A rise in rates will make a nonsense of the Chancellor’s Budget
A surprise increase in the number of inflation-phobic Federal Banking Board members augurs a swifter rise in rates than either Mervyn King or George Osborne would like. In particular, the Chancellor’s Budget projections would be blown miles off course – and the Government-owned banks plunged into further crisis.
The Slog has posted before about regional US Fed bank heads getting their day in the sun to tell everyone that Washington is wrong. More often than not, I’m bound to observe, the speeches they make offer a lot more commonsense than either Geithner or Bernanke. (I’ve given up mentioning the President in this regard, because he clearly hasn’t a clue about the economy and its fiscal management).
So far, folks from all points of the compass (most notably Dallas) have given Big Ben a roasting about QE and the spiralling US debt in general, and the need to raise rates in particular. This is an interesting tendency, given that any rise in rates will accelerate the growth of US debt overnight: if rates went to, say, 3.5% again, one tax dollar in three would go to servicing the country’s debt. The local Fed members do have a point – but the rock and hard place theory now applies to all US actions, and is an unavoidable diktat.
However, on Friday last we saw the first effects of recent rolling Board membership change, and an increase in those regional bankers wanting inflation to be tackled with higher rates. Philadelphia Federal Bank member Charles Plosser proclaimed his desire for the Federal Reserve to change to a strategy of inflation control only – that is, stop QE and raise rates. We have been endlessly through why Ben, Osborne and Trichet have to rush to the lavatory every time such things are suggested, but there remain some folks who think that society is more important than banks.
What was interesting, once Plosser had made his point, was the sudden headlong rush of other regional Fedders to get their three-ha’pence worth in. Chicago Fed President Evans hastened to the nearest microphone adding his support – and despite being stuck in a boring business meeting in Marseilles, Minneapolis Fed President Narayana Kocherlakota told the media that he too was for an abrupt end to QE. Finally, Atlanta member Dennis Lockhart said late on Friday that he just didn’t see the case for more QE – but he did see the case for dampening inflation.
Now as we’ve seen, George Osborne’s response to Bank of England MPC detractors has been to find a suitable Gulag somewhere else for them, as quickly as possible. But even this has still left a fine balance on that committee. And if stronger US payroll data emerge this coming week, the Fed’s rate hawks would have still more ammunition in favour of interest rate rises.
Much of Osborne’s Budget was based on the assumption of continuing low interest rates. Consider these extracts from his Commons speech:
‘Today our country’s market interest rates have fallen to 3.6%.We have a higher deficit than Portugal, Greece and Spain, but we have virtually the same interest rates as Germany. This is a powerful monetary stimulus to our recovering economy…..the [Office of Budget Responsibility] expect real GDP growth of 2.5% next year: they forecast it will then rise to 2.9% in 2013, 2.9% in 2014, and followed by 2.8% in 2015….Our fiscal mandate is to achieve a cyclically-adjusted current balance by the end of the rolling five year forecast period….that debt should be falling as a proportion of GDP by the year 2015-16…’
Even if the Government opts out of rate hikes to create a weaker Pound (and thus help exports) such weakness will reduce confidence and increase borrowing costs – as of course will rate rises being followed by those from whom we borrow. And if rate rises are adopted in the UK (let’s get real here, they must be) then the ‘monetary stimulus’ argument goes out of the window.
This is merely the latest stage in the continuing battle between the desires of banks and the needs of real people. Economies get depressed, but very few people die. Inflation destroys cultures and political systems given half a chance. But a rate rise to control inflation would immediately make the banks vulnerable to their lunatic rate-derivative bets.
Rate rises in the end are inevitable. Mervyn King knows this – hence his desire (along with Ken Clarke) to prepare people for the worst: a 2008 Part II to make the first part of this movie look like the first twenty minutes of the Exorcist: lots of creepy rumblings, but no Devils rising from Hell. The next time, every Satanic jackal will be unleashed.
The vast majority of us will benefit from it in the long term. The medium term, however, doesn’t bear thinking about. For George Osborne as the Chancellor of a hugely indebted, economically imbalanced country, it is a nightmare he must think about. It is, after all, his job.