Why the UK should raise interest-rates and why Portugal should call in the International Monetary Fund

Thank you to those who replied to my question about the UK’s relationship with the European Union. I notice that some were implying views that I had not really said so let me refine/restate my point in case I had not made it clear. I feel that our membership has been misrepresented by our political class as we are continually told that the EU is vital for our trade and our future and usually this comes with the implication that leaving would be a disaster. My response to that is we have consistently run a trade deficit with the European Union so in fact the European Union as a whole will always be very keen for our trade. So we need not fear that they would ever abandon us as our trading pattern favours them rather than us. If it is  important for the UK it is even more important for nations which as a whole have a trade surplus with us. I see a mismatch between this situation and the fact that our political class have seen a massive expansion in jobs and salaries for themselves as a result of our membership of the European Union. Sometimes I feel that they cannot see the difference between their own interests and ours. Accordingly I feel that we have more influence in Europe than we have deployed so far and that we should find a way of using it. I am not saying we should stay or go as for a start that is highly political and I avoid politics but simply we have operated under a misconception.

A chance to raise UK official interest-rates

Today the UK Monetary Policy Committee meets and at mid-day there is a chance that they might raise interest-rates. This is the first meeting for quite some time that we might get a change. Now the probability is rather low but it exists and it is a little higher than implied by the result of the 62 economists polled by Bloomberg who all voted for no change. Perhaps one or two voting for a rise would be about right. In terms of history the MPC has often moved on the results of official quarterly Gross Domestic Product figures and the last headline was -0.5%. Also last time round whilst 2 members did vote for a rise this means that 7 did not and we would be relying on members who have been willing to accommodate inflation being over target for month after month suddenly reversing course. I noticed one article which suggested that Spencer Dale might switch sides. This might have been influenced by the speech he gave in the autumn entitled “inflation,inflation,inflation”, however he is hardly a hawk on such matters as in his own speech he pointed out that inflation had been over target in 41 out of 50 meetings he had voted in!

Why they might raise base rates

The first point is that consumer price inflation has been consistently over target and at 3.7% is nearly double the official target of 2%. Next week we will get the latest figures and it is quite possible I will be able to take the nearly out of the last sentence. In my view Retail Price Inflation is a better measure and apart from a level of 4.8% being higher in absolute terms it exceeds it old target by 2.3% rather than the 1.7% of the current one. This often gets forgotten in the debate. These figures are being influenced by world commodity price trends which show few signs of abating.

This was reinforced by the British Retail Consortium which published its latest survey of shop prices yesterday.

Overall shop price inflation increased to 2.5% in January from 2.1% in December. Food inflation accelerated to 4.6% from 4.0% in December. Non-food inflation increased to 1.3% from 1.1% in December.

It had a good go at spinning these figures but as you can see the spin hit the rather inconvenient truth that all its measures had risen!

Added to this is the fact that manufacturing in particular is still doing reasonably well in the UK. I wrote in my article on Tuesday the 8th of February about how well it had been doing and this is still true overall in spite of a 0.1% monthly dip in December. For example, according to the Office for National Statistics manufacturing production rose by 4.4% in December when compared with a year earlier. Also industrial production rose by 3.6% when compared with a year earlier and November’s figures were revised higher by 0.2%. So overall not quite as strong as November’s but still good. We also should factor in that the National Institute for Economic and Social Research recorded an increase of 0.5% in economic output for the fourth quarter of 2010.


Regular readers will be aware that I feel that the UK has a persistent inflation problem and that the MPC should respond to it with an increase in official interest-rates. I would have raised them beginning back in late 2009 as it was plain that a problem was building. I know that this comes as a shock to some as it is a different view to the consensus presented by the mainstream media. So let me make some basic points.

1. Even if UK base rates were 2% this compares with a “neutral” base rate of around 4.5%, so my policy is still expansionary merely less so.

2. There are many other interest-rates apart form the base rate and many of these are not taking much notice of it. I write often about bond yields and longer-term interest-rates which have been rising for some months and are now more than 1% higher than their lows. There are also very wide divergences between base rate and many market interest-rates such as overdraft and credit card rates which are often well into double figures. If you look at savings rate you can also get 3%, a mere 2.5% over base rate! So in effect it is as much for show as effect.

3. I would also operate to stop bank “profiteering” as described above.

4. I cannot stop the rises in commodity prices but I can respond to likely secondary effects of it such as rising inflationary expectations.

5. Think of the pain inflation has caused the UK economy in the past then add that to our current situation! If it should accelerate further imagine the quandary we will be in then.

