All great illusions are based on some sort of theatrics and sleight of hand. So it was this week, when Mark Carney performed his great illusion, the one about the economy and interest rates.
Mr Carney is adamant that rates will be around 3% a few years down the road. When you consider that pre-crisis levels were 5% and above, then clearly that’s clearly good news for borrowers. And Britain is, if nothing else, a great nation of borrowers.
What’s more, Carney promises that rate rises will be “gradual, and the degree to be limited”. Phew!
But come on. As if this pinstriped soothsayer really knows anything. All Mr Carney can really do is make the crowd look one way. That is, tantalise and distract borrowers with a 3% cap on bank base rates.
Part of the deception involves the notion that the Bank of England is some bastion of prudence itself. Mr Carney says that the Bank has diligently researched how rates will affect the “most vulnerable” borrowers. They’re investigating the housing market for any bubble formations. “We’ll watch this market like a hawk – trust us!”
The Canadian conjurer tells us everything will be fine – “we know where rates are going”. Yet the reality is, these guys know nothing about where the economy will end up! They wouldn’t find a bubble in a heavily shaken tin of pop… and as for prudence, forget it.
Borrowing is back, thanks to the Bank
Now I’ve got a keen interest in the small banking group, Close Brothers. Though it’s not one of the biggies, it’s certainly a decent barometer of what’s going on in the market. This week, Close Brothers published another great set of figures. First half profits were up 21%.
In the words of chief executive Preben Prebensen: “The consumer is actually borrowing quite strongly – we can see that in motor, we can see that in property, particularly in London.”
And it’s all having a rather predictable effect on the economy. In fact, the UK is set to become the best-performing market of the G7.
Together the British government and the Bank of England are generating fantastic demand for credit. The only thing is, encouraging a credit-based boom has very unpredictable outcomes. We saw that in the US, some five years ago.
But that won’t stop the bank with this illusion. Even if they’re deluding themselves…
The new normal for interest rates
So how can Carney be so confident that rates are going to rise in a steady line towards the 3% level? The bank may set rates, but they cannot set the economy overall – and surely rates must be governed by the overall state of the economy.
Well, for more detail on the bank’s plan we turn to committee member David Miles. Miles states confidently that UK interest rates will not return to their “normal” level of around 5% because of fundamental changes in the UK and world economies.
Instead, he suggests a long-term “normal” interest rate around 2.5 per cent mark. “People are willing to accept a lower rate of interest on safe assets because it is a riskier world.”
Ah, that old chestnut: “It’s different this time!”
Well, I put it to Mr Miles that it was a deflationary shock and QE that have kept rates down – not because the world is now in some way more risky than it used to be.
If inflation takes off, then you can forget all about the magical idea that rates can normalise around 2.5%.
And anyway, where’s he pulling this 2.5% figure from? Oh, I know: it’s just tad above the 2% inflation target the Bank of England also aims for. You know, the forecast they never seem to quite hit.
How to hit your forecasts (by accident)
But hang on a second. Am I being too cynical? After all, the Monetary Policy Committee (MPC) now seems to have finally happened upon the magical 2% inflation target. And of course, that’s exactly why they now jubilantly claim they’re in control.
But the fact that the MPC has hit its inflation target is more to do with luck than judgement.
Sterling’s recent appreciation, together with a stabilisation in global energy and food prices has tamed inflation – for the moment. This has little to do with the MPC’s inflation shepherding prowess.
The truth of the matter is that inflation is a tough beast to tame, let alone forecast. Inflation is governed by many things, the most important of which is perception of where inflation is headed.
All we know for sure is that where inflation leads, so rates follow. As it happens, inflation has acted benignly over recent years. That allowed the central banks considerable leeway in their actions. But they now seem to think they exert control over the markets – that they can confidently predict their every move.
Don’t believe a word of it. The conjurer is deceiving its audience for sure. But more worryingly, he’s probably deceiving himself.
Right now, the public is taken in by the act. And that’s great. They borrow and spend, borrow and spend. That’s been uniquely brilliant for the UK economy. And it’s a success that could be emulated on European shores in due course. Things are going well for the planners – and they could go even better. There’s no need for concern just yet. So long as inflation remains subdued, so the planners will have their cake and eat it too.
So what if it’s all an illusion (or should that be delusion)? Let’s run with it, for the moment.