Britain's FTSE 100 stock index fell to a six-week low today — and for that you can thank the careless words of a central banker.
In a keynote speech, Bank of England chief Mark Carney warned that interest rates may rise from their current level of 0.5 percent this year. He hedged his comment by claiming that "no decisions have been made" yet, and that any decision would be "data dependent," but the damage was already done. It was a major slip, one that Federal Reserve Chairwoman Janet Yellen should seek to avoid.
In the case of central bankers, words really do matter. Former Fed Chairman Ben Bernanke inaugurated regular press conferences to clue markets in to the Fed's thinking. A false note can easily cause whiplash in markets, tighten up lending, and stoke expectations for weaker growth and deflation. And the worst part of it is that Carney had no reason to freak out investors as he did.
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Since 2008, the British economy has suffered a worse economic slump than the Great Depression. The economy is finally showing a few green shoots, growing 2.9 percent over the last year, with unemployment falling to 6.6 percent. British inflation remains a tame 1.8 percent, below the Bank of England's 2 percent inflation target.
You would think that interest rate hikes would be the last thing on Carney's mind; sustaining growth and lowering unemployment loom much larger as economic priorities. But apparently you would be wrong.
Now, Britain has a problem that the United States doesn't have. Britain has booming real estate prices, particularly in London. In the last year, average prices rose by 6.7 percent, and in London by 17 percent, stoking fears of a housing bubble. Carney has expressed worries about this in recent months.
Carney has correctly argued in the past that the problem is a lack of housing supply. "While you might describe London's annual jump of over 16 percent as being as a result of a very frothy market," Carney has said, "it is underpinned by long-term demand and a genuine shortage of housing supply."
So hiking interest rates will not deal with Britain's housing supply problem or its housing price boom. Only relaxing planning laws and building more housing stock will do that.
Of course, if inflation rises back above the Bank of England's 2 percent target, and unemployment continues to fall, then it would be appropriate to hike interest rates.
But there are significant reasons to believe that inflation is unlikely to emerge anytime soon. Inflation is low throughout the developed world, in spite of years of ultra-loose monetary policy, suggesting that deflationary pressure is strong. That doesn't mean that inflation won't suddenly rise. It could. But until inflationary pressure begins to show and markets are demanding rate hikes to quell it, why even talk about it?
Hopefully this was just a slip of the tongue. But the worrisome thing is that other central banks have drank the inflationista Kool Aid. That's what recently happened in Sweden, where the central bank hiked rates against a background of low inflation in the name of "financial stability," only to find itself with rising unemployment and sucked into a Japanese-style deflationary spiral.
Janet Yellen badly needs to avoid making these kinds of mistakes if the U.S. is to sustain its recovery.
