Expert View: The law of unintended consequences bites at Brown

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The Independent Online

Even among those of us who do not regard Gordon Brown as an economic genius, it is generally agreed that the decision in 1997 to make the Bank of England independent was a bold and sensible move. Awkward, then, that this is due to provide the latest in a long line of unintended consequences for the Chancellor. For it is quite clear from the latest spending revue that to balance the Budget, the Treasury needs the economy to grow above trend. The Bank of England, meanwhile, seems determined to prevent it doing so for fear of inflation.

Even among those of us who do not regard Gordon Brown as an economic genius, it is generally agreed that the decision in 1997 to make the Bank of England independent was a bold and sensible move. Awkward, then, that this is due to provide the latest in a long line of unintended consequences for the Chancellor. For it is quite clear from the latest spending revue that to balance the Budget, the Treasury needs the economy to grow above trend. The Bank of England, meanwhile, seems determined to prevent it doing so for fear of inflation.

The level of short-term interest rates is significant to the health of the UK consumer due to the ridiculous nature of our housing market, whereby a 25-year liability is funded at three-month money rates.

This, more than anything else, is why we have boom and bust in the UK. No one else has this system, and the relative strength of the UK economy over the past three years has largely been down to the fact that the UK consumer has benefited the most from the fall in global interest rates. And now that rates are going the other way, they are also going to suffer the most.

With an independent Bank of England, how far rates go up in the UK is now ultimately a bet on the Bank's view on inflation. It is often difficult to separate the Bank's views from those imposed upon them by the army of pundits, most of whom display an alarming degree of sado-monetarism. For them, all signs of growth are intrinsically bad, and to be punished with higher rates. In effect, with higher taxes, since the mortgage rate acts like a tax on disposable income. Take this week's round of economic lunacy as an example. Retail sales were up 7 per cent in June, bringing on shrill cries for the Bank of England to stop the runaway consumer. All very well if that consumer is spending wildly and driving up inflation. Except he isn't. The value of retail sales actually rose less than the volume. In other words, retailers got people to spend more money by cutting prices. This is the clearest signal needed that there is no inflation from the UK consumer. Not that anyone will mind.

Which brings me to the biggest unintended consequence of all. The housing market. The idea that we have a bubble in our housing market that needs to be burst is the stuff of countless columns of punditry. But we haven't got a bubble, not yet at least. That we may get one will be due to the fall-out from another one of Gordon Brown's early policies. If the independent Bank of England was one of his better moves, the removal of the tax credit on equity dividends will surely go down in history as one of the worst. Markets are all about risk and return, and a tax break provides extra return without extra risk. Remove it and you will trigger a large re-allocation of capital, in this case to lower yielding bonds.

Well-intentioned moves to encourage disclosure of pension deficits by companies completed the move to turn the best funded pension scheme in Europe into a basket case and ultimately undermine the UK equity market. And the natural response of the household? Channel more money into housing. Owning your own home on retirement is a key part of pension planning, and buy to let is the only way of borrowing to accumulate a pension asset, with tax deductible interest that offers a long-term stream of income that grows in line with wages.

Moreover, there are plans to allow property to be incorporated into pension schemes from next year. This will only enhance the relative attraction of property still further. A quarter point here or there will not stop this happening. Nor should it.

Mark Tinker is a director of Execution Stockbrokers. Mark.Tinker@executionlimited.com

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