The Bank of England Is Crushing the Economy – Unnecessarily

The Bank of England Is Crushing the Economy – Unnecessarily

The Bank of England Is Crushing the Economy – Unnecessarily

The Bank of England has got it wrong. Its interest rates increase is already restricting the UK economy with jobs and businesses being lost unnecessarily. The current 10.7% inflation rate is five times higher than the Bank of England’s 2% inflation target. However, there are positive signs that inflation is easing judging by economic behaviour in November.

Andrew Bailey, the Governor of the Bank of England, described it as the “first glimmer” that interest rates will start to fall over time but caveated it with the fact that there is still “a long way to go”. The Bank of England followed this positive note by yet again raising interest rates to 3.5% in mid-December. It used this latest rise to announce that interest rates are likely to continue to rise next year.

The challenge facing the Bank of England is clear. It must balance increasing borrowing costs without slowing down the UK economy – but soaring interest rates are not the way of achieving this.

The Bank of England is facing fierce criticism from all sides for its conduct in the months leading up to the collapse of the gilts market. Are its actions unnecessary? Did it fail to prepare the UK for inflation at a time when it could have taken proactive steps to avoid the current situation? Yes.

How does the UK’s response stand against that of our international allies, including the European Central Bank and the United States’ Federal Reserve? The next announcement on interest rates from the Bank of England is due to be made on the 2nd of February 2023. It’s important we use the intervening time to question the actions of the Bank of England and how it’s unnecessarily crushing the economy.

Interest Rates Up to 3.5%

The Bank of England has risen interest rates from virtually nil to 3.5%. The latest interest rate makes it the highest level for 14 years. However, it won’t instantly revive the economy with interest rises taking between 9 months to 2 years to fully impact the economy.

The key criticism placed before the Bank of England is that the institution was too slow to act in 2021 against the threat of rising inflation following the pandemic. Inflation first went above the Bank of England’s 2% target in August 2021. It took until December for the Bank of England to begin the interest rates that have continued steadily till now.

After failing to be proactive on interest rates throughout 2021 as the cost of fuel and food increased, the Bank of England is now on the back foot. It’s leading an inflationary surge that hasn’t been seen in the UK for over 50 years. Did it have to be this way?

The latest minutes of the MPC point clearly to a further 0.5% increase in February 2023.

Where is Inflation Heading?

Inflation” is one of the biggest buzzwords in financial journalism and mainstream news – but is the situation being overinflated? The Bank of England’s own projections shows that inflation will fall to zero or turn negative towards the end of 2024.

The Bank of England began to rise interest rates in December 2021. It was the first of the major central banks to begin a cycle of monetary tightening. Andrew Bailey told the Chancellor in a letter accompanying the latest interest rate hike that inflation has likely reached its peak. October saw inflation hit a 41-year high of 10.7% before dropping in November.

Interest rates are likely to rise again in the new year, even while inflation continues to fall.

Inflation forecast


But take a look at the inflation forecast above, which is taken from a Bank of England Powerpoint presentation, what it shows is that the Bank is expecting that the impact of the interest rise will be such that inflation turns negative early 2024 onwards, given that interest rate rises take 9 – 24 months to work fully through into the real economy that shows the Bank of England’s policy is to crush inflation and the economy along with it.

Whilst that puts a “marker down” for investors its the wrong policy for UK residents and businesses who have mortgages and businesses to invest in.

Can We Learn from America and the EU?

Economies are responding to the current economic upheaval in different ways. There’s much we can learn from our global partners but this much be examined in the context of each country’s specific situation.

We could follow the approach of the Federal Reserve, which is working to achieve maximum employment and inflation at the rate of 2%. However, the United States has seen modest spending and production growth, alongside job gains and low unemployment rates. Its issues and dynamics are different from the problems facing the rest of the world.

Another institution to examine is the European Central Bank. The institution suspended its two-tier system that safeguarded a 0% interest rate ceiling. The ECB believes that “keeping interest rates at restrictive levels will over time reduce inflation by dampening demand and will also guard against the risk of a persistent upward shift in inflation expectations. “. It announced a 50 basis points increase and an upward revision to its inflation outlook in mid-December.

Other countries have also been putting up interest rates to tackle soaring inflation.

On Wednesday, the US central bank increased the target range for its benchmark rate by 0.75 percentage points to 4.25%-4.5% – the highest it has been in 15 years.

And on Thursday, the European Central Bank put up rates for countries that use the euro by half a percentage point to 2.5%.

The Truss Government and the BoE

Liz Truss will go down in history as the shortes- serving Prime Minister of modern times. What her government will be remembered for most is its disastrous financial statement/mini-budget. However, the blame doesn’t lie solely at Truss’ feet. The Bank of Ireland failed badly to coordinate with her government when the policies within the financial statement were heavily trailed prior to their unveiling.

This approach was misguided and damaging, ultimately leading us to the situation we’re in today. A failure to coordinate with the Truss government is why the Bank of England was pushed into emergency action to protect pension funds due to the backlash against Kwarteng’s mini-budget that caused fears of a 2008-style financial crash.

While the actions of the Bank of England were necessary to prevent a ‘doom loop’, they could have been avoided if the Bank of England had worked in unison with No10.

