The scale of the interest rate hikes has not yet been fully felt, so optimism may be short lived.
The British economy seems to have escaped a bullet.
is not in a recession despite a massive energy price spike last winter, and the painful effects from a series of sharp interest rate increases.
The employment situation is stable. The pay rises outpace the price increases. Inflation has dropped sharply.
It is the same elsewhere in the West. The US economy appears invincible when it comes to rising borrowing costs.
Goldman Sachs for example, places the likelihood of a US economic recession as just 15pc. This is a level that’s considered normal, despite the fact that interest rates are rapidly rising to levels not seen since the financial crisis.
Even the Eurozone could avoid a major contraction despite Germany’s dire situation.
Not everyone is confident in the ability of these economies to continue their remarkable resilience.
Paul Mortimer Lee, an experienced economist who has worked for both the Bank of England as well as the investment bank BNPParibas in the past, believes that the economy is headed for a painful collapse.
What was his reasoning? It is still difficult to comprehend the magnitude of the interest rate increase.
I’d be surprised if there wasn’t a recession. Mortimer Lee, now a fellow with the National Institute of Economic and Social Research(NIESR), says: “I’d be surprised if there wasn’t a financial crises.”
Mortimer Lee is one of a few economists who believes that the central banks are at risk of killing their patients by overdoing it with economic medicine.
After almost 15 years with cheap money, his argument is that the financial system now revolves around low interest rates. As interest rate rises for longer, many of the business and investment models that support the economy are likely to be thrown off balance.
After the failure of liability-driven investments (LDI), pension funds were forced to sell bonds as soon as possible in response to the mini-Budget for 2022.
Everyone’s portfolios are set up for a totally different structure of interest rate. “When you tighten this quickly, bad things can happen,” says Mortimer Lee, a Brit based in New York.
According to him, the original crime was that the central banks overreached with quantitative easing during the pandemic.
Bank of England has massively increased its purchases of government debt, taking the balance sheet of its bank from PS435bn in 2010 to PS875bn at the end of 2021. Both the European Central Bank (ECB) and US Federal Reserve have also provided extraordinary stimulus.
Mortimer Lee says, “These guys were nuts about Covid.” “Covid may have been temporary, but their actions with their balance sheet were permanent.” They did much, much more for Covid compared to what they did after the global financial crises.
Rates to zero, purchase every bond issued by the Government – this is why the UK and US government deficit is so high. Money was freely available. This is the same as giving a child a credit card, and telling them to spend as much money as they want. “And that’s what governments did.”
The debt is due.
The Bank of England argues that many of the things we know now are only apparent in retrospect.
Ben Broadbent – a deputy governor of the Bank – has stated that officials were concerned that the ending of the Covid furlough program would result in a spike in unemployment.
The Monetary Policy Committee tightened policy only after it became clear that there would not be a sudden increase in redundancies.
The Bank had to increase interest rates very quickly to stop the price increases. Rates went from 0.1pc to 5.25pc by December 2021.
Mortimer Lee says that if the Fed and European Central Bank make similar moves, the results will be bad.
The “nightmare of the American business” is coming next year, as low-cost debt will expire and have to be refinanced with higher costs.
He says that the housing market is a disaster in waiting, and that many households have borrowed money as if rates would remain low.
Why, if he’s right, have we only seen a limited effect from the spiraling borrowing costs?
In monetary policy, the rule of thumb is that it takes 18 to 2 years for rate increases to have a full impact on the economy. The first rate increase by the Bank was in December 20,21. Two years are still not over.
The Bank of England has also continued to raise rates up until August this year. This means that the effects on the economy will continue to be felt over the next few years.
It is difficult for policymakers, given these delays to know exactly how much to increase rates.
According to the Bank of England, it has only done enough to prevent a recession and still bring inflation back to 2pc in coming years.
Policymakers, including Governor Andrew Bailey, insist that rates need to remain high for a while in order to eliminate inflation.
Last week, the Governor stated that it was too soon to talk about lowering rates. The Governor said last week that the rate of inflation is going down, but we must continue to work hard to achieve this.
The European Central Bank (ECB) is also sending the same message, which has pushed eurozone interest rates up to a record high of 4pc. Christine Lagarde said that it would be ‘absolutely premature’ to talk about cutting rates.
Jerome Powell, Fed president, insists on the other side that rate could rise rather than fall.
He said, “We’re asking ourselves if we should hike more.”
Mortimer Lee believes this is a grave mistake. He thinks that the Fed, in particular, is “driving a car with its rear window open, rather than the front”, and this is a mistake.
It may take a while for the impact of historic interest rate increases to be felt, but they are building.
The housing market has seen relatively little price declines as homeowners have chosen to stay in their homes rather than move. This is especially true in the US, where mortgage rates were low for at least 25 years before they began to rise.
Many may be forced to sell their properties, which could lead to a drop in the price.
Mortimer Lee says that “once people lose their jobs and are forced to sell their homes, the market will experience a major correction.”
The economy is already struggling and the job market is changing.
Insolvency rates in Britain rose to 2,300 businesses last month from 1,500 before the pandemic.
Mortimer Lee also points out that Britain’s shrinking currency supply is another warning sign of an impending downturn.
Although not a fashionable indicator, Mortimer Lee says that the money supply figures have “given the clearest signal in 2020 and in 2021 of inflation in the pipeline”, and are now sharply pointing downwards.
Mortimer Lee warns that recessions can come fast. Overnight, factories that took years to build can be shut down. It is possible to sack a workforce that took years to develop.
Mortimer Lee says that central bankers “are in denial” right now. He believes that central banks will have to make a drastic change in policy when the rubber meets the road next year.
This is one of the most stern warnings from the bearish analysts, who are concerned that central banks may have gone too far.
Albert Edwards is another example. He’s a notoriously pessimistic City analyst for Societe Generale.
Edwards warns in his latest report that the Fed could make a historic mistake by tightening its policy. This would be similar to the failure of the Fed to increase the money supply during the 1930s and allowing the Great Depression.
Edwards: “Central bankers would not make the same mistake again, wouldn’t they?” “Despite the Fed’s assurances, it’s happening again.”
We are still waiting on the crash.
Mortimer Lee says, “We’re now on the brink of a recession. Inflation is high, so central banks are reluctant cut rates. And budget deficits are horrendous.”
How can governments react to a recession by implementing fiscal policy? Answer: They can’t. The central banks have left us in a bind.