Time for interest rates to be sorted – Alternative Inflation Report

Inflation in the UK is officially supposed to be about 5% and thus is the highest among the developed economies who founded the G7. Despite this our Bank of England ‘Base Rate’ has for nearly 3 years been  0.5 % – one of the very lowest in the developed world and lower than that of  the Eurozone.

But in the real world,  borrowers in the UK are paying some of the highest interest rates in the developed world. We have highlighted this in previous reports and the chart (left) brings together some most recent comparable figures assembled by all Europe’s central banks and contributed to the ECB Data Warehouse.

We have compared the UK figures here with the Eurozone leaders and some of the countries in distress. The rate for savings is based on deposits that are only tied up for three months and the rate for loans is based on loans for house purchase based on a term of  at least 5 years .  So the savings rate is the one that would be appropriate to new and modest savers, and the housing rate is one of the most used in the UK given how much borrowing (even for business) is based on using houses as security.

With savings rates being so unattractive, there is little incentive to keep any savings in the UK. For example UK pensioners in Europe would get a better rate of return in keeping as much of their pensions as possible in accounts on the continent rather than leaving them in their UK £ accounts. Businesses would get an even better return on cash balances on the continent.

Hence the Pound, which has fallen by 20% since the credit crunch, has had no upward pressure on it since the time the very lowest of interest rates has been officially justified. This devaluation has exaggerated price increases in the UK. However, we have argued in earlier reports that devaluation has not and cannot now do much for employment in exporting industries.

Interest rate adjustment for 2012

Hence we now think that the government and the Bank of England should change the way they give guidance to the banks in setting interest rates. The Bank of England should now be recommending a savings rate of about 2% and maybe a lending rate based on 4%. They should discard the fictional rate of 0.5%. This would boost the £, and therefore bear down on inflation. But it would also safeguard domestic purchasing power and give a much needed boost to confidence.

Another variant would perhaps be not to recommend a drop in lending rates, but to suggest that the banks adopt a distress rate of 4% for individuals and sectors in difficulty. The banks could be told to come back with proposals for applying this first in the regions that are experiencing particular difficulties.

In the current crisis the West Midlands, where we are based, has suffered some of the worst increases in unemployment, especially for young people. This is a distress that is not evenly spread across the UK. Scotland for example has even seen unemployment fall in 2011. So the Bank of England could ask that the banks report on the credit situation in the Midlands.  This would be like the scrutiny regularly undertaken by the US Federal Reserve, who publish what is called the Beige Book, consisting of feedback from the local economies across the whole USA. Initiating such open assessments would allow the consideration of  distress arrangements that might be appropriate, as an initial step towards stability and relief in 2012.

Where the money is to be found

It can be seen that the UK banks are adding a stunning mark-up to the money they are lending. This mark-up cannot be justified in the current circumstances. Based on the rates presented in the chart above, the mark-up in the UK is roughly 700%. This is far higher than in any of the other countries in the chart. Their mark-ups on the same calculation would be:

Germany      200%

Greece        200%

France          80%

Ireland          40%

This scale of mark-up has only been occurring during our years of crisis. Back in 2004 the same calculations show a mark-up in the UK of a mere 64%, which was less than any of the other countries in the comparison. German banks were already marking-up 200% and the others averaged out at 135%.

This recent squeezing of their customers, while it must have done a lot for the profits of  UK banks, has done little for shareholder value.  But above all it has been the basis of the continuation of excessive bonuses for executives. The time has come when the revenues coming into the banking sector have to be adjusted to support savings in a UK that still imports other countries’ savings and also needs to relieve a UK  economy that in some parts is heading back into another recession.

So the time has come for the Bank of England to be more insistent upon its guidance, and get the banks to stop putting themselves first. The money is in their margins to allow this to be done. In 2012 we hope to attract more attention to how we would like to see the Bank of England reformed and made more accountable and responsive to the pressures being felt in the various parts of the UK economy.  We also hope to do this while continuing our long-standing work to change the way inflation is measured and controlled in the UK.

Our last report on inflation undermining consumer confidence and growth can be found here.

Andrew Lydon

 

 

Further details of our  Regional Prosperity & Inflation Project

Our mythical low interest rates – Alternative Inflation Report

With inflation now clearly established above the 2% target – in defiance of the hopes of the Bank of England – most commentators are now expecting interest rates to rise in the months to come.

Interest rates paid by UK households are, however, already some of the highest in Europe, despite all the talk of record lows you will hear from the mainstream media. Here are our average mortgage rates compared to the sick men of Europe as well as Germany:

This is despite the UK Base rate being 0.5%, and the Main rate set by the European Central Bank being twice that at 1.0%.

The record lows are what the banks are paying to savers. As can be seen here against the same countries and sourced from the ECB Data Warehouse (to which the Bank of England contributes the UK figures).

Squeezing borrowers and paying so little to savers is the main reason why the banks are currently losing less money and paying out bonuses again. But the consequence is that the wider UK economy is not recovering unlike most of the rest of the world economy. A more up to dates comparison can be found here.

The need to boost the Sterling exchange rate

If more people and businesses with savings brought them into the Sterling economy, the Pound would recover from its prolonged weakness, and this would bolster the purchasing power of everyone in the Sterling economy in buying food and energy in the international markets. This is the way in which increasing interest rates for savers helps to bolster UK living standards and domestic consumption/employment.

