Mindsets are switching. Just a few months ago it seemed generally the consensus that UK interest rates should, and will be raised in the not too distant future, but recent events in Europe and the emerging markets seem to have scared many into switching tac completely. Many now are pushing for the lowering of interest rates, in the expectation of an economic downturn.
There is certainly a compelling case for lowering interest rates. Emerging markets are faltering, the strong growth we are so accustomed to has begun to slow, added to the markets that are about as predictable as a UK election, it certainly seems like the far east Tiger is wounded. This is bound to have a knock on effect on UK which not only relies on this part of the world cheap imports and some exports. More importantly however, is the effect on global economic confidence as these emerging markets falter as confidence falters it seems only likely the UK economy will also slump. Greece’s recent misadventure will only serve to further knock confidence. The UK is also slowing up domestically; strong growth in early 2014 appears to have slowed, just 0.5% in Q4 of 2014. Thus, the case is that lowering interest rates will protect against these external and internal threats, ensuring strong economic growth and low inflation for years to come.
Wrong. Lowering interest rates shows a sign of weakness, one only has to look at the disaster under major in which the dramatic reductions in interest rates were taken as sign of weakness causing to economic chaos within the UK (you know the story). Lowering interest rates will have a similar effect, and I thoroughly believe in a modern era where financial institutions and the press have such a high degree of impetus into the economic performance, keeping confidence high is vital.
Furthermore interest rates are currently very low, and thus if they are lowered, the UK is left vulnerable if, and when a downturn does come about. Interest rates at their current levels could not possibly be lowered enough to protect against any sort of mildly global financial downturn and if they are lowered now, the UK will lack any sort of effective policy instrument to pull them out if a slump does arise. If interest rates are at rock bottom what can more can be done that is at all effective? More QE? Great..
We must also realise the UK economy’s slow down is not all its cracked up to be. Unemployment is still falling and the UK has its highest rate of employment since the in nearly half a century at 73.3%. Also, inflation is on the whole low and not a massive cause for concern (praise the Lord for low oil prices) alas with oil prices having such great effect on inflation, we can never truly feel secure until we start reducing our reliance on the thing. This is certainly not the time to panic and start slashing interest rates. Even when an economy grows there are bound to be fluctuations within that.
Instead, the MPC would be best going ahead and raising interest rates, slowly of course, which a resilient UK economy could handle. Now would be an ideal time to start with low inflation that could absorb the interest rates without dramatic effect. Potentially most importantly, it will give a key tool and a low more leverage if the UK does find itself in a bit of a future predicament.