HAMISH MCRAE: Interest rates will have to increase and the longer the delay, the greater the move will be in the end

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HAMISH MCRAE: Interest rates will have to increase and the longer the delay, the greater the move will be in the end
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Soaring inflation is crushing family budgets. Or more bluntly, if you have to spend an extra tenner filling up the car, that is £10 you can’t put towards Halloween festivities next weekend. 

Until recently the line from the Bank of England was first that it would not be a serious problem, and then that any peak would transitory. Now the mood is shifting towards alarm. Huw Pill, the Bank’s new chief economist, has warned that the Consumer Prices Index could rise above 5 per cent this winter, a level that would for the Bank be ‘very uncomfortable’. 

The CPI was 3.1 per cent last month, but the older measure of inflation, the Retail Price Index, was 4.9 per cent. The Government does not like this measure, and it is deemed ‘not a national statistic’. But it is still used as a base for interest on student loans and index-linked gilts, many pension contracts and excise duties including alcohol. 

You might reasonably ask if inflation is around or above 5 per cent, why on earth is the Bank’s base rate still only 0.1 per cent? The debate in the City is whether the Bank will start putting it up before Christmas or afterwards. There are the usual warnings from some economic commentators that it would be a grave mistake to move too soon, particularly when economic growth is held back by supply problems and, they think, inflation will fall back next year.

HAMISH MCRAE: Interest rates will have to increase and the longer the delay, the greater the move will be in the end
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There is a further twist to the argument. Rishi Sunak will confirm in his Budget on Wednesday that there will be tax rises in the spring. So if the Government is tightening fiscal policy it shouldn’t tighten monetary policy too. 

Frankly, I don’t think it makes much difference whether the Bank rate is 0.1 per cent or 0.25 per cent, or whether it goes up in November or February. Rates are so far below inflation everywhere that this is a pointless debate. Interest rates will have to go up and the longer the delay, the greater the move in the end. 

This is not particularly to get at the Bank of England. The Governor, Andrew Bailey, is sensible and experienced. So too is Jens Weidmann, the head of the German Bundesbank and a council member of the European Central Bank. He has just resigned early, it is thought because he feels Europe has been too soft on combating inflation. The problem is the experienced people have to work with colleagues who are too young to remember the great inflation of the 1970s and 1980s, and the social and economic damage that it caused.

So what will happen? Inflation will peak through the winter. It will go to 5 per cent or more here, and higher elsewhere. It is already at 4.1 per cent in Germany, and at 5.4 per cent in the US. The central banks will go on saying it is temporary and that the economies are too fragile for them to do very much. So there will be some token moves by the US Fed and the Bank of England, but very little by the ECB. 

Then next year inflation will indeed come down a bit, but not to pre-pandemic levels. Anyone with any sense will go on buying real assets: homes, shares of solid companies and so on. People with less sense (or maybe more courage) will put their money into the latest fashionable investment. One of the reasons why Bitcoin hit a record high last week was because some people see it as an inflation hedge.  

It is a measure of the current mood that an asset that can only be maintained by a huge input of electricity should be apparently so attractive in an age of rising environmental concern. It currently is estimated to use more power than Argentina, a nation of 45 million people. 

Eventually, there will be some sort of reckoning. If you are interested, the classic book on the subject is Manias, Panics And Crashes: A History Of Financial Crises, by Charles Kindleberger. It may be that things will canter along fine for a while yet. Maybe the air will be let out of the balloon slowly. 

Things do not feel nearly as bad as they did in 1974 when OPEC quadrupled the oil price, an act that helped trigger doubledigit inflation. US interest rates were increased by the Fed to 20 per cent in 1980. We won’t go there, but I fear Huw Pill is right. There will indeed be some ‘very uncomfortable’ months ahead. And not just for the Bank of England. 

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