George Osborne has a lot riding on the Bank of England getting it right. The chancellor would never dream of telling Sir Mervyn King and the other eight members of the monetary policy committee what to do but the government’s economic strategy is a variation on the good cop, bad cop routine. Osborne is bad cop, piling on the austerity; King is good cop, keeping interest rates low and cranking up the electronic printing press from time to time.
Thus far, the one small problem with the chancellor’s growth strategy is the complete absence of growth.
It might, therefore, have come as an unwelcome surprise to Osborne when Threadneedle Street followed the example of the European Central Bank in Frankfurt and adopted a suck-it-and-see approach. Threadneedle Street resisted pressure from the IMF to add to its £325bn QE programme and cut Bank rate from its record low level of 0.5%, perhaps as a hint that Christine Lagarde, right, should mind her own business.
Within hours, Fitch popped up with a warning that it would expect to strip the UK of its AAA status if there was a material downturn in the economy. That really would be a political nightmare for the chancellor, who is probably wishing the MPC was as quick on the trigger as the People’s Bank of China, which eased policy in an attempt to boost growth. This for an economy that is still expected to expand by 8%. The UK will be lucky to grow at all.
The assumption in the City is that the MPC’s decision was a close call, which it probably was given the fact that Britain is in a double-dip recession, the manufacturing sector is nosediving and the euro is on the brink of meltdown. There are a number of reasons, however, why the MPC has decided to risk falling behind the curve, as it did when the economy seriously ran into trouble in 2008. The first argument – that monetary policy has ceased to be effective – can be dismissed. There are economists who believe that QE is subject to the law of diminishing returns but the Bank is not in this camp.
The second reason might be lingering concern over inflation, which, at 3%, is high for a country where output is around 14% below where it would have been had the economy continued to grow at its long-term trend of 2.5% since the Great Recession began. But the fall in oil prices is feeding through into cheaper petrol, and when last year’s increases in domestic energy prices cease to have an effect on the cost of living over the next few months, the inflation rate will fall.