Why the Bank of England had no choice but to raise interest rates.
There is a reasonable chance that you may be aware that on Thursday 22nd June 2023 the Bank of England raised interest rates. Now I know raising interest rates hurts.
Today I am going to explain a few things.
· Why they had no choice but to raise them.
· What would have happened if they didn’t.
· What you can do.
Before I explain why they had to raise interest rates there are some basics you need to know.
The UK government’s income, at best is £1 trillion a year.
Every working day — Monday to Friday- Some £5 trillion is exchanged on the currency exchanges. Government income is nothing.
By far the biggest pressure on inflation is the strength of the UK pound (Sterling) against the 7 major currencies. Wages and company profits pale into insignificance by comparison.
The world’s 7 major currencies are:
· The US dollar.
· The UK pound- commonly known as sterling.
· The Euro.
· The Canadian dollar.
· The Japanese Yen.
· The Australian Dollar.
· The New Zealand Dollar.
The prime reason they raise interest rates is to encourage foreign investment into the city. These investments take time to work and grow the economy but they reap huge rewards for Joe Public but it takes time.
It would have been far worse without Brexit. One of the prime reasons for Brexit is so we could negotiate our own trade deals and investments from abroad without the interference of the European Union. As you will see later this really helped the recovery.
A weak pound is bad for Joe Public for several reasons.
A weak pound against the US dollar is bad.
· A weak pound piles pressure on the costs of goods, which can in turn, push up inflation.
· Items brought from abroad such as petrol, diesel, and many food items become more expensive. Something like 1/3rd of your food basket comes from abroad.
· Going abroad is more expensive.
· Investments lessen in value the commonest being pensions. This is why sadly some retirees have had to return to work.
The higher the rate of inflation, the slower the economy is growing.
The lower the rate of inflation the faster the economy is growing.
You have to remember that in March 2021 the covid pandemic started and we were not free of it until June 2022. Economically speaking that pandemic was just as bad as the great wars combined. People lost their jobs, businesses went bust, and the UK government gave people 80% of their salary through a furlough scheme. As such the UK government’s income plummeted and the government had to borrow money to keep everyone’s head above water- financially speaking!
As such financially, through no fault of the UK government, we were in dire straits.
Now let’s put this in football terms.
Imagine your team has scored 5 goals in the first 20 minutes of a game. You would be very happy. Let’s say that within a minute the opposition scored. You wouldn’t be that worried. Then two minutes later they scored another. You’d have a few jitters.
Then they scored another. Now you are worrying.
Imagine they scored another goal one minute before halftime. Then you are really worrying.
This is the situation the UK government found itself in. It was made worse on 24th February 2022 because Russia invaded Ukraine. That pushed up the price of oil tremendously, especially when you consider that oil is bought in US dollars.
The price of oil is very volatile. One minute it can be as low as $25 per barrel but by the time you press the buy now button it can be as high as $250 per barrel. By the time you come to buy your fuel at the pump, they could be making a huge loss on the money you pay them. That’s why they have to make such huge pre-tax profits- to insulate them against such volatility. If not, they’d go out of business.
During the covid pandemic the UK government’s income plummeted, many people were not working so they weren’t taking in as much in tax. In fact, the government was paying people through the furlough scheme. Many businesses closed compounding the problem. Bear in mind that in some countries to get a vaccine and treatment for covid you have to pay for it. In the UK, you get it for free through the NHS.
During that time the pound weakened against the US dollar. At the start of the pandemic £1= $1.42 which is great.
However, as time progressed by the time of September 2022 £1= $1.02- the lowest level since the war. Inflation had risen month on month. Economically we were in dire straits. Since oil is bought in dollars that’s why your petrol was so expensive.
That week the Bank of England raised interest rates in exactly the same way that a football manager would take drastic action if you were 5–0 up within 20 minutes but at halftime, you were now at 5–4. In doing so they opened the door to starting the recovery.
That week we had the mini-budget. Chancellor Kwasi Karteng raised the cap on banker’s bonuses and lowered taxes on foreign investment.
Now consider an analogy. You go into your supermarket which normally charges £1 for a pack of potatoes. Imagine they are now 50p per pack. Now consider if the tax on them was reduced (I get there is no VAT on food in the UK!) Add to this the supermarket giving you a £2 voucher for every £10 you spent.
Now consider some millionaire who has a whole load of restaurants and fish and chip shops comes in and sees those potatoes at such a price. Like you, he’s going to buy as many as he can. Then like you, he’s going to look around the supermarket to see what other offers there are available.
This is what happened. Foreign investors poured billions into the UK for 4 reasons.
· The pound was weak against the dollar so they could buy it up cheap.
· They were being taxed less so they’d make more money.
· They were making more interest.
· It was easier because of Brexit. We could make trade deals with companies from abroad because we didn’t have the EU to deal with.
The pound grew against the US dollar. Now a 0.75 cent to 1 cent rise per working week is great. However, it worked too well. Sterling grew by 1 cent against the dollar per day! It was 5 times greater than expected.
However, then something happened.
On Friday 14th October 2022 the Japanese Yen collapsed against the 7 major currencies. Within hours the pound grew like there was no tomorrow. Left unchecked the pound would become so strong making our items so expensive foreigners could not afford to buy them. If you remember how expensive petrol was before the mini-budget, you’ll understand what I mean.
In football terms, it would be like playing football in the National League football and then within hours being promoted to the premiership. It was too much of a growth too quickly.
As such Chancellor Jeremy Hunt had no choice, he had to cancel the mini-budget. So when the opposition crow about this, they didn’t know what they were talking about.
The investments kept coming in and as time went on the economy recovered. Sterling has grown at a very satisfactory 0.75–1 cent per week against the US dollar. Inflation is stabilizing
Over summer, historically speaking, the US dollar becomes very strong as people go on holiday and buy traveler's cheques in dollars. To stop the pound from weakening against the dollar they raised interest rates to encourage more foreign investment.
However, as time goes on I am confident that they will start to lower them.
So what can we do?
Whenever you can instead of buying online please make an effort to buy one more British-made item from a local self-employed trader in your community a week. That keeps people in your local community employed. If you buy British then it has a ripple effect because that trader can afford to employ more people. These pictures say it all.
When you pay at a local business please pay in cash when you can. In the worst-case scenario, a business owner has to pay 2.4% plus 20p per card transaction. In some cases when that comes into the bank account the owner can be charged 50p to £1 for depositing it in! With cash, all those charges are obliterated.
Before the lockdown, I had the great honour of being invited to the wedding of one of my students on Mums in Mind where I live stream aerobics classes across the net at 9 pm when the kids are in bed for £1.50 per day.
This lady is Jewish but what I saw at the reception amazed me. The groom is Jewish. He rents out loads of properties. All his tenants are Jewish families, students, or couples. The bridal dress and bridesmaid’s dresses all came from a Jewish bridal shop. The groom’s suit and the suits of his party came from a Jewish tailor. His solicitor, will writer, accountant, insurance broker, plumber, builder, gas engineer, roofer, and decorator were all present. They are Jewish. The flowers came from a Jewish florist. The reception was in a hall owned by a Jew. The caterer was Jewish. The local post office and supermarket are owned by Jews. Whenever anyone needed their wills written they went to the Jewish will writer. When they needed their household contents or buildings, public liability, or car insurance they went to the Jewish insurance broker.
You get the idea.
I spoke to the Rabbi about this and he said that this constant recycling of money means that all those in his flock are gainfully employed. He said that financially his community goes from strength to strength to strength.
That’s what we should all be doing.
If we all do this then the ripple effect will grow our economy like there is no tomorrow.