The MPC have sensibly kept interest rates at 0.5 per cent. It also maintained the scale of the quantitative-easing programme at £200bn. Personally, I would have voted to increase the size of the programme by a further £50bn, which I suspect is what Adam Posen voted for.
In all likelihood, Andrew Sentance voted alone for a rate hike. It is likely that Martin Weale reversed his vote for a rise in light of the poor GDP data and the new National Institute of Economic and Social Research (NIESR) forecast for growth, which was revised down. Weale was previously the NIESR director and the forecast is likely to have had a major influence on him, given his continuing close ties. It seems unlikely to me that anyone else joined Sentance. I think it unlikely that there was strategic voting, as the former external MPC members Tim Besley and DeAnne Julius suggested yesterday.
So what was all the ballyhoo about raising rates? Once again, it looks to me that the markets have it wrong. The expectations are for a rate increase by May, which I don’t think is on the cards. My view remains that interest rates will stay below 1 per cent until at least 2015. The growth data of -0.5 per cent in Q4 2010 were a clincher and showed signs of slowing, with or without the weather in Q4. Indeed, I have every expectation that growth of 1.6 per cent for 2010 (Q1=0.3 per cent; Q2=1.1 per cent; Q3=0.7 per cent; Q4=-0.5 per cent) will be revised down further. Data revisions tend to be up in a boom and down in a slump and the revisions for 2010 to this point have been down.
First, as Mervyn King said in his recent speech, the temporary factors of a VAT increase, commodity price rises and the impact of the exchange rate account for 3 per cent of the 3.7 per cent of the CPI. Within 12 months or so, they mechanically drop out of the calculations. Raising rates now would kill growth stone dead. Consumer confidence is currently at rock bottom so it would likely have a major impact on consumption, which is a risk that the MPC cannot afford to take. Raising rates helps savers but hurts the majority.
Second, given the time lags that exist from changes in interest rates to changes in inflation, the criticism of where we are suggests that interest rates should have been higher than they were in 2009 – which makes no sense. The major policy error in 2008 and 2009 was that rates were kept too high for too long after the economy went into recession in April 2008. Silly.
Third, fiscal austerity is going to impose a major downward pressure on growth, which is going to struggle to get anywhere near 2 per cent in either 2011 or 2012. Indeed, it is perfectly feasible that Q1 2011 and more likely Q2 2011 will see negative GDP growth or even both. NIESR is forecasting an average of only 0.1 per cent for the two quarters.
Fourth, unemployment will continue to rise and wage pressure will remain muted as the austerity programme hits. Data today on manufacturing output was poor and net trade is hurting – not helping – growth, as is the OBR forecast. The current debate feels similar to the discussion that took place in late spring and early summer in 2008 that, idiotically, was all about inflation and raising rates as the economy was about to collapse. The MPC made a major policy error and was well behind the curve. We are paying for the consequences of that error now.
Finally, I suspect that, in its inflation report, due out next week, the MPC will revise down its growth forecast to put them more in line with the consensus. As the shadow chancellor, Ed Balls, suggested at Treasury questions this week, there is a good chance that, at Budget time, the Chancellor will have to lower the government’s growth projections. We shall see.
Raising rates any time soon would be a major policy error. This is one of the few things George Osborne and I will agree on.