Jeremy Warner's Outlook: Bank abandons gradualist approach to rates

Mis-sold savings; Barclays old guard
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We've known for ages that interest rates were heading higher, but few would have predicted even a few months back that the Bank of England would raise them twice within the space of a month. The last time this happened was four and a half years ago at the height of the dot.com boom. In place of the technology bubble, we now have a fully blown housing boom. All the same, it is something of an embarrassment to the Bank to be having to tighten policy with such aggression when only a little while ago members of the Monetary Policy Committee were briefing on the importance of a "gradualist" approach to rising interest rates.

We've known for ages that interest rates were heading higher, but few would have predicted even a few months back that the Bank of England would raise them twice within the space of a month. The last time this happened was four and a half years ago at the height of the dot.com boom. In place of the technology bubble, we now have a fully blown housing boom. All the same, it is something of an embarrassment to the Bank to be having to tighten policy with such aggression when only a little while ago members of the Monetary Policy Committee were briefing on the importance of a "gradualist" approach to rising interest rates.

This envisaged rates rising by just a quarter point at a time every three months, to coincide roughly with the quarterly Inflation Report. The last Inflation Report, which showed inflation overshooting the target even if the market's comparatively modest expectations for interest rate rises were met, was the first evidence of cracks appearing in the suggested policy framework. Then came the minutes to May's meeting of the MPC, which revealed that members had discussed a full half-point rise. So has the Bank of England lost the plot?

Interest rates have now risen four times since last November to little discernable effect. To the contrary, house price inflation, which was at 14 per cent and falling when the Bank began to tighten, is now back at above 20 per cent, consumers continue to spend like there's no tomorrow, fuelled by ever rising levels of debt, and even the downtrodden manufacturing sector seems to be blossoming.

Yet I still don't see any great cause for alarm and I continue to think the "shock therapy" urged by some to bring the housing market under control would be a mistake. Suggestions by interest rate hawks that the repo rate could go to 6 per cent or more look to me wide of the mark. What is probably true is that short-term rates will be at 5 per cent by the end of the year, which is a steeper climb than the pundits were originally suggesting for the present interest rate cycle. Nor is it impossible to imagine that rates may be as high as 5.5 per cent by the middle of next year.

Yet despite the over-egged sensationalism you will read in some of this morning's press, that's hardly going to bring about financial and economic Armageddon. I wrote the other day that it is not clear interest rates even at 5.5 per cent would unduly affect the housing market. Having read a little more about the Australian experience, I'm not sure this is right.

Faced with a very similar set of economic circumstances to our own with house prices taking off like a rocket and booming consumer confidence, the Reserve Bank of Australia late last year tightened rates twice within the space of a month and warned of a possible third rate rise to come if things didn't dampen down. Early signs are that the medicine worked just as the doctor ordered. House price inflation has slowed sharply, with nominal prices actually falling in the hotspots of Sydney and Melbourne, but with no apparent effect as yet on employment.

The Australian economy too has slowed sharply, with both capital spending and business confidence well down on where they were. Yet the economy hasn't as yet been plunged into recession and employment remains robust. Confidence and growth seem to respond much more swiftly to interest rate movements in Australia than they do here and, anyway, the Bank of England wouldn't want to take lessons in monetary policy from the Reserve Bank of Australia.

Even so, the Australian experience suggests strongly that the housing market and the wider economy will eventually respond to what the Bank of England is trying to do. The neutral level for interest rates in Britain is reckoned by the Bank to be between 5 to 5.5 per cent. Anything higher and the economy would eventually grind to a halt. It's not yet clear that things have run so far ahead of themselves that the Bank will need to contemplate such action. If they have, then allegations of policy failure would seem more than justified. The Bank should plainly have acted sooner to cool the economy. Yet we are still a long way from being able to make such judgements.

Mis-sold savings

The Government is preparing the ground for a climbdown over proposals to cap charges on stakeholder savings products at 1 per cent. Ministers are expected to announce shortly that the plan has been junked, along with other key elements of the Ron Sandler proposals for a suite of cheap and cheerful savings products that could be bought off the shelf without the need for costly advice.

Instead, the Treasury will concede what the savings industry has been saying all along ­ that it is just not possible to provide these products on the non-existent margins the 1 per cent cap would allow. Part of the reason for this is the Government itself, which has so hedged the industry around with regulatory safeguards against mis-selling that it has hugely inflated the cost of all savings products. From Standard Life to Prudential, many of our leading life assurers are turning their backs on the British market and going overseas to seek expansion opportunities.

Labour started with good enough intentions and ideas for closing the savings gap, but the truth is that ministers have made a complete horlicks of the job. Things are now a good deal worse than they were seven years ago, with the industry in almost open rebellion over the oppression of government imposed regulation and price capping.

The original stakeholder pension has been a disaster, selling in such small numbers that it scarcely registers in the official savings figures at all. To the extent that stakeholder pensions have been bought by low paid workers, the original target market, the Government could reasonably be accused of mis-selling, as the effect is only to deprive these savers of the state benefit they would otherwise have been entitled to.

Similar flaws looked set to bedevil the Sandler suite of simplified savings products. In today's compensation fuelled environment, it would be madness to sell any long-term savings product without adequate health warnings or advice as to suitability. The Government has so disincentivised the process of savings with means tested pension credits that for many it is not worth saving at all.

The Government's stated aim when it came to power was to raise the amount of private pension provision to 60 per cent of the total. Seven years later and this ambition looks little more than fantasy. Instead, Government policy ­ from the abolition of the tax credit on dividends to the ever-growing mountain of rules and regulations that surround all aspects of savings ­ has served only to damage the industry further.

Belatedly, ministers are waking up to the demographic crisis that lies in wait for future generations. The Pensions Commission under the former CBI director-general Adair Turner is the best hope yet of a considered public policy response to the long term savings problem. But don't hold your breath. The Government has so far succeeded only in making it harder and more expensive to save voluntarily. Goodness knows what sort of a mess it's going to get us all into when it finally bites the bullet and introduces the notion of compulsion.

Barclays old guard

I'm picking up more mutterings of discontent in the Barclays hierarchy, where the chairman, Sir Peter Middleton, continues to rule the roost nearly a year after announcing his successor. This is to be Matt Barrett, the present chief executive, yet under the present timetable, Sir Peter isn't due to retire until the end of the year. Given the choice, he'd stay even longer. It's become one of the longest handovers in history, to the intense frustration and embarrassment of both Mr Barrett and the man who will step into his shoes as chief executive, John Varley. Yet I gather the logjam may finally be about to break. Expect news that Sir Peter has agreed to stand aside by the time of the interims in August.

jeremy.warner@independent.co.uk

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