The high priesthood of sterling

Bank of England Image copyright Reuters
Image caption The Bank is now officially watching the level of unemployment

While watching the Bank of England at a distance today, I was struck how much it resembles the temple of a religious cult.

It's not just the neo-classical architecture. Today, we got the priesthood seeking to discern the wishes of one of its most revered deities, the interest rate.

While they continue to make sacrifices at the altar of the inflation rate goddess, a new dimension has now been added. It's offering up the level of unemployment in the hope that this appeases the deity, without the sterling god unleashing the destructive wrath of his inflationary companion.

This is under the spiritual guidance of a new high priest, one Mark Carney, recruited from a similar cult in Canada.

And he's talking about a new theology, taking us to a higher economic plane. If we have faith and show confidence in our spending habits, we can achieve "escape velocity".

Blunt instrument

The point is not to disparage those who control monetary policy. It is more that they wield great power, which for most of us is masked behind an incomprehensible language.

Mighty brains are applied to the data available. And yet what they do in monetary policy is wield remarkably few, very blunt instruments. In the case of interest rates, it's a lever which has ceased to work.

In current circumstances, all this is largely done blind, because the economy has never been anywhere like this before.

The thinking behind "forward guidance" on interest rates is to give a bit more certainty to help businesses and individuals have more confidence that they can bank on interest charges remaining low for perhaps three more years at least.

There's a big proviso. Interest rates will only stay low if inflation doesn't take off. If it does, interest rates could rise.

Will inflation take off? We don't know. It's been stubbornly higher than target, and that's while British workers have been in a weak position to do anything other than accept years of falling real pay.

So decide for yourself how reassured you are by this heavily conditional forward guidance.

Savers stuffed

While most in business and across Westminster's political divide are pleased to get this novelty in monetary police, and hope it underpins that rare commodity of confidence, not everyone is enthused.

Image copyright Getty Images
Image caption UK car sales are beginning to accelerate

The Institute of Economic Affairs is a conservatively-minded think tank that argues it's dangerous for the Bank of England to target a threshold level of unemployment. It points out that the target can be skewed by many other factors.

And savers, who tend to be one of the more numerous but less vocal economic lobbies, will simply have to lump the prospect of three more years when negative real interest rates continue to erode their earnings.

Over the course of this extraordinary period of monetary dysfunction, one calculation is that they could have lost more than 20% of the value of savings.

Picking up pace

This is against the backdrop of some unusually strong indications that things are beginning to pick up. Both services and manufacturing have produced robust figures this week. British retail, car sales and the housing market are showing a bit of pace.

It's hard to remember so much positive news in one week, and of such unexpected vigour. So the Bank of England has joined those putting up forecasts for growth.

The catch is that the best explanation for this is that household (or individuals') spending has picked up.

That's good, right? It's what we've all been awaiting, particularly in the beleaguered retail sector?

Well, it would be good if only British households weren't still sitting on debts equivalent to around 140% of income, and the pain of that is masked by these very low interest rates.

Cheap loans

There have been some efforts to pay off household debt, but as trade unions were pointing out today, many other people are paying the bills by dipping into savings.

The UK government is keen to get people borrowing to buy homes, with special stimulus measures for shared equity and cheap loans funnelled through banks.

But household-fuelled growth is not sustainable for the whole economy unless there are other sources of demand to fuel growth, such as business investment or export growth.

Businesses continue to sit on colossal cash balances because they don't want to invest yet. And if you look at the state of the economy outside Britain, even including emerging markets, there is good reason for doubt that exports are going to drive much growth, least of all if growing British confidence sucks in increased imports.

If all we're doing is getting to "escape velocity" by adding to that stock of household debt, we run the risk of returning to more of the same risks run last decade, but without much of the debt damage having been repaired.

Escape velocity

There are other aspects of this latest departure in monetary policy, or theology, which should be of interest in the parts of Britain further flung from Threadneedle Street in the City of London.

Image copyright PA
Image caption London and south-east England could be first to achieve "escape velocity"

One is that, with the Bank of England now targeting a fall in unemployment from its current 7.8% to 7% of the labour force before interest rates rise, it only emphasises the bluntness of the instrument it's wielding.

Unlike the inflation rate, which was previously its sole target in order to control the interest rate, unemployment can be seen to vary widely in different parts of Britain.

So the Bank of England has created for itself an explicit recognition that monetary policy may suit some parts of Britain much better than others.

Around half of new jobs are being created in London and south-east England. That region could produce the thrust to achieve escape velocity, pulling unemployment below the threshold so that interest rates begin to return to normality.

Those parts of Britain that are not sharing in that success story, and whose businesses and households are not ready for higher interest rates, will just have to put up with it.

It has ever been thus, but now it will be explicit.

Dual controls

And that leads to the question of how you resolve different perspectives on monetary policy between the Bank of England in London, and an independent Scottish government in Edinburgh.

If that follows from next year's referendum, as the SNP government plans for it to do, you could imagine them agreeing that a 2% target for inflation is a good, shared objective.

But who sets the unemployment threshold?

Is it reached only when Scotland, the rest of the UK, or the average, has reached that target?

And what happens if those wielding the twin controls - the high monetary priests of London and Edinburgh - fail to agree?

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