Tuesday, 26 January 2010

Artificial Recovery?

Lots of people today have blogged that the 'growth' we're now seeing in the economy is in fact only caused by the £378Bn or so of additional spending that has been forced into the economy (QE and Deficit spending). No doubt they're right but I'm looking at the factor that is artificially keeping large parts of the economy afloat.

The graph above shows both RPI (a measure of inflation which includes things like mortgages and oil) and the Bank of England Base Interest Rate. As you can see, over the past few years they've tracked each other pretty closely.

Actually, Interest rates have tracked Inflation rates as the BoE Monetary Policy Committee (MPC) tries to keep Inflation within various bounds, but basically it's pretty clear that they're connected.

As you can see, inflation fell massively recently. As a result, so did interest rates.

However, inflation is now back up again (RPI was at 2.6% in December, the February figure is an estimate assuming that growth rate continues). When RPI was last around 2.6% (back in late 2005) the BoE Base Rate was around 4.5%. Now, it's 0.5%.

Of course, the MPC wants to keep interest rates low, as this ensures that the banks are able to build healthy profits.

Sorry, you thought it was to ensure that people weren't suddenly priced out of their homes? That might be true if the retail banks were passing on the unprecedentedly low interest rates to their consumers, but the typical mortgage is somewhat higher. Nationwide, one of the "nice" mortgage providers out there is quoting 5.74% fixed for only two years for a piddling £200,000 mortgage with an 83% LTV. That's over 11 times the current BoE base-rate.

By holding the 'cost' for banks to borrow money artificially low, the banks can make some seriously healthy product margins. As borrowing is generally cheap, consumer and corporate spending should increase and the economy should head back to growth.

It actually appears to have nearly worked as well. Technically the economy is back in growth by 0.4% (annualised). The problem is that inflation is running at 2.6%, meaning despite this, we're actually in the hole by over 2%.

Inflation is likely to continue to rise. Not least because in January we'll have the 2.1% increase due to VAT rising. Oil prices are hardly stable and with the US (and in fact every country aside from us) getting back on their feet, we'll no doubt see another rise.

Sooner or later the BoE is going to have to raise the Interest Rate. Will that cripple the economy? Probably. It'll certainly fuck the housing market over.

It looks good for Labour. They get to leave office with the country in 'growth' thanks to their artificial boosts and then watch the economy fall into another hole just as the Tories get in.

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