This can't be right. Growth is running at around 3 per cent, and projected to carry on at much that level. The economy is creating jobs at a rate of more than a million a year. Unemployment is now clearly below the 7 per cent threshold that the Bank of England indicated nine months ago it would consider increasing interest rates at. Share prices yesterday hit a fresh 14-year high. House prices are going up by 11 per cent a year. And interest rates are to stay at 0.5 per cent until well into next year? Common sense says this must be wrong.
Now let's aim off a bit. It is quite true that current inflation, as measured by the consumer price index, is 1.6 per cent, somewhat below the 2 per cent targeted mid-point of the range. But the CPI does not at present include housing costs, a not unimportant element of most people's cost of living. The old retail price index, which for all its flaws does include housing, is at 2.5 per cent, dead centre of the targeted range when it was the prime inflation measure. So you could say that current inflation is around the mid-point of where it ought to be, rather than significantly below it. In any case, it surely would be appropriate for the CPI to spend a period below the norm, having been so far above it in recent years – it peaked at more than 5 per cent – so that we claw back a bit of the lost ground on inflation. You can see the outlook for both growth and inflation in the Bank's fan charts, shown here.
Still, the low CPI does take some pressure off the Bank to act right away. The fact that sterling is reasonably strong takes more pressure off, because a rise in the pound has some of the effects of a rise in interest rates. Both are a form of monetary tightening. And in any case, given that US interest rates are similarly stuck at very low levels and the European Central Bank is thinking about some form of quantitative easing because inflation is so low there, it would make little sense for the UK to drive rates up unnecessarily fast or unnecessarily soon. There are perfectly solid arguments for delaying that first increase a bit longer, say to the autumn.
But Mark Carney, the Bank's Governor, by signalling that the first rise in rates is still a long way off, is in danger of giving a false signal, just as he did over that 7 per cent threshold last year. Remember that the Taylor Rule, the calculation that is the best guide to what rates should be, suggests that short-term rates should be around 2 per cent. He would probably say that there should be no sense of manliness about setting interest rates – machismo has no place in central banking. Nor it should, though the long-term reputation of the Bank as being soft on inflation is now clearly embedded in the markets. But it is not really about machismo. It is about balance of risk. A rise of rates of 0.25 per cent in, say, November would hardly destroy economic growth. Not doing anything until well into next year might lead to a much sharper increase as and when it came. The danger for the Bank is that it comes to be seen as full of clever people with poor judgement.
So what will happen, as opposed to what should happen?
We will get the minutes of the Monetary Policy Committee in a couple of weeks and the interesting thing will be to see if there are any dissenters from the mainstream view. The markets, as they should be, are split. Some commentators argue that there is a sizeable chance that the first increase will indeed come in November; others that the rise will not be until the back end of next year. What may determine the timing, or at least give an excuse for the hawks on the MPC to squawk much louder, will be new data on the economy.
In the autumn there will be a huge reassessment of the economy by the Office for National Statistics. Most of the changes are methodological, so in a sense they don't really change anything. It does, however, seem that they will show that the economy is somewhat larger – perhaps 5 per cent larger – than previously measured. But this affects the size of the economy, not rate of growth.
The really interesting thing will be whether the official statisticians also take into account the apparent growth of the informal economy, which a study by Charles Goodhart for Morgan Stanley suggested might add a further 4 to 5 per cent to growth since the recession. That would be consistent with other data, including growth in employment, consumption and the amount of cash in the economy. If the officials could at least acknowledge this possibility that annual growth has been a percentage point higher than at present recorded, then the case for an early increase in interest rates would be conclusive.
Of course, the timing of that first rise in rates, except as a signal, does not matter as much as the level to which they eventually settle. The working assumption of the markets is that they will rise by a quarter a quarter – 0.25 per cent every three months – and the new normal will be rates of 2 to 3 per cent rather than the 4 to 5 per cent that were normal before the crash. My own view is that governments and central banks around the world will do their utmost to hold down all rates, long and short, to reduce government financing costs. What we are getting here from the Bank is intellectual justification for financial repression: because governments have borrowed far too much and banks need cheap money to cover their bad decisions of the past, you screw savers. Or rather you screw unsophisticated savers. Wise ones think of something else – anything else – to do with their money.