JEREMY PEAT

No doubt I shall have to cover recent developments on the dreaded Brexit front later in this piece, but let me kick off by discussing the dilemma facing the Bank of England’s Monetary Policy Committee (MPC) as its members gear up for another meeting on 2nd November. This time around they will again be forced into a view on whether or not to start hiking interest rates. Even in this inevitably complex and uncomfortable discussion Brexit will feature prominently. There is no escape from its over-arching influence and importance for the UK’s economic and financial outlook.

The dilemma is best stated using the economist’s standard two-handed tool kit. On the one hand, UK growth is sluggish – below the rate of our European peer group. Given that higher interest rates tend to temper growth, it is understandably not standard practice to raise rates while growth remains weak.

Further, the MPC will be cautious about the outlook. Brexit-related risks and associated major uncertainties for business and consumers, suggest that growth could be set to weaken further through the (probably extended) transition stage and thereafter as Brexit eventually bites. These arguments all point to keeping rates at their all-time low for a further significant period.

However, turning to the economist’s other hand, maintaining the current low interest rate regime would underline severe risks. UK inflation is sitting above the Government’s set target at close to 3 per cent. Holding off on an interest rate hike would raise the risk of inflation staying high; possibly going even higher. And we know from past experience that letting the inflation bug out of the bottle is much easier than persuading it back in!

Inflation is not the only risk. The UK is still experiencing relatively strong retail sales, up 1% in real terms in August alone and helping to keep GDP growth is in positive territory. So far so positive; but this retail sales growth is not founded upon rising real incomes and positive expectations. Indeed real incomes are stagnant and consumer confidence is ebbing away. Rather it is funded by some combination of using up past savings and increasing borrowing. UK Finance note that growth in both credit card borrowing and loans and overdrafts has eased of late, but also note that ‘households are saving a bit less each month, rather than borrowing more’.

Despite this change in the balance of the funding of households’ expenditure, consumer debt around the UK remains at an excessive and distinctly dangerous level. An increase in interest rates just might encourage more household savings, but at the same time it could (probably would) cause many of the heavily indebted households’ real problems in servicing debt – credit cards, mortgages, overdrafts and all. Even a small interest rate rise could cause major problems for a significant number of households, especially if this rate rise was seen by the financial markets as the first of several.

Governor Mark Carney has argued in a recent lecture that the more efficient operation of markets, associated with the rising tide of globalisation, has resulted in limited inflation pressures as economies run closer to capacity. This would be another argument for deferring that UK rate rise. However, he has also argued that the UK’s departure from the EU would reduce our degree of globalisation and hence require a higher rate regime in the UK than if we were staying within the EU.

To my mind that last point is not an argument in favour of a rate rise soon. The balance of the argument remains firmly with those who would prefer to see rates kept right where they are, at a record low level, not just for now but right through the first months of 2018 – at least.

Neither the business sector nor households deserve higher interest rates. A rate rise in the near future, especially if flagged up as the first in a series, would further slow economic growth, tend to constrain our already weak level of business investment and cause many households, especially at the lower levels of the income distribution, serious financial problems. Mortgage defaults and the like would reduce consumer confidence and slow retail sales; and provide another downward ratchet on GDP growth and expectations.

Now is not the time to tighten monetary policy. But it is the time – crucially –to map out a way forward for the Brexit negotiations which reduces uncertainties for all sectors of business and re-emphasises the commitment to doing what is best for the UK economy. That implies, as now seems to be recognised, a lengthy transition period rather than some drastic cliff edge leap into the unknown. It implies maintaining the existing trading and investment relationship with the EU for as long as feasible. It also implies allowing free movement of labour across the EU, including the UK. That continuing freedom of access should be not just for the high fliers of great value to our financial service sector but also those of more limited skills; essential elements of our workforce across tourism and leisure, agriculture and large swathes of manufacturing and services.

We should know as early as December whether the Brexit talks are on course for some half reasonable outcome – or not! If the outlook then looks more benign, then maybe during 2018 it will be time to consider taking interest rates upwards – gently and slowly. Now is time for the MPC to be brave and do nothing!

Jeremy Peat is visiting professor at the University of Strathclyde International Public Policy Institute.