allowing inflation to get far too high. It was rightly cautious about starting to raise rates in case it triggered a recession and so waited too long. It risks being too cautious once again by ruling out lowering interest rates any time soon. This is a mistake.
If the Bank wants to avoid a long and damaging recession then it needs to act now. The MPC should vote to lower interest rates this week. It will be a bold move and policymakers will no doubt be criticised for doing so, but it is the right thing to do.
Ben Ramanauskas is a research fellow at Oxford University and a former government adviser.
