“Inflation in the Sixties”, wrote Bernard Levin in his celebrated history of that decade, “was a nuisance to be endured, like varicose veins or French foreign policy.” That increasingly appears to describe the attitude of the Bank of England today too. Though inflation is well above target, the Monetary Policy Committee (MPC) of the Bank stayed its hand at its meeting this week and kept interest rates at only 0.5 per cent.
For the Bank to hold interest rates at almost zero while inflation is accelerating looks less a calculated risk than a big bet. An early increase in rates would mitigate the risk of a large and sudden rise later. The MPC ought to take the opportunity at its meeting in April of increasing interest rates by 0.25 per cent. So small a rise would admittedly be mainly symbolic, but symbolism is important. Higher rates would signal that the Bank is aware of an inflationary problem and is committed to dealing with it. That is no small message.
The annual rate of consumer prices inflation stands at 4.0 per cent, double the target that the Bank is mandated to meet. The cost of goods leaving British factories is also rising. Figures released yesterday showed that producer output prices rose at an annual rate of 5.3 per cent in February.
The MPC’s remit does not require it to reduce inflation regardless of costs; it is mandated also to support the Government’s general economic objectives, including those for growth and employment. Too rapid an approach to curbing inflation might endanger those aims, by tipping the economy back into recession.
Even so, the Bank’s stance is exceptional. The MPC slashed interest rates to their current levels two years ago, in the wake of the collapse of the Western banking system. They have stood since at the lowest in the Bank’s 317-year history. That stance has been maintained even though inflation has consistently and substantially exceeded the target. In normal economic times, interest rates would be around 6 or 7 per cent by now.
Advertisement
The argument for keeping a very loose monetary policy is that economic growth is far from secure and the rise in inflation is mainly an imported phenomenon. Whereas other advanced industrial economies are growing, the UK economy actually contracted in the last quarter of 2010: GDP declined by 0.6 per cent. This weak performance would normally indicate a lot of spare productive capacity in the economy. The reason that inflation is accelerating is mainly the surge in oil prices, which have risen by around 15 per cent since the start of the year. This in turn reflects political turmoil in the Middle East. UK policymakers, so the argument runs, can have little effect on these inflationary pressures; all that a rise in the cost of borrowing would accomplish would be to curb consumption and investment.
It is true that oil prices are driving inflation and that economic recovery is far from assured. Moreover, the Government has shown little urgency in formulating a policy for growth alongside its policy for deficit reduction, and it is essential that George Osborne fill that gap when he presents his Budget on March 23. But these brute facts do not dispose of the logic for raising interest rates now.
Inflation targeting was introduced to the UK in 1992. In practice the approach has proved inadequate because it focuses too narrowly on consumer and not on asset prices, but it has this merit: it recognises and signals that inflation has big costs. Inflation erodes living standards, whereas price stability makes it easier for consumers, businesses and investors to plan for the longer term.
The longer that the Bank allows inflation to exceed target, the less credible will be its inflation-fighting credentials. A small rise in rates now would reinforce the Bank’s credibility. The costs of trying to regain credibility once it has been lost would be much higher.