The Bank of England held rates at 3.75%, but one MPC member wanted a rise. If inflation is driven by energy and fuel costs, squeezing households harder won’t fix the cause.
My illiterate questions are always "why does inflation need to be kept at 2%? Why not 4% or 1.5%? Wouldn't it find it's own position if the Bank stopped fiddling with interest rates? Why aren't there two interest rates - one for savers and one for borrowers? Why aren't mortgages on fixed for 25 year rates like they used to be?"
That is the million-dollar question. The 2% target has become something of a central banking dogma, but you're right to ask if it's fit for purpose in a supply-driven crisis. As for the 'two rates' or 25-year fixed mortgages, we’ve moved toward a much more reactive, short-term system that arguably prioritises bank flexibility over household stability. Great food for thought!
Fair point though missed biggest real world pressure on finances which are house prices which have been 2x’d by qe and artificially low interest rates. Growth would always be theoretically better with lower rates. The qe thumb is still on the scale - depressing still interest rates. House prices are strangling growth. So whilst you can target growth without the conditions for long term sustainable growth ie 3/4x house prices you are pissing in the wind - which is what the last 17 years of qe have shown. We may face a road runner moment soon when the market looks at uk and says no way and we see gilts up at the 9% level…
Spot on, Shaun. The disconnect between house prices and earnings is the elephant in the room that interest rate hikes don't address. We’ve essentially traded long-term productivity for an asset bubble. That 'Road Runner' moment you mentioned—where the market finally realises the ground has disappeared—is exactly what keeps the fiscal hawks up at night. If gilts hit that 9% level, the current conversation about 'growth' will look very different.
Good piece Jamie. My thoughts exactly. In any case, gilt yields have risen substantially since the war started which already has a tightening effect on the economy, so no need to risk double whammying it by raising the policy rate too.
At the end of the day, when consumer prices go up due to non-monetary factors - oil prices, supply chain issues etc - that is not real inflation (per famous Milton Freedman quote "inflation is always and everywhere a monetary phenomenon") - it is transitory "inflation" and will eventually resolve by normal market forces, even though that doesn't necessary mean in a short amount of time.
Exactly, Julian. When the 'inflation' is driven by the cost of keeping the lights on rather than an overheated labour market, squeezing the consumer further feels like a double whammy. The lag between the base rate and the actual market repricing of the 2-year yield has been fascinating to watch lately—it shows just how much the market is leading the Bank, rather than the other way around.
Is there a link between gilt yields and BOE base rate or are they independent? If Gilt Yields are rising does that limit what the BOE can do with the base rate?
Well the BoE base rate has most influence at the short end of the curve - 2 year yield and below. Far less influence at the long end, unless they reduce or increase the base rate by a lot, like if they moved it to say 0.5% tomorrow then the whole curve would reprice. But moving it 25bps here or 50bps there has almost no influence on the long end of the curve - eg. The 30 year. Now, the base rate doesn't always influence the short end - from July 2024 until Feb 2026, the BoE reduced the base rate by 150bos, yet in that time the 2 year was *broadly* flat at around 3.8% ish.
My illiterate questions are always "why does inflation need to be kept at 2%? Why not 4% or 1.5%? Wouldn't it find it's own position if the Bank stopped fiddling with interest rates? Why aren't there two interest rates - one for savers and one for borrowers? Why aren't mortgages on fixed for 25 year rates like they used to be?"
Questions, questions
That is the million-dollar question. The 2% target has become something of a central banking dogma, but you're right to ask if it's fit for purpose in a supply-driven crisis. As for the 'two rates' or 25-year fixed mortgages, we’ve moved toward a much more reactive, short-term system that arguably prioritises bank flexibility over household stability. Great food for thought!
Fair point though missed biggest real world pressure on finances which are house prices which have been 2x’d by qe and artificially low interest rates. Growth would always be theoretically better with lower rates. The qe thumb is still on the scale - depressing still interest rates. House prices are strangling growth. So whilst you can target growth without the conditions for long term sustainable growth ie 3/4x house prices you are pissing in the wind - which is what the last 17 years of qe have shown. We may face a road runner moment soon when the market looks at uk and says no way and we see gilts up at the 9% level…
Spot on, Shaun. The disconnect between house prices and earnings is the elephant in the room that interest rate hikes don't address. We’ve essentially traded long-term productivity for an asset bubble. That 'Road Runner' moment you mentioned—where the market finally realises the ground has disappeared—is exactly what keeps the fiscal hawks up at night. If gilts hit that 9% level, the current conversation about 'growth' will look very different.
Good piece Jamie. My thoughts exactly. In any case, gilt yields have risen substantially since the war started which already has a tightening effect on the economy, so no need to risk double whammying it by raising the policy rate too.
At the end of the day, when consumer prices go up due to non-monetary factors - oil prices, supply chain issues etc - that is not real inflation (per famous Milton Freedman quote "inflation is always and everywhere a monetary phenomenon") - it is transitory "inflation" and will eventually resolve by normal market forces, even though that doesn't necessary mean in a short amount of time.
Exactly, Julian. When the 'inflation' is driven by the cost of keeping the lights on rather than an overheated labour market, squeezing the consumer further feels like a double whammy. The lag between the base rate and the actual market repricing of the 2-year yield has been fascinating to watch lately—it shows just how much the market is leading the Bank, rather than the other way around.
Is there a link between gilt yields and BOE base rate or are they independent? If Gilt Yields are rising does that limit what the BOE can do with the base rate?
Well the BoE base rate has most influence at the short end of the curve - 2 year yield and below. Far less influence at the long end, unless they reduce or increase the base rate by a lot, like if they moved it to say 0.5% tomorrow then the whole curve would reprice. But moving it 25bps here or 50bps there has almost no influence on the long end of the curve - eg. The 30 year. Now, the base rate doesn't always influence the short end - from July 2024 until Feb 2026, the BoE reduced the base rate by 150bos, yet in that time the 2 year was *broadly* flat at around 3.8% ish.