Why I think a Base Rate cut in the UK is as likely as a rise going forwards

Today’s blog post title goes against quite a lot of conventional wisdom in the UK where we are continually promised that Base Rate rises are just around the corner. So far however we have found ourselves on a straight road and the chances of that continuing have moved higher. It was only last Thursday that I pointed out on here that the Bank of England was moving away from its promises of a Base Rate rise which continued a theme I had opened on the 27th of December last year.

So should we see any slowing of the UK economy in 2014 and the exchange rate of the pound continues to be strong there are factors pointing towards a base rate cut. This would be reinforced if the pound strength actually pushed inflation to below its target. The MPC would be likely to ignore the years of inflation being above target and concentrate myopically on the immediate figures in such a situation.

Okay so what grounds might there be for a Base Rate cut?

Some of these have been established this morning in a speech given by Bank of England Chief Economist Andy Haldane in Kenilworth.

So far, then, so bad. On this evidence, the UK economy is as weak as at any time in the recent or distant past. It is firmly on the back foot.

Okay Andy so what ground do you have for thinking in such a way? The emphasis below is mine.

Annual real wage growth in the UK – average weekly earnings growth adjusted for consumer price inflation – is currently running at close to minus 1%. Growth in real wages has been negative for all bar three of the past 74 months. The cumulative fall in real wages since their pre-recession peak is around 10%. As best we can tell, the length and depth of this fall is unprecedented since at least the mid-1800s.

Regular readers will be aware of this issue but I thought the sentence I emphasised a fresh way of looking at it. Some of you may already have spotted that he has missed a trick as the real wages data would look worse if he had used the Retail Price Index. As he is using data supplied by the Trade Union Congress for their Britain Needs A Pay Rise campaign I suspect they have missed a trick too. Oh and using an index (CPI) only just over a decade old to go back more than a century has its dangers.

Next up we got this.

Productivity – GDP per hour worked – was broadly unchanged in the year to 2014 Q2, leaving it around 15% below its pre-crisis trend level. The level of productivity is no higher than it was six years ago. This is the so-called “productivity puzzle”. Productivity has not flat-lined for that long in any period since the 1880s, other than following demobilisation after the World Wars.

Okay so a further problem and particularly troubling that it has not picked up as our economy has pushed forwards and had a better spell.

There is something of a departure for a Bank of England official in this next section which I wholeheartedly welcome. It is considering the effect of the credit crunch on savers.

Annual real interest rates – for example, rates earned by households on time deposits adjusted for consumer price inflation – are around zero. They have been near-zero for close to four years. Real deposit rates have not been that low since the 1970s, when inflation was in double digits.

This is something of a change as I can remember Deputy Governor the aptly named Charlie Bean telling us this back in September 2010. He replied “Yes” to this question posed by Channel four news.

This bad news for savers is the point of what you are doing?

Now Andy Haldane is implying that this is one of the things which have weakened the economy. Oh and Charlie Bean was displaying his usual anti-prescience skills back in September 2010.

At the current juncture, savers might be suffering as a result of bank rate being at low levels, but there will be times in the future — as there have been times in the past — when they will be doing very well.

So far some four years later such a situation has yet to arrive Charlie! Still I suppose that having retired with a pension fund valued at £3.96 million he has hardly noticed.

The Agony Index

Andy Haldane uses the concepts and data above to create an agony index which is not especially pleasant reading.

The agony index is currently at painfully low levels.
It has been around 5 percentage points below its 1970-2014 average since 2008. Such an extended period of agony is virtually unprecedented going back to the late 1800s, with the exception of the aftermath of the World Wars and the early 1970s.

Bank of England Forecasting Accuracy

The emphasis is mine.

And if you believe the MPC’s growth forecasts, that recovery is set to continue in the period ahead.

Indeed one of my themes has been confirmed here and it is nice to see some refreshing honesty for a change.

These suggest that the MPC, in common with every other mainstream forecaster, has been forecasting sunshine tomorrow in every year since 2008 – that is, rising real wages, productivity and real interest rates. The heat-wave has failed to materialise. The timing of the upturn has been repeatedly put back. Downside surprises have been correlated.

The future does not look especially bright

In the UK, real interest rates are now expected to remain negative for at least the next 40 years. An alternative hypothesis is that these developments reflect pessimistic expectations about future growth prospects, which are mirrored in expected policy rates needing to remain lower for much longer.

You may note that the “lower for longer” mantra of Forward Guidance has found the word “much” added to it. Yet another change? Perhaps and maybe soon we will be following the Bank of Canada and moving away from Forward Guidance completely.

