Hamish McRae: The economy is growing and shares have hit a 14-year high... but interest rates are to stay at 0.5% until late next year. Why?

Economic View: The danger for the Bank is that it comes to be seen as full of clever people with poor judgement

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.

News
More than 90 years of car history are coming to an end with the abolition of the paper car-tax disc
newsThis and other facts you never knew about the paper circle - completely obsolete today
News
people'I’d rather have Fred and Rose West quote my characters on childcare'
Life and Style
The new Windows 10 Start Menu
tech
Arts and Entertainment
There has been a boom in ticket sales for female comics, according to an industry survey
comedyFirst national survey reveals Britain’s comedic tastes
PROMOTED VIDEO
Travel
Bruce Chatwin's novel 'On the Black Hill' was set at The Vision Farm
travelOne of the finest one-day walks you could hope for - in Britain
Sport
footballManchester City 1 Roma 1: Result leaves Premier League champions in danger of not progressing
Arts and Entertainment
Gay and OK: a scene from 'Pride'
filmsUS film censors have ruled 'Pride' unfit for under-16s, though it contains no sex or violence
News
i100
Life and Style
Magic roundabouts: the gyratory system that has excited enthusiasts in Swindon
motoringJust who are the Roundabout Appreciation Society?
Arts and Entertainment
Hilary North's 'How My Life Has Changed', 2001
booksWell it was good enough for Ancient Egyptians and Picasso...
News
ebooksAn unforgettable anthology of contemporary reportage
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Trainee Recruitment Consultant - Birmingham - Real Staffing

£18000 - £23000 per annum + Commission: SThree: Real Staffing are currently lo...

Trust Accountant - Kent

NEGOTIABLE: Austen Lloyd: TRUST ACCOUNTANT - KENTIf you are a Chartered Accou...

Graduate Recruitment Consultant - 2013/14 Grads - No Exp Needed

£18000 - £20000 per annum + OTE £30000: SThree: SThree are a global FTSE 250 b...

Law Costs

Highly Competitive Salary: Austen Lloyd: CITY - Law Costs Draftsperson - NICHE...

Day In a Page

Ebola outbreak: The children orphaned by the virus – then rejected by surviving relatives over fear of infection

The children orphaned by Ebola...

... then rejected by surviving relatives over fear of infection
Pride: Are censors pandering to homophobia?

Are censors pandering to homophobia?

US film censors have ruled 'Pride' unfit for under-16s, though it contains no sex or violence
The magic of roundabouts

Lords of the rings

Just who are the Roundabout Appreciation Society?
Why do we like making lists?

Notes to self: Why do we like making lists?

Well it was good enough for Ancient Egyptians and Picasso...
Hong Kong protests: A good time to open a new restaurant?

A good time to open a new restaurant in Hong Kong?

As pro-democracy demonstrators hold firm, chef Rowley Leigh, who's in the city to open a new restaurant, says you couldn't hope to meet a nicer bunch
Paris Fashion Week: Karl Lagerfeld leads a feminist riot on 'Boulevard Chanel'

Paris Fashion Week

Lagerfeld leads a feminist riot on 'Boulevard Chanel'
Bruce Chatwin's Wales: One of the finest one-day walks in Britain

Simon Calder discovers Bruce Chatwin's Wales

One of the finest one-day walks you could hope for - in Britain
10 best children's nightwear

10 best children's nightwear

Make sure the kids stay cosy on cooler autumn nights in this selection of pjs, onesies and nighties
Manchester City vs Roma: Five things we learnt from City’s draw at the Etihad

Manchester City vs Roma

Five things we learnt from City’s Champions League draw at the Etihad
Martin Hardy: Mike Ashley must act now and end the Alan Pardew reign

Trouble on the Tyne

Ashley must act now and end Pardew's reign at Newcastle, says Martin Hardy
Isis is an hour from Baghdad, the Iraq army has little chance against it, and air strikes won't help

Isis an hour away from Baghdad -

and with no sign of Iraq army being able to make a successful counter-attack
Turner Prize 2014 is frustratingly timid

Turner Prize 2014 is frustratingly timid

The exhibition nods to rich and potentially brilliant ideas, but steps back
Last chance to see: Half the world’s animals have disappeared over the last 40 years

Last chance to see...

The Earth’s animal wildlife population has halved in 40 years
So here's why teenagers are always grumpy - and it's not what you think

Truth behind teens' grumpiness

Early school hours mess with their biological clocks
Why can no one stop hackers putting celebrities' private photos online?

Hacked photos: the third wave

Why can no one stop hackers putting celebrities' private photos online?