Bank of England Raises Rates Again

The Bank of England raised interest rates by 25 basis points to 5% yesterday. This is the highest UK rates have been since 2001, and analysts believe there’s a good chance of the BoE hiking rates again in February. The BoE is worried, like all central bankers, about inflation. Coming on the heels of local tax hikes and rising energy costs, one wonders if the cure isn’t worse than the threatened disease.

Objectively, the British economy isn’t facing any serious sort of inflation. The Consumer Prices Index in the UK has run above the Bank’s desired 2% rate for the past five months. However, it isn’t running that much above it – in fact, September’s CPI rate dipped to 2.4% from 2.5% in August. While four tenths of a percentage over the target is something to consider when setting policy, one must remember that the target itself is somewhat arbitrary. Why not a target of 1.84% or 2.1232% or 3.141592%? Quite simply, 2% is a nice round figure that nice round bankers like.

In practical terms, this will cost people with a mortgage of £80,000 an extra £13 a month, presuming the lender passes on the entire cost of borrowing. When all is said and done, 13 quid doesn’t break very many banks, and it doesn’t really even force people to economize. Since housing prices are up 1.7% in October, the British homeowner is actually ahead. So, why bother?

Charlie Bean, chief economist at the BoE, explained policy last month at the London School of Economics. He said, “If inflation has settled above target, a deeper or more prolonged slowdown is potentially required to bring it down.” The BoE believes it’s “better to err on the side of caution by preventing any sustained pick-up in inflation in the first place.” An ounce of prevention is worth a pound of cure, and all those other cliches would have served as well.

Yet, 2.5% inflation may not be hot enough in the event of a major terrorist attack, and London, Manchester and Birmingham are all potential targets. Significant economic activity will stop as it did in mid-September 2001, and if deflation is the result, there are every few things the Bank of England can do to fix it. Japan had deflation for a decade or so despite huge deficit spending. The world’s central bankers are rightly worried about inflation, but they seem to continue to miss the dangers of deflation. Given a choice, the world has more experience in fighting inflation, so perhaps if one must choose, one should opt for the problem that has a known solution.

© Copyright 2006 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Fedora Linux.

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