In essence we have a difficult choice to which there is no easy answer. However I feel that there is a wrong answer and that so far the Monetary Policy Committee has taken it.

Portugal and her financial difficulties

Here is a more extreme case of a country affected by long-term interest-rates. Her ten-year government bond yield closed at 7.32% yesterday which is a new high in her time as a Euro member. Firstly I think there is food for thought for the UK in this and our inflationary situation. The point is that markets can force longer-term interest-rates much higher if they lose faith in a country not that Portugal has the same inflationary problem as us which she does not. Should this happen to us we would be in a much worse situation that trying to  act more promptly. Here there is a similarity as Portugal and the Euro zone are forever blaming market forces and the so-called “Wolf Pack” for events which are the consequence of their actions.

Returning to Portugal and her situation, I have felt for some months now that she should call in the International Monetary Fund. As she has a balance of payments problem she could do so without involving the European Union although it is more likely that she would involve it too. Unfortunately my calls for prompt and indeed pre-emptive action have been ignored and it is likely that the situation will decline to such a state that Portugal goes into such an arrangement on her knees. We have yet to find out what would happen if a country acted promptly and decisively. We do however know what happens when they do not as the example of both Ireland and Greece is that whilst the ship gets temporarily shored up it is still a long way from its home port and looks likely to sink before it gets there.

Update 11:40 am

Today Portuguese government bond yields have surged again and the European Central Bank has stepped in again reversing its recent policy and pointing out that it appears to be the only buyer. Central banks appear unable to stop manipulating markets and determined to create false ones.


As time goes by we get more details on the so-called rescue package and both the EU and IMF have provided more information this week. However there have also been signs of what has dogged Ireland all along that her banking sector is in fact in an even worse state than we have been told. The Chairman of Anglo-Irish Bank gave a speech this week suggesting that the Irish banking sector will need an extra 50 billion Euros of funds. This not only way exceeds the estimate of the Governor of the Central Bank of Ireland who has stated that ten billion Euros will be needed but also much more than the 35 billion that is in the rescue package for this purpose. We are in danger of a rather familiar deterioration here….

The UK banking-sector Project Merlin

This was announced to a great fanfare yesterday. However some Eagle-eyed observers have spotted these points in the statement.

these five banks have agreed to aim to foster more demand, such that their intention for gross new lending in 2011 is now higher than what was actually delivered in 2010………….Each bank’s lending expectations, capacity and willingness, as set out above, will be subject to its normal commercial objectives, credit standards and processes and regulatory obligations, as well as the availability of the required funding.

If we are to behave like a command economy we will have to do better than “intention” and “aim to” and “normal commercial objectives” have no place at all!

The Football Association

This was on my mind as I watched England win last night (apologies to Danish readers). I keep hearing people say that the FA has virtually no power these days and that the power resides with the Premier League. I wondered what these people with no  power paid themselves and in the latest accounts I could find for the 2008 calendar year Directors remuneration totalled £938,000. Not bad for a group with no power! Added to this one Director received  £1,289,000 as compensation for loss of office,quite a lot when you compare it to the total for all the Directors.


22 thoughts on “Why the UK should raise interest-rates and why Portugal should call in the International Monetary Fund

  1. 1. Yes, now IS the time to raise interest rates, but the question remains by how much? Too little and any impact is diluted, too much and it could stop an already enfeebled recovery. Small does, perhaps, say 0.75% with the option of a further 0.25%-0.5% in the near future?
    2. Portugal is between a rock and a hard place. I recall the government has proposed several strategies for change but they appear stalled (somewhere). The least-worst choice is the IMF in my opinion.
    3. Project Merlin COULD have had significant impact, but doubt that it will bearing in mind the caveats with which it is surrounded.

  2. I could not agree with you more about the EU, but leaving politics aside:
    1. Could you explain how raising interest rates will curb an inflation which is caused by worldwide commodity prices? Is it that our currency will rise, cutting the cost or is it that by cutting demand here, prices will somehow moderate. If the latter, how does this work?
    2. Whenever I have come across people blaming the wicked speculators on bond yields , the Wolf Pack above, I always ask them if they would lend their life savings to, say, Portugal at 7% for ten years or Greece at 11%. It doesn’t seem to be a popular investment choice among the people I meet!

  3. Portugal has had cheap credit for years since joing the EMU. The economic elites have profited but the cost of living for the ordinary folk has risen much more sharply than salaries. Have you been to Portugal recently? It is not that cheaper than the UK. I fail to see how this flow of cheap money has improved the lifes of the ordinary Portuguese citizen. Portugal should not call the IMF. It should go Iceland, leave the EMU and call for haircuts for foreign investors.

