So, I should start this post with an introduction. Sorry I haven’t posted since the election (Wow three months). Life has been rather hectic as I am living it up in the big city. I have just started to finally get into the routine which I certainly want to involve continuing this blog. This week was a big week in the economy with lots of announcements. As usual, I will explain the basics then consider it in a bit more depth.
There were two big releases with inflation and unemployment data. These were in the lead up to Thursday’s big Bank of England interest rate decision, meaning what could be announced in these could have a bigger impact.
Read this piece as a story, see the deeper picture and try and link it all together, then one day you will be a master of the economy.
For some previous info about interest rates please see: Why have we just lowered the interest rates?
Inflation in the nation:
How best can one describe inflation? The common example is the frog shaped chocolate bar most know as a freddo. It cost 10p in 2007. It costs 25p now. In fact, when future generations read this blog (As this article will be seen as the beginning on the end for man), they will question how a Freddo is less than £5. This rise in prices is known as inflation. We don’t like inflation very much because it makes things expensive, we have to work harder to find cheaper goods and if our salary isn’t increasing we will be worse off.
The bank of England have a goal of 2% as some inflation is good as it encourages people to spend more and is usually a sign of economic growth (As more demand means higher prices).
The CPI figure is 2.9%. So above the target and an increase from last months 2.6%. As a result, people started thinking that interest rates would go up.
Interest rates are the cost of borrowing and lending. An increased interest rate means that the cost of borrowing goes up as does the reward from saving. As a result of both of these, there should be less investment (as firms wait until its cheaper to borrow), meaning less goods produced and less jobs.
Less investment means that less people have jobs (and wages stagnate) and demand slows in the economy. Consequently, inflation should fall as prices go down (Basic supply and demand). Therefore, the logic was that higher inflation could lead to a decision to raise interest rates as we look to get inflation back down to 2%.
Of course, we will get to the interest rate decision later in the article, however, firstly we need to discuss employment.
On the job bob
Unemployment fell to 4.3%, its lowest level since 1975. To put things into context, when unemployment was last this low:
- Harold Wilson was Prime Minister
- Average wages were half of what they are today (Inflation Adjusted)
- Queen were at number one with Bohemian Rhapsody
- West Ham were holders of the FA Cup
- The first season of Fawlty Towers aired
- The next year, Save All Your Kisses For Me won the Eurovision song contest
A record low unemployment looks like something to celebrate. It suggests that lots of people have jobs and is below zero unemployment (Essentially the gold standard).
However, its not all good news. UK average earnings (Excluding bonuses) only went up by 2.1% (On the year). While this may seem reasonable, it is less than the rate of inflation meaning that workers are, in real terms, becoming less well off. The reason for stagnant wages is that there is little confidence from employees and consumers with Brexit coming about. Lots of jobs being created are low skilled or low hours.
With consumer confidence appearing shaky, this meant that the decision on whether to keep interest rates as they are or to raise them became much more clearer as a more fragile economy may not be able to handle the shock of higher interest rates and the effects which were stated earlier.
The big decision
So, here we are… on the Thursday… Mark Carney and the Monetary Policy committee make their decision about whether to raise interest rates. The end result is rather anti-climatic as the MPC votes 7-2 to keep interest rates low (As has been the case in previous months).
However, the pound rises… This is rather odd. The usual logic is that if interest rates rise, then the reward from investing rises. Therefore, there is more demand for pounds and basic supply and demand means that pounds cost more, thus a rising pound.
But if interest rates stayed the same, then why did the value of the pound rise? Well, Mark Carney, in his comments, stated that if inflation carries on and the economy keeps growing, we would have to think about raising rates. This is rather hawkish for Carney, however a clever rouse.
Carney knows that a good chunk of inflation is as a result of weaker sterling pushing up the price of imports, therefore if the pound strengthens then inflation would lower. Ergo, by giving this speech, he is giving the economy a hand and not having to raise interest rates, so keeping growth up and lowering inflation. A win win.
Hold on Joe; Why are the markets falling for this?
Well, reader, the markets are stupid and over-reactive.
While writing this piece, it felt near impossible to structure as everything is so linked. So, instead of putting together separate parts, as was my original intention , this has amalgamated into a story. Inflation, unemployment, interest rates and the currency are all linked and seeing those links is what makes the life of an economist difficult. Carney and co all have difficult decisions to make with this and more all in consideration. This article was a tough read for beginners and probably needs a couple of reads to understand, but the main idea I hope you understand is that of how everything is all linked and there is more to see than just individual headline numbers.