To do this while discouraging abrupt increases in outgoings for borrowers, would require the Bank of England and the Treasury to urgently revise how the Bank of England ‘Base Rate’ is used as guidance. And this is a revision that is now well overdue.

Some might object that the sagging value of the Pound holds down our export prices. Twenty years ago when David Cameron was a Treasury special advisor, manufacturing accounted for about 25% of UK employment. And devaluation did launch the employment boom after the Pound fell out of the European Exchange Rate Mechanism in 1992.  But now manufacturing is just under 10% of employment, even in an old heartland like Birmingham. So gains or losses in manufacturing employment would need to be two and a half times as large to have an effect with any similarity to what happened while David Cameron was working for Chancellor Lamont .

So any monetary policy other than safeguarding domestic living standards makes less sense than ever before. Especially as the sort of inward investment in manufacturing that we saw after 1992 from the silicon chip industry, Toyota and even BMW is not happening now.

Getting inflation in proportion

Other major G7 countries are managing inflation better than we are. They measure it better. They measure it as it impacts upon different parts of their countries and social structure – something we want to see done here in the UK and are currently pressing for. This has allowed inflation to be long-term suppressed by more painstakingly proportionate decisions.

The USA gives out the most comprehensive set of inflation figures every month. This month the CPI-U, representing the broad urban population, is  2.1% .  But it also gives a CPI-W figure for ‘urban wage earners and clerical workers’ which this month is  2.3 %. But they don’t just give a national figure for each of these populations. They also give a CPI-U figure and a CPI-W figure for most of their big cities and the US census regions.

This has made the USA very sensitive to emerging inflation and has prompted the USA to be one of the world’s lowest inflation economies.  A worker in Chicago and the Mid-West knows whether his prices are rising in line with the official figures for his area, in a way that someone working in Birmingham, England cannot because we only get a couple of different national disembodied averages for our official figures. So if the US figures are out of proportion with what workers are finding in the American cities the figures can be challenged in a way they cannot be in the UK.

Although the monthly figures can vary quite a bit across the US, in the longer run their system keeps them in line. On the basis of the index running since the early 1980s, price rises for Chicago have been less than for the US as a whole.  But only by a couple of per cent over what is now a whole generation (USA average currently at 221 and Chicago at 216). Prices for the workers have risen less than for the broader population – 218 for the US and 210 for Chicago workers, despite the current monthly figure being higher.

France also has an index that is intended to represent the total population as well as one that represents what is called an urban household  headed by a worker. It is particularly used for adjusting the minimum wage. For France  inflation was   1.7 %  for the main population in February and 1.6 % for the worker’s household. Until the 1960s France used to only calculate an inflation rate for Paris and say that that was the French inflation rate. But they continued to maintain a Paris index until about the time the Euro was launched.

The French have been able to keep inflation for these worker households in step with that of the overall population. Below you will see the figures showing how prices have shifted in the first years of the Euro before any of the dramas of recent years intrude into the story. In the table below 100 = 1998.

The figures are very much in step, as were the US figures because a more sensitive approach to tackling inflation tends to follow from such detailed indexing.

The Italian indices for registering inflation are today pretty much identical to the French system. In February the inflation rate for the broadest population was  2.4 %, and 2.3 % for workers’ families. Unfortunately the Italians no longer translate their full monthly release. It can be deciphered with only a basic French/Italian at the link here.

Table 4 of the Italian monthly release gives inflation rates for most of Italy’s big cities. This is most probably because inflation indices were first started by the big industrial cities like Milan, and led by Milan. It was Mussolini who brought in the national index, almost certainly because it would justify lower pay settlements for workers in the industrial cities than the local city inflation rate would justify.

So a basic local figure has since acted as a double check on the system – as it does in the USA. Milan is Birmingham’s twin city and inflation there is slightly less than the Italian national norm being currently registered as  2.3  %.

German inflation for February is 2.1%. Germany now only does one figure for the broad population of Germany. But most of the large federal states have produced a figure for their own local population since the 1960s. The State of Hesse, which is home to Birmingham’s twin city of Frankfurt, has an inflation rate which is slightly lower at 1.8%. We also have a twin city in the former East Germany which is Leipzig in the state of Saxony. The Saxon inflation rate is currently higher at 2.2%

However, Germans have lost trust in German price statistics since Germany went into the Euro in 1999. This is because the German government abandoned its more extensive range of monthly inflation indices. Former West Germany had produced price indices based on four household types across Germany. They were as follows:

The old West Germany ran such sub-headings since the 1960s when the managerial household was added to complete this set. When the West took over East Germany in 1990 they began to run a parallel set of sub-indices for there. By 1999 when these sub-indices were abolished along with the D-Mark, they were holding the inflation rates for all these households remarkably in step in both the former East and West Germany. Based on 1995 being 100, the family households in both East and West were at 105 on the index, and the ‘All household’ indices and the pensioner households were on 106.

Germany abandoned these baskets when they entered the Euro. They said this was because there were not enough four-member families to justify it. But had they assembled a more contemporary basket for families they might have maintained the confidence that there had been in the old system.

From what has been shown here of how other G7 countries register inflation, you will be able to appreciate the basis of what we are proposing should become our framework of inflation indices.

Our report for last month, which outlined how the global price spiral had to become the focus of our domestic economic policy, can be found here.

Andrew Lydon

Regional Prosperity & Inflation Project