Some care is needed here as we have just concluded that forecasts are not far off hopeless right now but the summary of wages and the labour market is also somewhat ominous.

Taken together, this paints a picture of a widening distribution of fortunes across the labour market – a tale of
two workers. The upper peak of the labour market is clearly thriving in both employment and wage terms. The mid-tier is languishing in both employment and real wage terms. And for the lower skilled, employment is up at the cost of lower real wages for the group as a whole.

Let us cut to the chase

Here is the implied policy judgement from Andy Haldane.

And recent evidence, in the UK and globally, has shifted my probability distribution towards the lower tail. Put in rather plainer English, I am gloomier.


There is a fair bit to consider here and let me open by pointing out that Andy Haldane has got gloomier over a period where the UK economy has apparently grown strongly again (0.7% according to the NIESR). Also the ESA 10 revisions have left our economy somewhat larger in recorded terms but little solace seems to have been gained from that. Perhaps he is not much of a fan of them either!

Also I wish to point out that there was another side to the speech as you might guess from the title of “Twin Peaks”. There was an ecstasy alternative to the agony. But I have the feeling that we are being feed a policy shift in what might be called bite-sized chunks. As I have argued before the chances of a future Base Rate cut are much higher than you are likely to read elsewhere. Please do not misunderstand me as I would not vote for it but the possibility is edging up on the horizon.

If we move to an international perspective then the United States may be edging in the same direction. Here is James Bullard of the St.Louis Federal Reserve on Bloomberg.

Inflation expectations are declining in the U.S…… “That’s an important consideration for a central bank. And for that reason I think that a logical policy response at this juncture may be to delay the end of the QE.

Now who is left raising interest-rates? Oh and did the markets or the central bankers move first?


20 thoughts on “Why I think a Base Rate cut in the UK is as likely as a rise going forwards

  1. Hi Shaun, and thanks again for an excellently set out article.
    If you add in the difficulties in the housing market, of people stretched, but not getting the wage inflation necessary to cut them some slack, you see why I said, not so long ago, that I couldn’t see real interest rate changes for a decade at least.

    • You are right, the longer borrowing costs remain low, the longer mortgage rates will stay at historic lows. This artificially created ‘affordability’ will become the norm and as larger proportion of the home owning public, over time, buy at these levels the harder it will be to increase rates later on.

  2. The Friday flowchart:
    Deflation mooted – Stocks jitter – Bankers gloomy – Rate rise delays mooted – Stocks bolster

    It’s all getting pretty theatrical. But I still think we’ll move if and when the Fed moves. But will Yellen stick to her guns and shut it down on the 29th?

    • Hi Peter

      The was for a while suggestions that the good ship QE4 was now likely to come down the monetary policy slipway but it immediately drew criticisms along the line that the current effort or QE3 is still in operation. I think that the main factor in the short-term until the 29th is what happens to the stock market. Central bankers seem to pretty much target it these days….

      As to Janet Yellen it was interesting to read her thoughts on increasing inequality. Except of course the QE she has supported has been a cause of some of it.

  3. Hi Shaun

    excellent article as always. The boe were never going to raise rates unless forced to. Endless excuses and now they have another one. The ‘recovery’ caused by increased debt and fiddling the figures never really happened.

    Eventually the house of cards will have to crash around us.

    • Hi Anteos

      The opportunity to raise Base Rates was missed back in 2010 as I pointed out on here back then. It would have helped with the inflationary period we saw and thereby on real wages which were impacted by it.

      Now it is very difficult as I would like to see them higher but the road there is nowhere near as good as it was back then.

  4. Hi Shaun,

    Nice to see a bit more honesty from a Bank official, and as you note, a refreshing change from the insolent smirk of Mr Bean who to my eyes always seemed to be extremely pleased with himself.

    We can only wonder why the Bank weren’t quite so concerned about falling real wages when inflation was over target for the thick end of five years, especially when it was @5%pa…

    Still, I’d rather be in our boat with a growing economy and a floating currency than Italy’s sinking ship, which is making an ominous glugging noise…


    • Hi Andy

      I suspect that the Bank of England believed its own forecasts for wage inflation back in 2010/11 which would have been based on models which assumed real wage growth. Maybe they nudged it down a bit but it was a case of the theory dominating reality. A clear policy error in my view.

      As to Italy it is very very sad to see such things happening to what is a lovely country.

      • Well surely if you’re not improving productivity there is no justification for a wage increase.
        But if you’re simply looking for stoking inflation, if that’s the most important issue, then of course campaign for wage rises even though productivity is falling.
        Of course then you’ll soon see more company failures and the unemployment rate will soon start to rise again.

