Each week this month, the Bank of England is scheduled to purchase about £3.5bn of UK government bonds as part of its policy of quantitative easing (QE), with the objective of easing financial conditions and supporting economic growth. The bank is carrying through a policy of asset purchases agreed at the end of last year. But the world has changed dramatically since then.
The UK economy is now rebounding, and inflationary pressures are rising. The UK economy is expected to grow by around 7 per cent this year and 5-6 per cent next year. Unemployment has not hit the heights expected in the depths of the pandemic. There are now over 950,000 job vacancies, compared with 700-800,000 before the pandemic hit. In other words, the balance of economic pressures has shifted towards higher growth, lower unemployment and more inflation.
The most recent headline measure of consumer price inflation (CPI), published last month, showed a fall back from 2.5 to 2.1 per cent. But this is a temporary respite, as most economists expect a rise to around 4 per cent or higher in the second half of this year. These forecasts reflect growing evidence of price pressures in the pipeline.
Factory gate prices are 4.9 per cent up on a year ago, and input costs for energy and materials in manufacturing are up nearly 10 per cent. Shortages of skills and materials plus capacity constraints all point to more upward pressure on prices and costs. These factors—together with other temporary ones—indicate we are heading for inflation of around 5 per cent by the end of this year. Meanwhile, house prices are up over 13 per cent on a year ago, as loose monetary policy fuels a surge in the property market.
In the face of all this evidence, the Monetary Policy Committee (MPC) of the Bank of England seems to be stuck in a time warp. Its policy—keeping the official interest rate at 0.1 per cent and continuing with the current QE programme—has not responded at all to these changes in the economic climate.
Monetary policy should be a flexible tool, responding to changing circumstances in the economy. But that is not how it is operating in the UK at present. Yet only one member of the Bank of England MPC, Michael Saunders, appears to recognise these arguments by voting for an end to the current round of quantitative easing. The rest seem keen to plough on with the QE programme they agreed before the end of last year.
Quantitative easing is an emergency monetary policy, and is most effective when deployed if the economy is in a dire situation. That was the case in early 2009 when it was first introduced in the UK. At the time, I was on the MPC and I fully supported the deployment of QE to halt the decline of the UK economy and restore financial confidence.
But the situation now is totally different. The UK economy is not in decline: it is recovering from the pandemic, as restrictions are eased. And financial markets are stable; there is no need to intervene to arrest a decline in confidence.
The UK economy is currently set for the strongest period of growth since the end of Second World War. Inflation is set to rise quite sharply. The appropriate monetary policy response should be to remove monetary stimulus, not add to it.
If I was still a member of the MPC, I would be voting for an immediate end to QE and a gradual rise in interest rates. The current level of UK Bank Rate is 0.1 per cent—the lowest in the history of the Bank of England. Even in the depths of the 1930s recession, UK official interest rates were not reduced below 2 per cent. It is hard to justify continuing these extremely loose policy settings as the UK economy bounces back over the next 12-18 months.
In addition, monetary policy needs to be forward looking. Policy now should be set to influence economic conditions one or two years ahead, and to anticipate future trends and developments. Waiting for the economic traffic lights to be signalling red will be too late in terms of responding to inflationary risks.
The least that the MPC could have done last month to signal they were concerned about inflation and responding to the changing economic circumstances would have been to put the current QE programme on hold. An even stronger signal would have been to cancel the current QE programme altogether and to start raising interest rates.
We have an independent Monetary Policy Committee within the Bank of England for a reason. It is there to take decisions which politicians find difficult, particularly when it comes to tightening policy and withdrawing monetary stimulus. It is also there to look ahead and ward off inflationary dangers. Since 2009, the Bank of England has ducked this responsibility—and it looks like it is now doing the same again.
The MPC could have reasserted its authority by ending QE at its August 2021 meeting, instead adjusting monetary policy to the changed circumstances of the UK as it recovers from the pandemic. By ducking this challenge, the bank’s credibility and perceptions of its independence may well be harmed as a result.
When the committee meets again next on 23rd September, there is another chance to reassess the evidence and adjust UK monetary policy. But don’t hold your breath. The MPC’s recent record points to delay, not decisive action.
