John Redwood

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THE UK MONETARY AUTHORITIES AND INTEREST RATES -  BENIGN NEGLECT OR MALIGN NEGLECT?

I thought it worrying that on one of the worst days of market turbulence the Chancellor of the Exchequer should spend his time rubbishing proposals from the Economic Policy Review I had chaired and which he did not seem to have understood, instead of trying to work with other Financial Ministers and with monetary authorities to sort out the crisis.

We now see that this policy of indifference to what is happening in the markets is spreading to the Bank of England. They solemnly announced no change in their base rate of 5.75% - the only trouble is inter bank rates are not 5.75% or anything like it. They are now pushing 6.9%. It makes the UK monetary authorities look powerless and irrelevant.

The UK markets have in the last few weeks put through an increase of more than 1% (100 basis points) in interest rates. These new interbank rates will become the rates that decide how much people pay for their mortgages and how much companies pay for their borrowing, whatever the bank of England may like to happen, unless the Bank does intervene to bring market rates back into line with its own base rate. The ECB and the Fed have been more active, trying to keep some control over rates in their respective markets.

Those who thought this financial crisis would just wipe the smile off the faces of some well heeled bankers and hedge fund managers should think again. The so-called "repricing of risk" which Central Banks have called for means dearer loans for many individuals and companies. It means banks trying to recoup the losses they have made on the last lot of dodgy loans, by charging more for new ones. It means less borrowing and dearer borrowing. It means slower growth. It will have an impact on house prices in the UK, as it already has more dramatically in the USA.

the UK authorities  should not funk the decision. Do they really want interest rates to be 1% higher than their current base rate?  If they do not, then they should use all their powers to intervene in markets to get market rates down to their base rate. Like the other leading central banks, they also have to decide when the problem has shifted from one of controlling inflation, to being one of avoiding too sharp a slow down. They were behind events in trying to control inflation on the way up. Indeed the main central banks all encouraged the credit pyramid by keeping rates too low for too long. It looks as if the UK authorities want to be behind events on the way down as well.