ALEX BRUMMER: The Bank of England should have prevented further rate hikes… or even cut them
Central banks around the world were out of rhythm when it came to acknowledging that the inflationary genie was out of the bottle in 2021.
They are repeating the mistake. All, including the ECB, the US Federal Reserve, the Swiss National Bank (SNB) and the Bank of England, acknowledge that the turmoil in the banking sector means that credit conditions, the availability of loans and liquidity they have hardened.
The impact, then, is not dissimilar to that of an interest rate increase in constraining growth prospects. In fact, tighter credit conditions are likely to have a more immediate impact on inflation than monetary policy, which takes time to work.
However, global groupthink appears to have taken hold of decision makers, with the Bank of England following the Fed, ECB and SNB in raising rates.
Schoolboy mistake: the Bank of England has raised the base rate by a quarter of a percentage point to 4.25%
The reaction to the failure of Silicon Valley Bank, the collapse of Credit Suisse, the tightening of credit conditions, and sharp falls in bank share values (which weaken capital buffers) have been the reverse of responses to other global events.
At the start of Covid, there was a rush to cut interest rates, expand money printing, and arrange global currency swaps to stabilize nervous markets.
During the UK liability-driven investment crisis, the Bank immediately launched a lifeboat to prevent a vicious cycle of insolvencies.
Faced with uncertainty this time, he has raised the bank rate by a quarter of a percentage point to 4.25 percent.
You don’t have to be former monetary policy committee dissident Danny Blanchflower to admit that this is wrong. It’s economics 101 (an undergraduate teaching lesson) that doesn’t go full Herbert Hoover and adjust politics in turbulence.
Fed Chairman Jay Powell at least acknowledged that the ongoing banking crisis was a factor in the Fed’s decision to move its key fed funds rate by just a quarter point and curb forward guidance.
There’s still a lot we don’t know about the health of regional US banks. Also, the noise around San Francisco’s First Republic Bank may have died down, but the issues remain unresolved.
At the ECB, Christine Lagarde was overly enthusiastic about her adoption of a half percentage point increase, certainly from a lower starting point.
The eurozone has never resolved its underlying sovereign debt crisis or dealt with the fact that some Italian and Greek banks continue to be backed by the central bank.
Here in Britain, the tone of the Bank of England minutes is fascinating. The nine-person monetary policy committee was in a difficult position because of the February surprise when consumer price inflation popped up.
Although the 10.4 percent annual jump may have been erratic, the Bank, having lagged on the cost of living for so long, could not afford to ignore it.
However, there was enough material in the minutes to provide a contrary opinion.
For much of the past week, Threadneedle Street has declared that UK banks have sound capital (does that include challenger lenders?) and that the system is resilient.
This is a bit like the football club praising the coach before dismissal.
But the reality in money markets is that ‘wholesale costs of money have increased’ as a result of the tensions, so there was a contraction before the last quarter point increase.
A two-person minority in the MPC, outside members Silvana Tenreyro and Swati Dhingra, wanted a pause while the energy price shock played out and the full effects of the monetary tightening played out.
It was argued that policy had become increasingly restrictive and that rate hikes would need to be reversed.
Spiraling inflation around the world has challenged the apparent infallibility of central bankers and made target setting foolish. UK prices continue to climb five times the target set by HM Treasury.
Bank of England Governor Andrew Bailey and his fellow central bankers have clearly felt that there is no choice but to tighten monetary conditions if institutional credibility is to be restored.
The old lady was concerned enough about the banking events of the past month to ask for a special assessment of the recent turmoil for her May meeting. The sensible thing to do would be for her to have paused or even cut rates now before the study.