    • Hi Pedro
      Welcome to my blog. It is a few years since I have been to Portugal but I enjoyed my time there. I enjoy a glass or two of your country’s eponymous drink too!

      As to elites benefitting at the expense or ordinary citizens this is a common theme of my blog and of these times. It particularly saddens me to see democracies suffering from an increasing dose of it. Earlier this evening there was more examples of the same sort of thing in Egypt with Mubarak not going today as some claimed he would.

      I have been lookin at price differences between the UK and parts of the Euro zone and will write on this subject…

  4. Responding to Pedro:
    Would you not agree that access to a wide selection of tariff-free goods from within the EU does contribute to general prosperity? Secondly, question that Iceland is a good role-model to follow; leaving the EU would create even worse chaos for the ordinary citizen BUT agree 100% with ‘haircuts’ for investors. BUT first get the IMF involved.

    • Ray,

      How does tarriff-free goods help anyone who is on a low income? And why are incomes so low? Because past Governments have not help the economy grow. It’s like saying the poor should be grateful for handouts.

      • Robert,
        Thanks for your response. I did mention “general prosperity” but fully accept your reasoning as to why income levels are low. It is to be hoped that structural reforms will in some small way alleviate this long-lived problem.

  5. Shaun,

    I forgot to ask yesterday, but in yesterday’s post you said, “Yesterday the United States Treasury auctioned some US $32 billion of 3 year bonds and it did not go well.”. Out of interest, what is the definition of not going well? Did the US sell all of their bonds, or did it only scrape through? I only ask because I’ve no idea how the sale of bonds works.



    • Hi Robert

      The debt buying banks were left holding 62% of the US debt as international investors avoided the offering. However, yeasterday’s 10yr auction was 3 times over subscribed so just a question of hte rates on offer it would seem.

      Hope this helps


    • Hi Robert
      There are various things to look for and they do vary slightly from country to country. In general at a first reading I look for the price and yield in comparison with recent similar offerings and also if the full amount was sold/alloted.
      So looking at the US the 3 year auction of a couple of days ago was at a higher yield (from just over 1% to more like 1.4% if memory serves me right). Which wasn’t good.

      However for the full picture you need to let things settle for a few days as the whole process is a type of bargaining and unexpected demand may emerge (perhaps investors were trying to get cheaper stock) or selling if either investors or primary dealers were gambling or ended up with more than they wanted. Of course at the same time the world is moving and events may change their minds..

  6. Interest rates will not go up until its far too late, the Bank is using the last ounce of its credibility before it gets dumped and monetary policy moved back to the Treasury. The only question is whether inflation will grow fast enough to reduce the real level of debt before interest rates fly upwards…..

    • I think the Bank wants to be removed from the political arena. Otherwise it could have sorted out quite a few problems by now. It’s a death wish!

  7. There’s an unreality about the discussions on inflation. Compounding anything by 2% does not produce a stable outcome. A gradual increase in interest rates will not have a widespread affect on either increasing or decreasing inflation because current commercial rates of interest do not reflect the current BoE base rate.

    The argument for raising interest rates now is that it is best to do it incrementally than leave it too late and then raising them sharply (noting that BoE reduced interest rates too late).

    • Hi Sean
      Again and again we make a timing mistake when it comes to interest-rates. After a “honeymoon” period the MPC seems to have entered a phase where its timing is no better than that of politician’s. In a round about way we are revisiting the debate over whether they have become quasi-politician’s…

      The mistake of letting market interest-rates diverge from official rates was made on the way into the credit crunch and was one of the factors which triggered it. We had 7% or so rather than 5% or so…

  8. I can’t help but feel that the main beneficiary from the BoE base rate is the banks. I don’t Know where Libor is now, probably .55%. QE low base is a massive attempt to prop up banks that are about to enter another crisis as the housing Market had a sharp adjustment.

    Regarding the European question, there must be imbalances in trade by definition. I think we have been huge consumers and this has lead to the imbalance. But all good things …

  9. On the Europe point, you are right of course, that it is not obviously beneficial to be in a trading block when our balance of trade is consistently negative. But then, the same argument would appear to go for the whole World – and on that basis we’re not getting anything out of globalisation, the WTO etc either.

    I also agree that the EU comes at a relatively high bureaucratic cost (although not huge relative to our total bureaucratic cost in the UK).

