Amid the panic last week, traders are clinging to one silver lining.
At least, they think, the Bank of England won’t raise the base interest rate to 6% this month. Not now.
And it’s true, that with all the upheaval in the global credit markets finally making its presence felt in equities, the Bank is likely to feel extremely reluctant to pile on the pressure while the City is feeling so wobbly.
That doesn’t mean that it shouldn’t though…
Most commentators are now expecting the Bank of England to hold interest rates this week. And it seems likely that it would take a lot more courage of conviction than the Monetary Policy Committee is currently demonstrating to actually hike interest rates this week.
But if the Bank does hold rates, it’ll be a mistake. There’s been a lot of vague talk of consumers and house prices showing signs of slowing down, but the reality is that most of this talk comes from companies and estate agents warning that people might slow down in the future.
Retailers and property pundits aren’t daft - they know how to spin their results and their surveys at a time like this. Put on a glum face, make comments about ‘rates starting to bite’, let the newspapers do the rest, and suddenly you have a mild climate of fear.
But it‘s important to remember that if we are slowing down, we’re right at the start of it. John Lewis, for example, came out with an extremely strong set of results last week. If there’s a consumer slowdown burgeoning, the department store chain hasn’t noticed.
As for house prices, inflation still remains strong - with annual house price growth still in the high-single digits, according to most surveys. And lenders are still finding new ways to get people to take out bigger loans - the latest wheeze, judging from the amount of coverage its got in the papers recently - is to take out a foreign currency mortgage.
Nobody mentions that this is probably the single most toxic form of the carry trade there is - borrowing money in a foreign currency to pay for your home. Fine, you get a lower interest rate - but that’s not much use to you if the euro suddenly strengthens sharply against the pound. Even your average hedge fund manager would think twice before betting his home on his ability to read the forex markets. Yet the personal finance sections of most newspapers will happily include this as a way to pay for what is the most important asset in most people’s lives.
Anyway - back to the Bank. The point is, most commentators are expecting another rise to 6% this year - and if the current market turmoil hadn’t erupted, there’d be a lot more people looking for it to happen this Thursday.
So it’s not as if a further hike would astound the markets. It would just drive home the fact that the Bank of England isn’t going to allow a few days of extra volatility- which after all, as US Treasury Secretary Hank Paulson said last week, “we are always going to have” - derail its attempts to bring inflation under control.
And that’s the important point - inflation isn’t going away. Oil prices remain higher than anyone really expected them to be at this time last year. And meanwhile, food price inflation is becoming a real theme. We’ve been talking about it for a long time now – the last time was back in May, when we suggested how you could profit from rising prices (to read the story, click here: Harvesting profits (http://www.moneyweek.com/file/29493/how-to-profit-from-rising-food-prices.html).
But now we’re not the only ones talking about it. Investing in soft commodities has hit the front pages of at least two investment magazines in the past fortnight, while historian Niall Ferguson warned in this week’s Sunday Telegraph that he’s more concerned about peak grain, than peak oil (if you didn’t read the piece, it’s well worth five minutes of your time (http://www.telegraph.co.uk/opinion/main.jhtml?xml=/opinion/2007/07/29/do2901.xml).
So while the credit markets may be collapsing, input costs are set to keep on rising. Those costs have to go somewhere – and shop price inflation is the most likely destination. So while the Bank may well pay more attention to the market’s current spasms when it meets on Wednesday and Thursday, it would be better for us all if it focused on its long-term game of catching up with and squashing inflation before it becomes any more entrenched
Source-Money Morning