The Politics of Money

The Bank of England is left to choose between the twin threats of inflation and a stalled economy, something it is not qualified to do


Rodney Hobson | 24-09-10

The Bank of England is sinking deeper into the political quagmire. It is thrashing around in both directions with no obvious means of escape.
When Gordon Brown handed control of interest rates to the Bank I could not understand why this was hailed as a masterstroke but such was the overall adulation that I thought I must be wrong. Time has proved otherwise.

Interest rates are a political decision, never more so than now. For with the country facing the twin threats of inflation and a stalled economy, the Bank of England is left to choose between the two, something that is not in its remit and which it is not qualified to do.

Raise interest rates, as the Bank should have started doing already to combat inflation that remains persistently above target, and the economic recovery could be choked off before it really gets going. We already know this is a danger, for tax receipts are ominously falling well short of plugging the government’s spending gap.

The Bank has once again shied away from what would be an unpopular move, with the minutes of its September meeting showing just one lone voice of reason. I had hoped that Andrew Sentance would have persuaded one or two more monetary policy committee members to join him by now but no joy so far.

Presumably the Bank is concerned that it would get all the opprobrium from an interest rate rise. Too bad. That is not the Bank’s concern. The Bank’s concern is tackling inflation, a task given to it by Brown in 1997 and never withdrawn.

In any case, as I have argued so often in this column, the real world of interest rates is now completely divorced from the Bank’s 0.5%. I know from the email responses I have received that many readers agree.

Running the economy is a political matter. If the current Chancellor George Osborne chooses to put economic growth ahead of curbing inflation he is perfectly entitled to do so. That should be his decision.

To make matters worse, the Bank is toying with the idea of quantitative easing, a policy that I had only just learnt how to spell and still had difficulty in pronouncing when it was suspended after running its £200 billion course. Pushing money into the economy is potentially inflationary.

So presumably the Bank will do what it did last time: use a small percentage to help businesses and plough almost all the cash into buying gilts. This way the inflationary aspects of quantitative easing are avoided. In fact, by holding down the interest rates paid on gilts the Bank will be suppressing rather than encouraging higher interest rates.

I was among the first to argue that the first batch of quantitative easing was coming to an end while some parts of the media were merrily assuring us that the scheme would be extended beyond £200 billion. Nor have I rushed to join the chorus hailing the resurrection of the scheme. It was obvious that quantitative easing would first be suspended and secondly be left in abeyance to see whether it worked or not.

It did little or nothing for private enterprise but it did fund the government debt quite successfully. We are now far enough down the road to go for it again with more assurance this time. The massive government debt leaves little choice and I now feel that quantitative easing will eventually be back with us, especially if the argument for an interest rate rise prevails.

The timing will depend on whether gilt sales falter, something that has not happened so far despite our huge Budget deficit. News that Ireland is falling back into recession after its economy shrank 1.2% in the second quarter is a double edged sword.

It could help to tip the UK back into recession but it has encouraged some switching of hot money into gilts, which postpones our day of reckoning. For as long as we can sell gilts, I believe that the next bout of quantitative easing will be postponed and I do not see it happening this year.

However, once again this is a political decision for the Chancellor, not the Governor of the Bank of England. I have no doubt that its was the then Chancellor, Alistair Darling, who decided to launch the first wave of quantitative easing, so why we need to go through the charade of having the Governor of the Bank asking for permission to do the Chancellor’s bidding is quite beyond me.

The implication for shares in the run up to Christmas is a sideways movement until the economic picture becomes clearer. My suggestion last week that 5,000 points on the FTSE has been established as a floor was misinterpreted by one reader who thought I was implying that shares would fall below that level. My view is the opposite: I think they will hold above that level, although we could well see some wavering with the index falling back from its recent high above 5,500.

Hold your nerve and buy on the dips.

Cable Drum
Much has been made of the bank and business bashing dished out by Vince Cable at the Liberal Democrat party conference. A good deal too much.

Cable is clearly ill at ease in government. Perhaps that is because he is just not cut out for government; perhaps he is not cut out for a coalition government; perhaps he is not cut out for a coalition government with the Conservatives. I think it is a mixture of all three.

His term as Business Secretary will be defined by the unfortunate moment when he walked out of Downing Street after his appointment, unaware that a car and driver were waiting for him. He looked completely bemused then and the expression has not left his face.

My advice to investors is to take no notice of his conference speech. It was for the benefit of party workers. He will not be allowed to take any decisive action.

Rodney Hobson is a private investor writing about his own portfolio. The opinions expressed in this column are those of the individual, and not of Morningstar, and should not be construed as financial advice.

This article originally appeared on Hemscott.com. Morningstar and Hemscott are now one company. You can see the original version of this article on the Hemscott.Com.


From Morningstar published on 24-09-10