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The Challenge for the Bank of England

by | Sep 27, 2022 | Politics, Strategy

I’ve mentioned before the challenge of having an independent Bank of England with a strategy of keeping inflation low and a government set on increasing borrowing by eye watering amounts, with all the inflationary pressure that creates. When the Bank of England was given its independence to set interest rates away from political pressures, the landscape was benign. Monetary policy was tight, but not recessionary, and inflation was benign. The chancellor at the time, Gordon Brown, was financially literate, and aware of the importance of market sentiment, in 1997 the move gave markets a reassurance that New Labour would honour their commitments. They did. Today’s government has ignored their commitments. Johnson did so somewhat, but in understandably unusual circumstances. Truss/Kwarteng, did not just ignore their fiscal promises, they destroyed them. They ignored the oversight of the Office for budget responsibility, and seem to consider sentiment in the Markets as something that can be ignored.

Expectations.

Just a week or two ago, the expectation was for interest rates rising to no more than 4%. Today the bank is talking of a peak of 6% “at least” I suspect we may for a while next year see rates of around 8%.

Mortgage Mayhem.

One example of how this impacts the economy and ordinary people is playing out today. Mortgage companies are cutting out new fixed rate deals based on current rates, and there is a general tightening of policy around affordability. Rightly, the companies are limiting lending when reviewing the longer term and the likely costs that will arise as mortgage deals end. That’s having an immediate impact on the housing market, with new sales delayed. New building will be affected quickly if buyers can’t afford the properties nearing completion, because of mortgage rates, and pretty soon that works through into new build starts. That impacts employment in the building sector quickly, too. Jobs, and investments, will go because of a ‘Budget for growth’.

Policy, Policy, Policy.

This disconnect between fiscal policy of the government and the Bank isn’t going to resolve itself. In such circumstances markets can be cruel, mainly because they are driven by, and reflect, sentiment. The Bank will take its responsibilities, and sentiment, seriously. They are masters at thinking through the impact of monetary policy and have sufficient experience to apply that expertise in the context they now face. My sense is that on the other side of the fence, the government is acting in haste, and without sufficient experience. There’s precious little sign of them seeking the advice of masters in this field, (perhaps at the OBR, for example). That’s a recipe for ideology rather pragmatism, and the markets are concluding that it is deeply flawed. That’s partly why I think that for every loosening of monetary policy by Kwarteng we can expect a tightening by the Bank.

It’s time for a change.

What’s needed is an alignment of policy, but with the OBR excluded this time, and the Bank’s remit remaining unchanged, that’s not likely in the immediate term. Time is ticking.

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Written by: William Buist - all rights reserved.