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Sensemaker: Interest and inflation

Sensemaker: Interest and inflation

Thursday 28 October 2021

What just happened

Long stories short

  • The European Court of Justice fined Poland €1 million a day for ignoring a ruling that the country must stop undermining the independence of its judiciary.
  • Iran blamed a cyberattack that disabled its petrol distribution network on a foreign “state actor”.
  • Luxembourg’s prime minister, Xavier Bettel, plagiarised all but two pages in his 56-page university thesis.

Interest and inflation

The most important part of the UK’s second budget this year was in Annex D. It contained new modelling that found the effects of the pandemic weren’t as bad as thought even a few months ago. The Office for Budget Responsibility’s expectation of growth in 2021 went from 4 to 6.5 per cent – the fastest in 50 years.

This gives Rishi Sunak £35 billion extra to spend each year for the rest of the parliament. And spend he will: £2.2 billion for the courts and £6 billion for the NHS to help clear their backlogs, £1.7 billion to help disadvantaged localities level up, £150 billion for government departments – a rare 3.5 per cent real terms boost. But fiscal spending at this level can drive up prices, and they’re already high.

By the numbers:

  • 4.4 per cent – the OBR’s inflation forecast for next year, up from 3.2 now and double the Bank of England’s 2 per cent target. The last time inflation ran at that level was when energy prices spiked in 2011.
  • 0.15 percentage points – size of expected rate rise next month, with big knock-on effects for mortgage-holders. This would add £33 a month to monthly payments of £2,345 on a £450,000 tracker, or £10,000 over an average mortgage term. The increase would be £21 a month for a £300,000 mortgage and £15 for £200,000. Fixed rate mortgage-holders will be protected for the duration of their term but will face pricier mortgages after that. 
  • £52 billion – estimated increase in government debt service costs given a 0.15 percentage point rate rise. The bill would be equivalent to 0.1 per cent of GDP. Sunak appears ready to wear this thanks to the optimistic new growth forecast, and his letter yesterday to the Bank of England reaffirming its remit to achieve low and stable inflation was a signal signal to the bank’s governor that he believes the economy – and government – can now sustain a rate rise. That’s what financial markets expect (see graph below).

The Bank’s next decision on the interest rate is due on 4 November. Huw Pill, the Bank’s chief economist, said the decision will be “finely balanced”. Here are some of the things he’ll be weighing up in addition to mortgage and public debt service costs:

  • Quantitative easing – the Bank’s buying of bonds to lower rates on savings and loans – is still running after being ramped up during the pandemic. Pill has suggested this programme will gradually and predictably fade. “If you want excitement,” he said, “you should be looking at rates.”
  • A higher rate will be good for savers who for a decade have had to contend with exceptionally low returns on their money. In fact, the current combination of a low rate and Sunak’s big spending plans may prove unpalatable to the Conservatives’ own support base. One interpretation is that the chancellor’s trying to have his cake and eat it: spending ahead of an election, and getting someone else to worry about rates.

Should Sunak be more worried? Andrew Bailey, the Bank’s governor, has so far been relaxed about inflation because he saw the supply constraints behind it as transient and the economy as still weak.

But there’s a lot of mortgage debt and defaults are becoming more common. Mortgages may seem more affordable because wages are growing fast, but so far wages are only growing in line with inflation, meaning there’s little to no real income growth. Many economists expect households will be significantly worse off over the next year.

And the public debt burden is high by post-war standards.

It all comes back to those OBR forecasts in Annex D of the budget. A closer look reveals the OBR stopped feeding in data on 24 September. New data has been released and old data has been revised since then. The economy is actually 0.8 per cent below its pre-pandemic level – not the 2.8 per cent level the OBR used, and which forms the basis of its forecasts of faster growth. Such is the power of OBR forecasts – and the risk.

“What the OBR giveth,” the Institute of Fiscal Studies’ Paul Johnson said, “the OBR is perfectly capable of taking away at the next fiscal event.”

Belonging identity, society, beliefs, countries

Italy anti-homophobic violence bill
Italy’s senate voted down – 154 to 131 – a bill that would have made misogyny and violence against LGBT and disabled people a hate crime, with prison sentences of up to four years. Far-right parties argued that the bill would have suppressed freedom of expression and promoted “homosexual propaganda” in schools. “They wanted to stop the future,” former prime minister and current Democratic Party leader Enrico Letta said. “They wanted to bring Italy back in history.” It seems they managed.

New things technology, science, engineering

A banner year for big tech’s earnings – again. The latest quarterly earnings reports are even better than financial markets expected. Microsoft and Google’s combined revenue was $110.4 billion, a growth of 33 per cent on last year’s third quarter. Apple and Amazon will report their earnings today, but are expected to see similar growth. It’s easy to forget these companies are already gigantic. “I don’t know how much better it can get from Microsoft,” Brent Thill, an analyst with the investment bank Jefferies, told the Financial Times. “To grow at that rate, at their size, is insane. I have no other way to put it.”

The 100-year life health, education, living, public poliCY

Jabs, kids
Advisory boards to the US Food and Drug Administration and the Centers for Disease Control and Prevention decided that Pfizer’s Covid vaccine is safe enough for use on children between five and 11 years old. Public bodies are expected to follow the boards’ advice, meaning some 15 million doses will be distributed for this end. The decision is significant in that a large share of new infections come from unvaccinated children returning to school.

Our planet environment, natural resources, geopolitics

Big oil in DC
Leaders from Exxon, Chevron, BP America and Shell are all in Washington DC today, but not to see the monuments. They’re testifying before the US Congress on the fossil fuel industry’s denial of its role in the climate crisis. Cop26, now just three days away, is focused on the future but there’s a role too in addressing the past. The environment subcommittee issued a press release ahead of the hearing, claiming the industry has had scientific evidence about climate change since 1977 but for decades “spread denial and doubt about the harm of its products”. The subcommittee wants the oil giants, in effect, to come clean.

Wealth investment, fairness, prosperity

Billionaire tax
Senate Democrats planned a tax on 700 billionaires. It was a good idea – it would have targeted their shareholdings – but it collapsed. Moderate Democrats didn’t like it. They said it was right to make sure the wealthiest Americans pay their fair share, but wrong to target one asset class over another. That, in fact, was the point: many billionaires’ draw their income from shares – taking lines of credit against holdings – thereby getting around income taxes.

Thanks for reading, and do share this around.

Paul Caruana Galizia

Produced and edited by Xavier Greenwood.

Photographs Getty Images