Speaker 0:
joining me here in the studio, we have Simon French, chief economist at Mill Gordon Simon. Thanks for being here. Pleasure. Rory. I wanted to touch on an article that you published in The Times this morning about lags and in particular interest rates and the effects it has. Do you think currently, at the moment we've got a bit of a misunderstanding on how lags work and the effect or the length in which it goes from there?

Speaker 1:
I think it's the right way of describing it. There's a misunderstanding, not necessarily amongst monetary policy makers. Look, they're they're a small bunch. They understand their mon theory.

Speaker 1:
But there it is, beholden on those central banks around the world who have raised interest rates quite a lot over the last 18 months to explain the lagged effect on prices. Because while interest rates, the policy rate may go up pretty instantaneously,

Speaker 1:
the transmission through credit markets, housing markets in terms of refinancing and approval for new projects, new activity that does take time, the aforementioned lags. So it's part of the communications. I think of central banks, which they are doing at the margin they are in the minute they are talking about that lag time, but I think they probably need to extrapolate that into their public communications to make it clear

Speaker 1:
that a lot of the pain and there is pain for a lot of mortgage holders and and businesses who've refinanced at much lower rates is still to come. Over the next couple of years,

Speaker 0:
I'd like to come back to mortgages, but just in the meantime, you made the case for there being shorter like times with technology and speed, in which people can receive information also longer in the sense that businesses have locked in that lower cost of borrowing. So what happens then, when refinancing comes at a higher interest rate environment?

Speaker 1:
Were you right to say there's uncertainty in conflicting arguments as to whether that lag has elongated or indeed, shortened?

Speaker 1:
That is in many ways, if you like, raises the bar or raises the advantage of taking a bit of a mid cycle pause like we've seen from the Bank of Canada, Reserve Bank of Australia, the Federal Reserve pausing and getting more information to understand that lag because you only learn stuff about the modern economy and how it might have changed

Speaker 1:
based on those different stimuli, Um, by looking at the data. And so the degree to which those, uh, data points will inform the next move, I think, is the element that, uh, we're all learning because this cycle hasn't really been done for about 20 years in terms of the scale of interest rate increases and the way that households businesses react in an economy which is in many ways unrecognisable from the economy we had two decades ago

Speaker 0:
and staying with homeowners leaving fixed rate deals. So when that refinancing comes, I think you described in the article as a lag becoming more of a

Speaker 1:
drag. Yeah, it was a bit of a sound bite. And I, I made no excuses for that. You know, uh, it's it's journalism after all, But, um, look, you're absolutely right. There is a cohort of borrowers and take the UK data. There's about 8.5 million homeowners with the mortgage. Um,

Speaker 1:
the average interest that they paid or what is an outstanding mortgage? Stock of about £1.7 trillion hit an all time low of 2% at the back end of 2021 Now, many people watching this will say Sorry, 2% thinking of the type of deals. Either they've been out to the market to get in recent weeks, months or indeed are anticipating when they're going to refinance that debt

Speaker 1:
and therefore that drag effect. If you are moving off a deal at 2% and you're moving into a deal at 6% interest rate, that drag is money taken out of your disposable income, which otherwise you could have spent in the hospitality trade. Or, you know, holidays on consumer durables, which is going to be have to divert be diverted to fund

Speaker 1:
your mortgage borrowing. That is why, with a lagged defect, we will see a drag. It's it's not a bug. It's a feature of what central banks are trying to do to bring inflation back under control. But make no mistake, it's coming. And it's coming at a time when the economic outlook is already quite weak, particularly in the UK context,

Speaker 0:
and coming back to the crux of the article are lags enough of a reason to pause the interest rate cycle. Is it enough on its own, does it need?

Speaker 1:
It has been I. I mentioned that other central banks around the world have used that as a justification to pause.

Speaker 1:
The problem in the UK context is one of credibility and

Speaker 1:
I don't think all the blame for current elevated inflation is can be put at the door of

Speaker 1:
the Bank of England and the Monetary Policy Committee clearly factors in global energy markets. So, you know, driven by events in Ukraine and Russia, events originating in China in terms of the pandemic. All of those have fed into the reason why inflation has been above target. But I think one would layer in some additional criticism of the way the Bank of England have communicated over recent months. You would layer in a bit of criticism of their um

Speaker 1:
continued use of quantitative easing during 2020 21 when financial conditions were pretty loose,

Speaker 1:
then chips away at the credibility amongst market market participants and therefore, if the bank are going to carve out a position of pausing for more information, which I advocate is a good path,

Speaker 1:
they need to have the confidence of markets that they're not going to be taking a pause and letting inflation run away from us and move ever high. That credibility deficit comes with a price, and I'm afraid we're seeing that right now. But

Speaker 0:
that credibility staying with that and thinking further down the line if they lose the ability to guide the expectations of businesses when it comes to rates, what happens then to inflation? Does it then spiral?

Speaker 1:
You're right to focusing on expectations, because clearly, as we go into price setting wage setting for the next 12 months, um, agents around the economy, be they workers, be they business owners, um,

Speaker 1:
take their starting position for setting prices based on what they expect prices to be Now the Bank of England would argue that, um, survey based inflation expectations are pretty well anchored to use the jargon, and they're right based on that, that that data, they also would point to market based measures in the bond market of where inflation is going, that they see it

Speaker 1:
going going down. But those are sensitive to missteps, policy mistakes, if you like. And this is why when I speak to investors at the moment, looking at UK macro, they are worried that we are on the cusp of a policy mistake. And that policy mistake may have a blowback in terms of inflation expectations and price setting, which is pretty unfavourable at the moment compared to its major economy. Comparators

Speaker 0:
si, Thank you very much.

Speaker 1:
Thanks, Rory.