The Telegraph today have an article putting across the view of the Ernst & Young ITEM club, who believe that the Bank of England should keep the base interest rate at the current low level of 0.5% for years to come -- until 2014 in fact. This view is not shared by the government's new Office for Budget Responsibility (OBR), who forecast a similar level of economic growth over that period but they foresee the base interest rate going up steadily to around 3% over that time. Here.
Who are the ITEM club? Well, they're a bunch of economic thinkers paid by big business to come up with forecasts about what the future economic policies of the government should look like. They share the same model of the economy as used by the Treasury and also the OBR. So, you would think that all three parties ought to end up singing from a very similar song sheet at the end of the deliberations. But they don't. Could this be because ITEM's forecasts are spun in favour of the interests of big business, rather than the wider economy, do you think?
It seems to me that there is a significant body whose views have not been represented in the Telegraph article: the global bond market. These are the parties that will be buying (or not) the government's bonds at the paltry rates ITEM would offer. My feeling, and I am quite sure it is also the feeling of the Treasury and the OBR because they would never suggest raising rates if they didn't feel it was strictly necessary, is that the bond market will not buy our bonds at these rates for much longer. They are simply not being compensated for the risk they are taking, especially with the inflation rate in the UK unexpectedly being stubbornly high. If the bond market participants steer clear of our government bonds, we can't fill the budget deficit any more. Not unless Quantitative Easing (printing money to buy our own bonds from ourselves) is resumed in earnest, but at this point in time this approach would likely have dire consequences for confidence in the Pound, and therefore its exchange value. We would then be looking at a much worse problem than simply trying to keep the base interest rate down for political gain at home.
Tuesday, 27 July 2010
Should rates stay where they are for an extended period?
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