Just when will rates rise?

Last week, the governor of the Bank of England, Mark Carney, suggested that interest rates in the UK might rise sooner than the market expects. You can see why he might feel the need to flag this up. UK GDP has grown rather faster than expected recently: in the last quarter, the economy grew by 3.1% compared to a year ago.

But to think that interest rates will soon rise, you also have to think that growth is likely to continue to surprise on the upside.

That, as anyone on the MoneyWeek cruise with me this week (we’ve done Venice and are heading for Dubrovnik as I write) will know, is not a given. Why? Bank lending, as James Ferguson has been explaining.

In a modern economy that is genuinely recovering, you’d expect to see lending rising. But – despite the impression given by the banks’ PR campaign – that just isn’t the case. Net mortgage lending has risen slightly since the financial crisis, but all other lending hasn’t. Instead, it has been falling.

That, says James, tells us that our banks aren’t yet completely fixed (a view shared by some of the participants in our Roundtable this week). Banks with clean balance sheets lend new money, banks without them don’t.

If you are prone to investing in banks – which I am very firmly not – you might note that Lloyds and RBS are contracting their non-mortgage lending the fastest. That suggests they aren’t nearly as healthy as their share prices might suggest.

Normally, a fall in bank lending would mean a fall in broad money supply and hence in nominal GDP. This hasn’t happened in the UK. Instead, we have rising GDP. Why? Quantitative easing (QE) has made up the difference – we have printed just enough money to keep broad money supply more or less constant.

The problem – for Carney at least – is that UK QE is supposed to be over, but that bank lending is still falling. This suggests a contracting money supply – something that means lower, rather than higher, growth.

In turn, that rather strongly argues against an immediate increase in rates – as do
a number of other factors, whether they be prudent or politically motivated.

But what, you may be thinking, of the housing market? There appears to be a consensus that the UK is in the throes of yet another out-of-control housing bubble. So surely we must raise rates regardless of growth to burst it sooner rather than later?

Not so. London and some of the southeast might be in the midst of a semi-hysterical housing bubble (or possibly nearing the end of one). But, as I said a few weeks ago, the rest of the country probably isn’t.

And leaving you to mull over that happy news, I’m off to join the rest of our party for a glass of champagne on the lido deck.

  • Pinkers Post

    Mr Carney appears to be in a state of utter confusion. However… can we detect a flicker of light at the end of the tunnel? It looks as though even the BoE has finally ditched the ideology behind the Five-Year Plans for the National Economy of the former Soviet Union, first created in 1928. “Policy driven” replacing “forward guidance”? One would have hoped so!

    Confusion will reign as long as policy makers continue crystal ball gazing. Stanley Fisher, the Fed’s recently appointed vice chairman, last year wisely commented on the merits of forward guidance: “You can’t expect the Fed to spell out what it’s going to do. Why? Because it doesn’t know.”

    OK… we all love a bit of soothsaying… but Pinkers would like to suggest appointing the fox in the garden of former FT columnist Kevin Goldstein-Jackson who (the fox!) has widely been acknowledged as one of the more reliable forecasters!

    Pinkers’s guess is that the formidable Mrs Yellen might yet spring a surprise on us. To describe her as a ‘dove’ would be foolish to say the least: The lady will turn the screws when necessary and that’s when the music stops… watch this space!

    More on this subject: Entries dated 16 Jan, 13 Feb, 4 & 15 May, 13 June: on https://pinkerspost.com/post.ph… (please scroll down).