Mark Carney, the governor of the Bank of England, is hardly the most reliable guide to anything.
He has warned constantly that interest rates will have to rise soon, but has managed to get through three years in office without changing them even once. He has been through several versions of “forward guidance,” and come up with a range of newfangled ways of managing monetary policy, only to abandon them after a few months. An East German Trabant was more likely to get you to your destination on time.
Even so, if the bank does not cut interest rates tomorrow, and possibly launch another round of quantitative easing, it will come as a major shock to the markets.
And yet, that may well come to be viewed a huge mistake.
In fact, the British economy was already in a perfectly healthy state when the electorate decided to leave the European Union. Since then, there has been a massive devaluation of the pound GBPUSD, -0.0824% , and the government has effectively abandoned fiscal restraint.
What happens when you take an economy running at capacity and stimulate it? It starts to overheat.
The real risk for the U.K. is not of a Brexit bust, despite all the warnings in the immediate aftermath of the vote. It is of a Brexit boom — an overheating economy that may ultimately crash. The best way to avoid that would be to keep rates on hold.
Carney may have let down the City last month by keeping interest rates steady, but he has all but promised to move this week instead. Overall, 45 out of 47 City economists expect rates to be cut this week, with the majority looking for a quarter-point reduction to 0.25%.
But it could be more. The bank may well decided to slash rates all the way down to zero, and perhaps even into negative territory, while launching another round of quantitative easing, and possibly even coming up with some emergency measures to help the housing market.
Whatever the precise mix, some kind of stimulus looks a done deal.
But hold on. Does the British economy really need that?
True, if you look at the survey data, there is plenty of evidence of a significant knock to confidence in the wake of the referendum result. Companies are certainly feeling less bullish.
Then again, what would you expect? Every expert on the planet has been saying that Brexit is the worst thing to happen to the economy since the Black Death. If that doesn’t make you think again about building that new warehouse, or expanding your call center, it is hard to know what will.
The hard data tell a different story. The jobs market? Pretty good. Figures published on July 20 showed unemployment hitting a 11-year low of 4.9% with the number of people in work at an all-time high. House prices are still rising. Average wages are going up at slightly more than 2% — not fantastic, but respectable when inflation is close to zero. Retail sales have taken a hit, but that has more to do with a soggy, rainy summer than anything else.
You need a very nervous personality to describe any of that as a crisis.
No one would argue that Brexit is not a threat to the economy. But we also have to keep in mind that the U.K. is already been given a massive stimulus. In the immediate wake of the vote, sterling dropped by about 10%. That is a massive devaluation, of the kind other central banks keep trying to engineer. It will help exporters, and will start narrowing the trade gap.
On top of that, the government appears to have abandoned fiscal austerity, such as it was. The goal of balancing the budget has been indefinitely postponed, and, given that the cost of state borrowing has dropped yet again, a big round of infrastructure spending seems likely (a new London airport is at the top of the list).
If that were not enough, Brexit is likely to lead to lower levels of immigration. Since a vast supply of cheap foreign workers has depressed wages, there is a real chance that earnings will start to accelerate, and possibly quite quickly. A devaluation, more government spending, and higher wages? That sounds like a big stimulus, especially for an economy running at close to full employment.
Is a cut in interest rates really necessary on top of that? It is perfectly possible that leaving the EU will be damaging to the U.K. eventually. But it hasn’t happened yet, and we don’t know what the terms will be. Britain may well negotiate full or partial access to the single market, in which case most companies will hardly notice the difference.
Even if it is bad on a decade-long view, that doesn’t mean it is bad in the short-term.
In fact, what we will probably see now is something that runs contrary to all the mainstream forecasts — a Brexit boom. The U.K. will be getting a massive boost to demand when it was already doing pretty well.
But here is the problem. If the British economy has a structural weakness, it is that it is prone to short-term, demand-led booms, which are swiftly followed by busts. It happened repeatedly in the 1960s and 1970s, and again in the early 1990s, as governments overstimulated the economy. Ever since the BOE became independent in 1997, it has curbed that. And yet, right now there is a real danger that cycle is about to re-emerge.
The sensible move for the bank would be to postpone any cut in rates. The economy is strong enough already. It can always cut rates in the months ahead if there is real evidence of a painful slowdown. Until then, the real risk is of a Brexit boom that runs out of control — and if any kind of policy move is needed, it is more likely to be a small hike in rates to keep that under control than a cut.
Matthew Lynn is the founder of Endeavour Press. He is financial columnist for WSJ MarketWatch, Daily Telegraph and Money Week, and the author of the Death Force thrillers
Source: Market Watch