  5. Italy’s sinking ship, which is making an ominous glugging noise…

    I thought Berlusconi and Bunga-Bunga parties were a thing of the past?

  6. Hi Shaun

    Thanks for another great article.

    I think Andy Haldane’s speech is significant both in terms of monetary policy and in (diplomatically) laying down the gauntlet to politicians ahead of the General Election.

    His focus on the fall in real wages and his direct linking of that to the abysmal productivity performance of the economy since the recession begs a question of politicians – ‘what are your macroeconomic policy proposals to deal with that problem, or is your solution simply to hope and forecast sunshine tomorrow?’

    He emphasizes that point by linking the need for rates to stay low for longer due to economic failure, or in his more nuanced language, ‘pessimistic expectations about future growth prospects’.

    Is it just coincidence that his analysis makes reference to how workers in the upper peak of the labour market are clearly thriving (in contrast to mid and lower paid workers) the day before Janet Yellen states that the extent and continuing increase in inequality in the US ‘greatly concern’ her?
    Central bankers standing up for the peasants, whatever next?

    Whilst I’m delighted by the frankness and detail of Haldane’s speech, I cannot help but feel uneasy that these powerful unelected officials are now edging more overtly into the political realm (witness the Governor’s intervention at the end of the Scottish independence referendum).
    My word, he’s even given the Shadow Chancellor some great sound bites – ‘the sunshine tomorrow Chancellor, who delivers economic agony to the many, whilst the upper peak thrive’!

    • Agreed, what is going on with all this emoting from economists? And the literary language – agony/ecstasy etc, Yellen outrage on behalf of the poor – I’m flummoxed.

    • Hi Gus

      I was about to reply that Andy Haldane was going down a road prepared by the ECB but then I recalled the complaints about some of the interventions made by Mervyn King when he was Governor of the Bank of England.

  7. hello Shaun,

    I think that we”ll see more QE myself , the banks still are not fixed and there’s asbolutley nothing been done to prevent another Bodger Brown moment

    savings rates all time low
    compared to high street borrowing rates ? appaling !
    HMG is still broke , we’re not America

    and China and Germany are receding ……

    And we need growth but all we get id debt growth for current accounts , investing to make a future ? forget it

    And as commodity prices fall because USA has withdrawn the drugs of free QE money and the market is , for once in 5 years , having to use its own ……… well they $hit scared from what I can
    see !

    Because things have NOT got better , we’re really worse off , wages are not increasing because they can’t

    The year long drop in the Baltic Dry is one indicator that all is not well, throw in the likely hood that lower oil prices will harm US shale more than Russia , and that shale has steep decline rates and I can predict we’re in for another super spike in 6 months time…….

    ah interesting times !!!


    • Hi Forbin

      There was a issue that the Bank of England would run out of UK Gilts to buy. For example not buying index-linkers excludes some £260 billion in terms of issue price or £453 billion if you use market price. Also it did not want to buy too much of particular bonds. However as you hint at our continuing fiscal deficit problems means that there is a fresh supply not only have been provided but on its way.

      Mind you there is a clear theoretical issue as at these yields what exactly do they expect to gain? After all it did not work buying at higher yields….

  8. Shaun! This is excellent news! One of the mouth pieces of an organisation with one of the worst forecasting track records feels gloomy about the future!

    Commodoties have fallen a long way and the $ is currently acting like gold. We are heading to a surge next year tempered by the $’s value, although my model predicted flatline/slight recession next year but Andy Haldane’s feelings about the future confirms it and I am not being sarcastic, I amc ompletekly serious.

    • Hi Noo2

      Very droll,very droll! 🙂 Actually I think Andy Haldane is a bit split down the middle and I wonder exactly what sort of forecasts we might get in the next Quarterly Inflation Report. So in a way it is simply more honest as in they do not know.

      If you had a punt/investment the other day as you suggested then I hope it worked out. Any sign of an equity market dip soon gets the central banking cavalry out these days doesn’t it?

      • Actually I’m very slow – I’ms till thinking about it and only make3 or 4 moves a year..

        I dont trade but invest with a 2 – 5 year outlook. Whilst I share some of your thoughts on the general downward trajectory and the reprehensible increase in inequality, it is not lost on me that the CB’s with the encouragement of the IMF always have one eye on the markets and over the medium term will always look after the markets. So I stay invested come what may happily gaming the CB’s and buying on the dips – I think it has further to fall yet – around 6000 for the ftse 100 and maybe less but I think 6000 would be my trigger with a minimum 1 year outlook.

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