As you probably know, both the ECB and Bank of England chose to leave interest rates alone yesterday. Yet strangely, while the central banks stay put, commercial banks are cutting rates.
According to Reuters, the average rate on a two-year mortgage is now at the level seen before the credit crunch.
Meanwhile, the Abbey has joined Lloyds TSB and Halifax in dropping rates in the last few days.
But this is the snag. Rates may be falling, but it’s tough getting the loan. As Ray Boulger, of John Charcol said: “Anybody who had a deposit of less than 10 per cent will still struggle to get a mortgage.”
And that in a nutshell is the issue.
The media and analysts are writing reams on which way next for interest rates, but that seems almost irrelevant. The Bank of England could slash rates tomorrow and it is far from certain the move would make much of a difference at all. The issue now is not the cost of money, but its availability.
There seems to be a certain misunderstanding on the role of interest rates in controlling inflation. When Mrs T came to Downing Street with all her bold ideas about monetary policy, the idea then was that the money supply controlled inflation.
The author of this article was studying economics at the time, and his professor used to say: “The question is not whether the money supply controls inflation, it is whether it is possible to control the money supply.”
Interest rates can affect demand for money, which in turn can affect money supply, in turn influencing inflation. But right now, supply is low, irrespective of demand.
For as long as credit remains crunched, the factors that determine inflation in the long-term will recede.
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