THE BLOG

Interest Rate Hawks Should Return to Their Nests

24/07/2014 12:30 BST | Updated 22/09/2014 10:59 BST

The interest rate hawks are circling over Threadneedle Street. Should they choose to strike early or unexpectedly, the consequences for the UK's recovery and growth prospects will be significant.

What most troubles the businesses I speak with up and down the country is the insouciance of the economists and commentators who favour rate rises. The hawks say, over and over again, that rates "have to go back to normal sometime", as if that was a reason for immediate action. A few point to the frothy housing market in London and the South East as a reason for action, while others seem influenced by the strong and vocal political lobby representing savers who are feeling the squeeze.

But the hawks haven't made a coherent case for early rate rises. Saying rates have to rise sometime simply isn't good enough.

Those in a favour of a swift rate rise seem to be ignoring some inconvenient truths.

Inflation remains below target, despite last month's surprise increase. Barring an overseas shock - such as a substantial rise in oil prices given recent events in Iraq - the domestic factors suggests it will remain close to the Bank of England's 2 percent target. While we understand that rate-setters look ahead to the medium-term outlook for prices, the inflation picture at present is relatively benign. Our businesses are not seeing or contemplating huge wage increases, barring the occasional intervention from politicians. Neither of these important bellwethers indicates a need for immediate rate rises.

Then there's sterling. Our currency has already appreciated 12pc against the dollar over the past 12 months, making life more complicated for both new and experienced exporters. Raise rates too early, and the resulting upward pressure on sterling could nip export growth in the bud - when we all know that UK economic growth needs to be weaned off the twin drugs of government and consumer spending.

If exports are one form of economic methadone, business investment is the other. We have seen significant growth in business investment in recent months, following abysmal levels over not just years, but decades. Raise rates too early, and this incipient good news story becomes yet another casualty of economic orthodoxy. By driving up the cost of credit for fast-growing businesses, many of whom do not sit on the same healthy cash piles as their more established counterparts, precipitous rate rises may mean more limited growth ambitions among the very firms we are counting on to diversify our economy.

If the much-discussed state of the housing market is a concern, there are other tools at the Bank of England's disposal to cool the market. Already, there are signs of a let-up in the mortgage market, suggesting that the existence of these tools is helping. Only a major increase in housing supply would drastically slow price rises in sought-after parts of the country. So why try to use interest rates to do the job, when the potential collateral damage to business, to jobs, and to growth is so high?

Businesses, like consumers, realise that interest rates will eventually rise. Most are planning for rises to begin sometime in 2015, and are counting on the Monetary Policy Committee to ensure that any upward trajectory is both slow and smooth.

But earlier than expected rate rises could mean that current levels of growth, at 3pc, are 'as good as it gets' for the UK economy. The case for acting more swiftly has not yet been made. Companies need to be confident that they will be working in a low interest rate environment for some time yet, and that from next year they will face only gradual rather than sudden change.

The hawks of Threadneedle Street need to stop circling and return to their nests. It's not yet time for their interest rate hunt to begin.