What if economics doesn’t work?
Forgive another briefing on interest rates. However, as part of our offering as your eyes and ears on the FX market, it’s important we bring you coverage on those topics dominating market discourse. Unfortunately, those not too fond of monetary policy and economics might find the market’s latest fixation on interest rates somewhat tiresome. At least it’s not Brexit every day, eh? I want to talk about a different side of the interest rate discourse taking place in the market. So often due to monetary policy’s centricity to the inflation and wider economic debate, adjustments to interest rates are taken as an axiom: that inexcusable and unavoidable antidote to inflation. But.. what if it isn’t?
As we wrote yesterday, the market is divided on what the Bank of England could, should, might, would, or will do this week. There’s greater reason for that than a variety of diagnoses of the UK economy. As we exposed yesterday, much of the pricing and expectations for this week’s publication revolve around how former raises in rates at the central bank level are feeding back into the real economy. At best, economic theory isn’t working as it ought to in this post pandemic environment. At worst, it’s being obstructed by consumer and business access to markets.
There are two possible outcomes to monetary policy adjustment: to make money more expensive, or to make money cheaper. When money gets more expensive think of higher borrowing costs and higher savings rates. Being opposites, a higher opportunity cost to not saving brings down demand in the economy by dragging money out of the system and into longer term deposits. Higher borrowing costs have the same effect to net debtors: reduce consumer appetite for borrowing and unnecessary consumption and investment. However, the problem with centralised monetary policy could be that we do not directly borrow or lend to the rate setting body, the BoE.
In a recent publication the FCA announced that just 28% of rate increases at the central bank in the UK have been passed onto savers via interest rates in deposits held. Those most parsimonious banks will have until August to justify why they have not passed on central bank savings to consumers. However, this is likely too little too late. If retail banks are standing between central bank adjustments and consumers who underly the economy, then the path ahead for the BoE’s hiking cycle could be more tumultuous and elongated. To truly appreciate the path GBP and UK rates might take we must also account for the limitations of the BoE to reach the underlying economy within the present financial infrastructure.
Discussion and Analysis by Charles Porter
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