    But this all misses the point, which is why are we failing to make and export as much as we import? Membership of the EU, or the global economy does not condemn a country to consumer status – but it does require us to compete. We chose not to compete in manufacturing (but to outsource to cheaper countries (in and out of the EU)) and to consume more and more imports fueled by increased borrowing.

    This model disproportionately benefited (and valued) ‘money’ over ‘people’ and has proved unsustainable.

    • The point is that there is a large body of politicians out there who try to stifle all debate about any sort of cost/benefit analysis of the EU. This is part of a wider refusal to allow any sort of democratic involvement in the direction of the EU (witness the refusal to hold or, when held, abide by, referendums).

      No-one is disputing the fact that the single market encourages trade (as do the WTO etc), but Shaun’s analysis is spot on, in that the trading relationship with the EU would be very unlikely to change whether or not we are in it, as the trade imbalance would encourage all other member states to continue the free trade relationships that we currently have.

      I like the fact that Shaun does not like to get involved in politics and I would not wish to be the one to drag this blog down from the Olympian heights of economics to the Stygian gloom of politics, but the credit crunch/bail-outs/banking crises have conspired to pull politics into the economic forum in an unprecedented way.
      This is apparent in the refusal to put interest rates despite the inflation rate, in the refusal to allow blatantly insolvent Ireland, Greece, Portugal either to default or to leave the Euro so as to take the traditional devaluation route. It is also apparent in the extraordinary attacks on speculators when not many sane people would lend to any of these countries.
      So, whatever we think about membership of the EU, I am becoming increasingly alarmed about the political attempts to solve a crisis, which seem repeatedly to ignore economics or, indeed, common sense.

      • I’m certainly with you on the default. In Ireland, the banks should have been allowed to go under, with the Government only guaranteeing retail deposits. In Greece, the Government should have been allowed to restructure its debt with the appropriate “haircut”.

        We are where we are. But whatever else comes out of this, we need
        a system in the future whcih allows the risk in these debts to fall where it belongs. I have previously compared Greece to California – both are likely to default at some point in the near future and there’s no reason to suppose that this will destabilise the Euro or the dollar: it may even persuade people to be more circumspect in their lending and borrowing in future.

  10. Personally I find the entire the EU debate in UK poisoned to a point where a normal debate is impossible. I also think a cost/benefit analyse of EU membership impossible to calculate or to be really exact the benefit part is impossible to calculate.


    I always assumed trade is a ‘zero-sum game’ so if there are huge trade surplus countries (Germany, Japan, China) you naturally also need to have huge trade deficit countries (USA, UK, peripheral Eurozone) meaning it’s impossible for Britain to turn itself into a trade surplus country.

    • Thanks. I’ve been thinking about this, and you’re obviously right on two levels. Mathermatically, at any one time the deficits must balance the surpluses. Equally, this must always be so for any one category of goods/services traded.

      But it surely can’t follow that the UK is bound to be and to remain a deficit country. That would seem to negate the whole premise that trade, and behind that specialisation, is beneficial: and the logical response would be to cut ourselves off.

      To my eye, this doesn’t make sense. The logical response is to identify those areas where we have a competitive advantage and concentrate on selling those while buying those products that others can makje better and/or cheaper. The problem, so far, is that the balance has tipped so far we don’t have the edge in enough areas (there are still some thankfully)and everyone else is making a lot of stuff better (Germany) and/or cheap0er (China). If it is impossible to turn that around then decline seems inevitable.

  11. King is now so wedded to his Keynesian mentor that he will use all his powers to prevent a rate rise. Remember, savers are hoarders and the way to prevent capital scarcity is zero interest rates? Increase interest rates and the spenders will stop spending and the savers will continue to hoard?

    King has read all the books and he is a very persuasive talker but he is either completely lacking in common sense or scared stiff of doing something that his textbooks or fellow Keynesian economists at the bank would not recommend.

    They tell us it is all working out just as they expected except that it will be a jobless recovery. Not so difficult to tell that it is not a recovery then, is it? We can do no more than look on whilst they systematically wreck the economy because it would appear that 30 months into this recession nobody has asked, even politely, for Kings resignation.

    • Keynesian economists would call this a liquidity trap. Keynes knew the limit of monetary policy, like a recurring theme of this blog he could see the difference between long term interest rates and base rate.

      The question is what to call King’s supporters?(which doesn’t involve rude words). It seems his supporters seem to be a lot of people with business or political background rather than economists.

      BoE has two mandates stability and inflation. So, yes, regicide should be called for.

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