In the City
An ill-timed squeeze
Nicholas Davenport
The blinkered mandarins at the Treasury and the Bank of England, following the ancient rules of their money books, have been responsible for an ill-timed and outrageous rise in Bank rate from 10 per cent to 12/ per cent. It is the highest rate since the sterling panic days of October 1976 and, an told, higher in real terms than it has been for forty years. How, you may well ask, did they get the consent of the Chancellor and the Prime Minister to their misJudgment? They must have caught the Chancellor When he was in one of his petulant moods. He showed his rage on the Weekend World Programme when he said that if there wasa Pay explosion he would either cut public sPending or raise taxes or both. When he was questioned as to whether he would really take such tough measures and squeeze the money supply in an election year he replied: 'They don't know Healey If they think that'. When you come to the end Of Your tenure of office you are certainly not afraid to say what you think. Incidentally, tie has left the new money supply target at 8 Per Cent to 12 per cent but it is a slightly stricter target because it runs from a lower base, To gain the Prime Minister's consent may not have been difficult. Mr Callaghan is now above the petty worries of his departmental Ministers. He is unmoved by Mr Shore Ilearing his hair, which is purposely kept rcing, over the shocking rise in the mortgage att from 91 to 11/ per cent or by Mr Healey about the money supply. He is so confident of his mission — leading the countrY back into the promised land of less inflation and more productivity — that he can afford to let the Treasury and the Bank o ccasionally make an appalling error of 117', Mg. He knows that the country will trust make 0,41.1 to put things right in the end and him trade union bosses see sense. But I wish could have made the Treasury and the riank see sense today. With Bank rate at 4i Per cent and the mortgage rate at 111 per cent it will not be long before the economy is plunged into an unnecessary and deep recession. A slow-down is already indicated by retail sales and output figures. Last week I was at pains to argue that a rise in Bank rate was unnecessary (although money rates were pressing it up) and I was supported in my view even by some monetarists and by Tim Congdon, the well known economist at Messels. I am glad to see that Tim stands by his guns. Sterling,,he says, is under no real pressure in the foreign exchanges. Our short-term interest rates are much higher than those in the US (our Treasury bills yield about 3 per cent mere than the American). The demands for bank credit in the private sector have been easing even under a 10 per cent Bank rate. Companies have been reducing their borrowings because of the high level of their stocks. The funding of the budget deficit through ginedged sales has been well on target. So why raise Bank rate by an unprecedented 2&P cent to a level which can only be regarded by the nation as a sign of immediate crisis and a call for immediate deflation? Was it really intended as a clout to the trade unions who have cocked the snook at the 5 per cent pay guide line? It is true that the Prime Minister has said that if the trade unions did not co-operate and exercise restraint in their pay claims he would have to impose a restrictive monetary policy and increase taxation but he was looking ahead — towards the next budget. That is why he has now been having quiet talks with the union leaders at No 10, hoping to bring them round to a reasonable accord with his anti-inflation policy. lithe talks break down he can say to Messrs Murray, Moss Evans and all: 'Now you know what to expect when you misbehave— you get a slump from the Bank of England. But it was premature. A pay explosion is undoubtedly threatened but it has not yet happened. Mr Healey still hopes, he says, that the rise in earnings this year could be kept at an average of 7 per cent. Even so, If there is no rise in productivity, a 7 per cent compound rate of increase in earnings would have the real value of cash wages halved in about ten years time. These are the laws of arithmetic which Mr Healey referred to but has not yet properly explained lo the uneducated trade union leaders. Will a premature slump make these illiterates more or perhaps less inclined to learn his lessons in mathematics? I fear it may make them more pigheaded.
The first industry to feel the monetarists' slump will be the building industry and its ancillary trades. Many thousands of would-be borrowers will not be able to afford mortgages at these penal rates and will cancel their orders to buy or build. But do not imagine that this will bring down the price of houses. Wages will be going up and the cost of financing the building of a new house will go up. The millions of existing mortgage payers will have to suffer in three months time a sharp rise in their monthly payments and will then have to cut down on their living expenses. At the same time businessmen, with bank loans costing 12/ per cent or more, will be reducing their borrowings, cutting short expansion and cancelling plans for industrial investment which have become unprofitable at the new stinging rates of interest. So the immediate effects of this ill-timed credit squeeze will be a rise in unemployment and a rise in the rate of inflation. This is likely to infuriate the trade union bosses and play into the hands of the extremists who want to bring Mr Callaghan down. Moderation in wage bargaining is more likely to be won if Mr Callaghan's pay policy is seen to be working towards better trade and employment.
The view taken in the City of this ill-timed credit squeeze was as usual a cynical one. The gilt-edged market assumed that this was 'over-kill' and that the future course of money rates must be downward. So there was a rush to buy the long-dated 'tap' stock — Exchequer 12 per cent 1999-2002 — which was then offering a yield to redemption of over 131 per cent. In a flash the £500 million of stock outstanding was snatched up. This leaves the short end of the market still extremely cheap with yields of over 12/ per cent. The opinion most frequently heard in the market was that if the Government had cut public expenditure and had reduced its borrowing requirement this credit squeeze would have been unnecessary.
I have put the blame for this ill-timed Squeeze on the blinkered mandarins at the Treasury. On one of the ex-mandarins, still blinkered, must be laid the blame for upsetting our approach to European Monetary Union. Lord Armstrong, as chairman of the Midland Bank, launched into an absurd and ignorant attack on EMU, while the chairmen of the other three clearing banks gave their support. Sir Jeremy Morse, chairman of Lloyds, who really understands international monetary affairs, gave cogent reasons for a European Monetary Fund. It would be fatal if we are left out at the start.
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