HAMISH MCRAE: interest rates will have to increase



Warning sign: The debate in the city is whether the bank will start raising the base rate before Christmas or after

Galloping inflation is crushing family budgets. Or more bluntly, if you have to spend a tenth more to fill the car up, that’s £ 10 you can’t spend on Halloween festivities next weekend.

Until recently, the Bank of England line was first that it wouldn’t be a serious problem, and then that any peak would be transient. Now the mood is turning to alarm bells. Huw Pill, the Bank’s new chief economist, warned that the consumer price index could exceed 5% this winter, a level the Bank would be “very uncomfortable”.

The CPI was 3.1 percent last month, but the old measure of inflation, the retail price index, was 4.9 percent. The government does not like this measure and it is not considered a national statistic. But it still serves as the basis for interest on student loans and indexed gilts, many pension contracts and excise duties including alcohol.

You might reasonably ask if inflation is around 5% or above 5%, why the hell is the Bank’s base rate still only 0.1%? The debate in the City is whether the Bank will start implementing it before Christmas or after. Some economic commentators usually warn that it would be a big mistake to act too soon, especially when economic growth is held back by supply problems and, they say, inflation will fall again next year.

There is another twist to the argument. Rishi Sunak will confirm in his budget on Wednesday that there will be tax hikes in the spring. So if the government tightens fiscal policy, it shouldn’t tighten monetary policy either.

Frankly, I don’t think it makes much of a difference whether the bank rate is 0.1% or 0.25%, or if it increases in November or February. Rates everywhere are so much lower than inflation that it is a pointless debate. Interest rates will have to rise and the longer the delay, the larger the final movement.

It’s not particularly about getting to the Bank of England. The governor, Andrew Bailey, is savvy and experienced. The same goes for Jens Weidmann, president of the German Bundesbank and member of the board of the European Central Bank. He has just resigned prematurely, it is believed, because he believes that Europe has been too soft in the fight against inflation. The problem is, experienced people have to work with colleagues too young to remember the great inflation of the 1970s and 1980s and the social and economic damage it caused.

So what will happen? Inflation will peak during the winter. It will go up to 5% or more here, and higher elsewhere. It is already 4.1% in Germany and 5.4% in the United States. Central banks will continue to say that this is temporary and that economies are too fragile to do much. There will therefore be some symbolic movements from the US Fed and the Bank of England, but very little from the ECB.

Inflation will indeed drop a little next year, but not to pre-pandemic levels. Any sane person will continue to buy real estate: houses, stocks of solid companies, etc. Less sane (or perhaps more courageous) people will invest their money in the latest fad investment. One of the reasons Bitcoin hit an all-time high last week is that some people see it as a hedge against inflation.

It’s a measure of the current mindset that an asset that can only be sustained by a huge supply of electricity should seemingly be so attractive in an age of growing environmental concern. It is currently estimated to use more electricity than Argentina, a nation of 45 million people.

Eventually there will be some sort of calculation. If you’re interested, the classic book on the subject is Manias, Panics And Crashes: A History Of Financial Crises, by Charles Kindleberger. Things may be going well for a while yet. Maybe the air will slowly come out of the balloon.

Things don’t feel as bad as they did in 1974, when OPEC quadrupled the price of oil, an act that helped trigger double-digit inflation. US interest rates were raised by the Fed to 20 percent in 1980. We won’t go there, but I’m afraid Huw Pill is right. There will indeed be “very uncomfortable” months to come. And not just for the Bank of England.

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