The decision by the Bank of England to leave interest rates unchanged has avoided ‘GDP suicide’ according to Jim Leaviss, the head of retail fixed interest at M&G.
Despite the consumer price index (CPI) measured inflation having remained above the 3% level throughout 2010, exceeding the bank 2% target in 46 of the last 55 months, the bank chose not to tighten policy.
Leaviss draws parallels between the current global economic environment and that of 1993/4 in order to argue that rate hikes would perhaps kill core inflation but at the cost of bringing deflation risks back into play.
The recent rise in government bond yields, owing to a combination of sovereign creditworthiness, a decrease in demand for safe haven assets and a rise in inflation expectations has prompted calls for a rise in rates.
A rallying of government bonds in 1993 led the Federal Reserve to hike rates in 1994, leading to a 200bps sell-off in Treasury yields. (article continues below)
Leaviss argues that the concern is regarding employment levels which are far higher today. In 1993, the unemployment rate in America was falling towards 6.5%. Today, it is at over 9%. In Britain it is about 8%.
The concern is that the unemployment rate is just too high and the fall in the participation rate too severe for rate hikes to be considered a viable policy.
Ian Kernohan, an economist at Royal London Asset Management, warns that the fiscal squeeze should intensify in 2011.
Even if mortgage spreads were to take some of the strain of a bank rate increase, Kernohan warns the hit to confidence could be material should households start to think interest rates were returning to pre-crisis levels.