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Inflation Watch

Updated: May 19, 2022

My core belief about the first interest rate rises here in the UK but also across the pond is that they’ll happen much later than many think. True, Mark Carney and Janet Yellen would dearly love to normalise monetary policy, but the reality is it’ll be a while before they’re able to an d I think they know it. The reason they talk about it I believe is because it is the only tool they have to stop asset prices, whether financial or real, from rising too much and causing problems down the road. Their main job is promote stability in the price of goods and services and right now these need supporting not supressing (core inflation in the UK has fallen from 2% a year ago to 0.8% currently).

"If the banks don’t need to borrow, what good would a rate rise do?"

Furthermore, I think both Carney and Yellen are well aware of what happened when the Fed raised rates slightly in late 1936 following a few years of moderate growth: a severe economic contraction and a halving of the stock market. Rates were quickly reduced and did not rise above 1% until the late 40s, a good ten years later.

Mark Carney’s comments to the Treasury Select Committee last month were strong on rhetoric but light on substance, saying only that “The point at which interest rates may begin to rise is moving closer.” That doesn’t really commit him to very much.

The final point to note, and this is specifically about the Fed Funds rate, is that it may be hard, as a result of QE, to induce an increase in rates The Fed Funds rate is the rate depositary institutions lend excess reserves to each other. When actual reserves are close to required reserves, this rate matters. However, actual reserves are currently 30 times required reserves, the result of quantitative easing, so banks do not need to borrow. If they don’t need to borrow, raising the Fed Funds rate won’t have any effect.

Talking of the Fed, Janet Yellen was also on parade last month, this time in front of Congress. In relation to inflation, she said that factors that had been holding it back such as higher joblessness would subside. She was a bit more specific than Carney on the timing of the first rate rise, saying that “economic conditions would make it appropriate at some point this year to raise the federal funds rate target.” My question to her would be, if the banks don’t need to borrow because you’ve stuffed them with reserves, what good would a rate rise do? Seems to me she’ s trying to talk down asset prices.

STOP PRESS: Following Yellen’s remarks about the likelihood of a rate rise this year , Carney came out and hinted during a speech at Lincoln Cathedral that the Bank of England may raise the base rate around the turn of the year. “The decision as to when to start such a process of adjustment will probably come into sharper relief around the turn of this year,” he said. This was more precise than his remarks two days earlier to the Treasury Select Committee, and suggests that he is taking a cue from Yellen. In some respects this is to be expected. If the Fed chair suggests the US economy is stronger than previously thought, that would indeed have implications for the global economy and thus the UK economy. But for him to change his tune so quickly, and for him not to have consulted colleagues, seems a tad brusque.

Published in Investment Letter, August 2015

The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.

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