Wednesday, 16th May 2018
No closer to normality….
Cast your mind back to this day in 2007….
Can you remember what you were doing? Probably not….
Can you remember what interest rates looked like back then?
Allow me to refresh your memory….
Back in May 2007, the interest rate set by the Bank of England’s (BoE) Monetary Policy Committee (MPC) had just hit 5.5%….
Don’t worry, that’s not a typo….
I know it sounds fanciful, but I really do mean 5.5%….
- A 6-year high and more to follow….
That figure represented a 6-year high….
It was the result of the BoE increasing the rate for the fourth time in just 9-months….
The rate is the baseline figure that (to some extent) informs borrowers what they can expect to pay for credit and tells savers what they can expect to be paid on deposits….
The bank had been increasing the rate in a bid to curb an inflation figure that in March 2007 had been running at 3.1%….
The hope was that a rising interest rate would encourage consumers to stop spending money and start saving it instead – taking heat out of rising prices….
I don’t tell you these things because I think you’ll enjoy a trip down Memory Lane. I tell you because I want to remind you what normality looked like a decade ago….
Just a few months later – in July 2007 – the BoE acted again. Once more, the target was inflation reduction. The BoE increased the rate to 5.75%….
- Then the first tremors were felt….
Things started to change in September 2007….
What became known as the banking sector ‘credit crunch’ hit the UK….
Northern Rock was the first British bank to run into trouble with liquidity levels – and it ran straight to the government (taxpayer) for help. The government (taxpayer) responded with emergency funding….
The bank was eventually taken into public ownership in 2008. But back in the early autumn of 2007, Northern Rock was just an early indication – a warning tremor – that something was wrong….
More tremors followed. The government pledged £10 billion in emergency funds to assist multiple troubled banks….
By now the ‘credit crunch’ was affecting banks and mortgage markets across the world. Lehman Brothers, Merrill Lynch, HBOS and other high-profile banks collapsed….
Others were in dire trouble. Governments were injecting billions into short-term money markets to enable banks to lend to one another….
The BoE cut its interest to 5.5% in the December. Then again to 5% in April 2008. And then again in October to 4.5%….
- Then the big shock….
The big shock came in November 2008 when the BoE cut the rate by a full 1.5% to 3%….
That represented the biggest single cut to the rate made by the BoE since being granted independence back in 1997….
But they didn’t stop there. They couldn’t stop there. The ‘credit crunch’ was in full swing and adversely affecting developed economies all over the globe….
In December, in line with other central banks around the world, the BoE cut interest rates again – this time to 2%….
Sir John Gieve, Deputy Governor of the BoE with responsibility for financial stability, told reporters the bank had underestimated the severity of the financial crisis….
‘We didn’t think it was going to be anything like as severe as it’s turned out to be….’
- More bad news….
It got worse. Britain fell into an economic slump….
The Bank cut the interest rate yet again to 1.5% – hoping to kick-start economic activity. It didn’t even register….
Just a few weeks later, the British economy was officially in a recession….
In February 2009, the BoE cut the rate to 1%. Then again in March to 0.5% – the lowest rate in the Bank’s 315-year history….
With interest rates already on the floor and offering little in the way of wiggle-room, central bankers needed another tool to make the economy do its bidding….
And that’s when the money-printing started….
Central bankers conjured hundreds of billions of pounds worth of new money into existence and used it to buy government and corporate bonds….
- Fast forward….
The lowest interest rates in history and billions of pounds of fresh cash created out of thin air were the tools used by the BoE planners to prop up the British economy, drag it out of recession and spur growth….
At the time, we were told that these drastic and unprecedented actions amounted to ‘emergency’ measures – a necessary short-term response to an unforeseen but temporary situation….
Fast forward to May 2018 – a full 10-years-on – and the emergency sirens are still wailing. All the red lights are still flashing….
The result of a decade of cheap credit and billions in hot-off-the-press new money is an economy that grew 0.1% in the first quarter of 2018….
Fragile isn’t the word. Blow on this thing and it will not just fall over. It might require a defibrillator….
- We must accept what cannot be avoided….
Hence last week, the BoE had to announce another delay on the journey back to normality….
The MPC had been expected to hike the interest rate another quarter point to 0.75% but they couldn’t bring themselves to do it – for fear of the consequences….
The British economy is so fragile right now that even a fractional increase in the interest rate might tip it into reverse….
And the central bank doesn’t want to do anything to damage the economy’s ‘recovery’ at this critical stage of the ‘emergency’ – a full 10-years on since the pointy-heads started pushing the buttons and cranking the levers to bend the economy to their will….
At this rate, it’s going to be a long time before the economy is ready for ‘normal’ – the kind of normal we had before 2008 when it cost money to borrow money and savers were rewarded….
5% interest rates – no more no less than the norm over the long-term – introduced right now would be the root cause of an awful lot of pain and misery – in the economy, in business, in over-priced markets and in households up and down the country….
- Confronting reality….
Markets would crash. Asset prices would nosedive….
Businesses would go bust. People would lose jobs, houses, cars….
Debts would be widely defaulted on by individuals, by businesses and by government….
It would be all-out pandemonium. It would feel like the sky was falling in….
But maybe some pain is exactly what is required to get things back to where we need to go – back to ‘normal’.
Maybe the mistakes of the last decade need shaking out of the system. Maybe it’s time to get the stables mucked out. Maybe some pain is what is missing – what is necessary….
Instead of trying to avoid it – as the BoE has been doing with its monetary policies for the last 10-years – maybe it would be best to embrace the notion of pain, brace for impact, grit our teeth, take the blow and get it over with….
Maybe it would be best to accept what must happen and let it happen – come what may.
Maybe then things can finally start getting back to something like normal.
That’s how it looks from here….
All the best,