PORTFOLIO HOLDER’S REPORT: FINANCE February 2011 

From Ben Sharp, HSBC, Director Kent Invicta Chamber of Commerce.

Small British businesses balked at news from the Bank of England MPC minutes that three of its nine policymakers wanted to raise interest rates earlier this month.

BCC wasted no time in calling publicly for the bank to hold-off rate-rises that it said could put the U.K. back into recession.

Two Monetary Policy Committee members voted for a 0.25 percentage-point rise in February, and renowned hawk, Andrew Sentance went even further, calling for a more aggressive 0.50 point hike. External member of the MPC, Adam Posen, has argued that the bank must not allow the public’s fears about inflation to push it into increasing interest rates. Mr Posen suggested that many of his colleagues were wrong to be concerned about expectations of rising prices creating a “self-fulfilling spiral”. The comments are evidence of the deep divisions within the MPC. Companies, especially smaller ones, are worried that a rise in borrowing costs could make it even harder to secure lending from banks, as well as choke off the consumer spending they need to survive.  George Osborne reached a deal with the biggest banks this month to boost lending to businesses, but there are no guarantees it will work. In the meantime, small firms told BOE agents in January they had a “strong perception” that credit isn’t available.

The government itself desperately needs businesses to take up the slack from the public sector, which it is cutting back as part of a £111 billion austerity program.

Whether the MPC pays heed to businesses’ cries for help is another matter. Its only remit is to return annual consumer price inflation to the 2% target in the medium term (normally two years, but it can use discretion over the time frame). The measure of this challenge is reflected in an increase to CPI from 3.7% in December 2010 to 4% in January 2011 and during the same period, an increase in RPI from 4.8% to 5.1%. 

But the minutes do show some committee members are on the same page as businesses. The six MPC members who voted to keep rates on hold saw merit in waiting for growth figures from early 2011 before raising rates, to make sure the economy could withstand it.

Raising interest rates in the short term for those more concerned about growth and jobs would claim that it would reinforce the MPC’s reputation for being “inflation obsessives”, out of touch with the real economy. The evidence for rebalancing activity is still patchy and exporters would not welcome the boost to sterling that a rise would likely cause. The spare capacity across the country implies a lack of corporate pricing power and a continuing squeeze on costs and margins. Most compelling is the absence of medium-term inflationary pressures in the form of resurgent earnings growth, sparking the UK’s traditional wage-price spiral. The faster growth of inflation over earnings growth is having the same deflationary effect as pushing up interest rates.

The shock contraction of GDP in Q4 2010 came as a stark reminder of the fragility surrounding the UK’s economic recovery. The truth behind the weak GDP figures may take some time to fully evaluate as additional data becomes available. During the first decade of the MPC’s existence, its forecasts tended to be too cautious on GDP growth, but relatively accurate on inflation. But the recession has changed this, as inflation has consistently proved higher and activity weaker than expected. The current central bank view is that inflation is a result of three factors largely outside the MPC’s control (sterling depreciation, higher commodity prices, and rising taxation) and so raising interest rates will do more to slow growth than ease prices pressure. 

 The number of mortgages approved for home purchases was broadly flat over January, indicating continued weakness in the housing market. Just 29,000 mortgages were approved by the High Street banks in January, slightly ahead of the two year low from the previous month.    

Most analysts still expect unemployment to rise in the coming months, largely because of public sector spending cuts implemented by the government, which are designed to bring down the UK’s budget deficit. Economists suggest the economy would have to grow at an annual rate of about 2% for unemployment to fall. Few currently believe this will be achieved.