OpinionJan 30 2020

Why the Bank of England left interest rates unchanged

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Why the Bank of England left interest rates unchanged

This means, there is no point in cutting rates if consumers choose not to borrow what the bank is now willing to lend them, or if they respond to lower mortgage repayment costs by simply saving the cash for a rainy day. 

The fund manager Bruce Stout, describes the fondness of some economists for simply focusing on the supply of money in the system, and not the demand for money as “you can take a horse to water, but you cannot make it drink.” 

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.