Opinion  

Why the Bank of England left interest rates unchanged

David Thorpe

David Thorpe

The likelihood of a consumer spending the extra cash they are supplied with as a result of a rate cut is dependent on their level of confidence.

The uncertainty of a general election and the Brexit process in 2019 dented confidence, which was negative for most of last year.

Negative consumer confidence implies individuals were choosing not to spend or borrow more, at the present interest rate, so if consumers view recent political developments as providing greater certainty, then they are more likely to increase spending, without rates needing to be cut. 

In the Bank of England minutes, this scenario was explained as follows: “Domestically, near-term uncertainties facing businesses and households have receded.

"Surveys of business activity have picked up, quite markedly in some cases, and investment intentions appear to have recovered.

"Housing market indicators have strengthened and consumer confidence has increased slightly.

"The Committee will monitor closely the extent to which these early indications of an improved outlook are sustained and follow through to the hard data on domestic activity in coming months.”

If this happens there is then no need to lower rates to achieve economic growth.

But while there may be no need to cut interest rates, if the economy is starting to grow, and this would be viewed as a positive,the central bank also pointed to negative connotations. 

Cutting interest rates only boosts economic growth if there is unused capacity in the economy.

If the economy is already growing at its full potential, then a rate cut boosting demand simply leads to higher inflation, and potentially lots of cash being deployed in speculative ways, creating a bubble in the economy such as that which happened before the global financial crisis when the extra debt in the system was deployed into property assets. 

The Bank of England’s chief economist Andy Haldane previously told the Treasury Select Committee of the House of Commons that as a result of lower immigration and higher barriers to trade due to Brexit, the level at which the UK economy has reached its full growth potential has fallen from 2 per cent to 1.5 per cent.

This means cutting rates if growth is 1.5 per cent or higher would lead to higher inflation, not higher growth. 

In the minutes of the meeting today, the central bank said it now feels the potential growth rate for the UK economy over the next three years is just 1.1 per cent, meaning that any interest rate cut if growth is at, or above, that level, would simply add inflation, not growth, meaning there is no need to put rates up.