Even the Truss Government – for its short tenure – was critical of the Bank of England. One of the most vocal was Suella Braverman, who had previously run as a leadership candidate. Braverman spoke out against the Bank of England as Attorney General, questioning whether it was ‘fit for purpose’.

She suggested that Liz Truss would look at whether the Bank of England was “fit for purpose in terms of its entire exclusionary independence over interest rates” during a Sky News interview in August 2022. While No10 quickly squashed this suggestion, it’s an interesting insight into the mood within the Conservative party.

Liz Truss also raised a question on the future of the Bank of England during her tenure as Prime Minister. She stated that she had a desire to “change the Bank of England’s mandate to make sure in future it matches some of the most effective central banks in the world at controlling inflation”.

While the history books will eventually determine the reasons why Truss’ premiership lasted a short summer, there’s an argument for the Bank of England being her Achilles’ heel. The Washington Post published an op-ed in October 2022 with a view that is likely shared amongst our global allies. It presented the view that the “Markets didn’t oust Truss, the Bank of England did — through poor financial regulation and highly subjective crisis management”.

Bank of England’s MPC

The Bank of England’s Monetary Policy Committee is a nine-member group responsible for voting on whether to cut, keep, or raise interest rates. They’re in an inevitable position and must forcefully curb inflation without feeding into an economic contraction.

The Monetary Policy Committee within the Bank of England showed little dissent in the face of this crisis. Silvana Tenreyro, Professor in Economics at the London School of Economics, was one of the few external members of the Monetary Policy Committee to recognise the issues the Bank of England was facing.

December’s 3.5% interest rate was voted on by 6-3. Two of the 3 individuals who voted against were in favour of maintaining the 3% bank rate, while one called for an increase of 0.75%. The Bank of England defended its decision to increase rates as inflation begins to fall because global inflationary pressures “remain elevated”.

The latest rates rise to 3.5% brought the first signs of legitimate division between members of the MPC. Some appeared in favour of the 75-bps rise while others declared that now is the time to stop tightening monetary policy. However, industry experts don’t expect this to be the final interest rate hike.

Vivek Paul, the UK Chief Investment Strategist at Blackrock investment Institute told Reuters that “they’re not done. There’s an element that the bank will stop a little bit…their own numbers have been pointed to a recession for a little while, and they’re still materially hiked interest rates”.

Growing Criticism of the Bank of England

We’re not alone in criticising the Bank of England. Some of the UK’s leading economists have been warning of the Bank of England’s failure to act quickly enough since the start of 2022.

Gerard Lyons, a former economic advisor to Boris Johnson and Gordon Brown, accused the Bank of England of failing to “nip inflation in the bud” and instead taking a “complacent attitude” towards interest rate rises. Its Lyons’ opinion that the actions of the Bank of England are worsening the cost-of-living crisis.

He furthered his criticism by saying that the Bank of England’s inflation forecasts had been “poor and wrong” with Andrew Bailey taking “a complacent attitude to the possible inflation risk” that was evident in the summer of 2021. Lyons believes Bailey misread the economy and his failure to effectively communicate with the markets allowed the “inflation genie out of the bottle”.

What Should the Bank of England Do Now?

Where can the Bank of England go from here? The current situation bodes badly for the future. It’s clear we need to revise the existing system. The UK needs a financial leader who can drive change, like how Alan Greenspan stepped up to the challenges in the US Economy as Chairman of the Federal Reserve

The UK presently lacks a figure like Greenspan at the Bank of England who can shape the future of the economy. The Bank of England requires a charismatic communicator at the forefront. Andrew Bailey is not this.

Some sympathy must be shown to Bailey though. He took up the job of Governor of the Bank of England in the initial days of the COVID-19 pandemic in March 2020 and hot off the heels of Brexit. Few Bank of England governors can say they’ve served through such a period of economic instability.

Criticism of Bailey focuses primarily on his inability as a communicator. He has a track record for making comments that are badly received by the public, using terms such as “apocalyptic” when describing the rise in food prices and calling for the need for “painful” wage moderation.

Where is the Bank of England going in the future? Its independence has come under question, particularly in recent months. While the government sets the remit of the bank and appoints its senior policymakers, there may be room for a greater role of the Treasury Committee. Its growing influence is clear, and it already has the power to question Bank of England officials and review candidates for senior appointments within the Bank. The Chancellor himself now appears more willing to take a stronger response to the Bank of England.

It’s unlikely that any major changes to the Bank of England are coming in the immediate future. Such change would require a lengthy review, like what Australia’s central bank is currently going through. It would likely take at least 18-months, similar to that of the European Central Bank. This time frame poses the question as to whether a government could sustain political interest for this long or use the political capital necessary to make it happen.

The last five years have been unprecedented in the UK. The Bank of England has navigated Brexit, the pandemic, and the energy crisis in response to the war in Ukraine. While the Bank of England has been dealing with this, households and businesses are the ones at the forefront of its impact. The Bank of England has been unable to reassure them that they have the right plans in place to protect the economy.

It’s clear that the Bank of England is failing. It could have taken proactive steps in August 2021 when inflation was starting, and the writing was already on the wall. The Bank of England has failed to provide the price stability that a well-functioning economy requires. It’s unnecessarily crushing the economy and forcing businesses to control cost rather than focussing on growth and investment.

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