This is an audio transcript of the Economics Show with Soumaya Keynes podcast episode: ‘The case for holding rates, with Catherine Mann’
Soumaya Keynes
Before we begin, we would love to hear a bit more about you and what you love about this show. We are running a short survey, and anyone who takes part before August 29th will be entered into a prize draw for a pair of Bose QuietComfort 35 wireless headphones. You can find a link to the survey and terms and conditions for the prize draw in our show notes.
[MUSIC PLAYING]
Last week was a chaotic one for economists and also market watchers. Disappointing job numbers in the US seemed to lead to an unwinding in Japan. A freak-out in US markets on Monday launched a frenzy of speculation that the time for the Fed to cut rates was very much now.
What an interesting time to speak with our guest today, Catherine Mann, member of the Bank of England’s Monetary Policy Committee, which voted to cut rates on August 1st. Mann, however, was a hawk in a doves’ meeting voting to hold. So today on the show, we are going to talk about the right path for rates and how to think about managing the global economy.
[MUSIC PLAYING]
This is The Economics Show with Soumaya Keynes. And I’m joined by Catherine Mann here with me in the studio in London. Catherine, hello.
Catherine Mann
Great to be with you, Soumaya.
Soumaya Keynes
OK. I’m gonna start by asking you a silly, arbitrary, stupid question. So supposing there’s a scale from one to 10. One is super dovish. Ten is as hawkish as you can imagine. Where are you now? And have you always been there?
Catherine Mann
I would say I’m a seven. But in the past, I have been a 10.
Soumaya Keynes
OK, so you’ve actually moved more dovish . . . over time.
Catherine Mann
Oh, I have. Absolutely, I have. You could know that because I changed my vote from a 25-basis-point increase to a hold in February.
Soumaya Keynes
Oh, OK. Great. So there’s growth there. Let’s go a bit further back. So I first met you when we were both trade people. And look how far we’ve come. (Laughter) But you know, maybe once a trade person, always a trade person? And so my question is: how do you think that background has informed your perspective now as a monetary policymaker?
Catherine Mann
Well, in a country like the UK, which is a small, open economy, trade plays a very important role. Exchange rates play a very important role in driving the real economy and in driving inflation. We have to make judgments about the macroeconomy with regard to GDP growth, employment growth, inflation prospects. But in order to understand the dynamics underneath those and how a vote would affect those macroeconomic elements, we really have to do the disaggregated analysis. And I think the background in trade, which is a long time ago. as you say, started us off in that direction right away.
Soumaya Keynes
OK. So now I want to talk about monetary policy, and I want to start by putting you in the awkward position of explaining an action that you didn’t agree with. So you voted to hold rates. The Bank of England committee voted to cut rates. Why did they do that? What is the strongest argument now in favour of cutting rates?
Catherine Mann
Well, you’re not actually putting me in an awkward position, because what I do before each meeting is take a piece of paper, draw a line down the middle and put, you know, Action A and Action B at the top, and this time around, it was Hold and Cut, and then start to do my analysis. So I don’t have to speak for anybody else, which we try not to do. I can speak for myself and tell you, OK, what was in the Cut column? What was in the Cut column was the obvious situation where you would already hit the target of 2 per cent and prospects over the medium-term monetary policy horizon was, in fact, for the forecast to be lower than the target. So that seems to be an obvious reason to cut now.
There was also the process of getting to this inflation forecast. Well, inflation was coming down, that meant inflation expectations would be coming down. That meant that wage requirements to maintain real wages would be coming down. That would mean that firms would be able to not price so aggressively. So that would bring inflation down. So this whole process, that process was under way, and it would happen naturally. And so we would have guidance based on our forecast that that would be the benign outcome, the soft landing. And we would get there.
Soumaya Keynes
OK. So essentially, based on current trends, it looks like inflation is going to where it should be. Everything is ticking along. And so the current stance of rates looks very restrictive in that context.
Catherine Mann
Maybe there would be a little bit of additional unemployment as vacancies started to fade away. And so all of that would add up to an outcome where we would achieve the desired objective of stable inflation at 2 per cent in the medium term, without too much of a trade-off with regard to unemployment. And we could cut now in order to kind of cement that. OK, so that’s the Cut column.
Soumaya Keynes
Can I just ask about the recent events? Right, so we’ve had this huge market volatility in the US. The discussion has very much been, well, doesn’t this mean that the Fed should cut? How does that play into the thinking in the UK?
Catherine Mann
Because I think they’re related. It is related to two factors. One is there is a very important effect of the Federal Reserve’s decisions on global financial markets and therefore on the UK yield curve. And of course that’s related to what our decision might be. So that’s one important relationship, is Fed’s spillovers.
The second important relationship is the extent to which the volatility that we see in asset prices and in inflation, because it has been volatile over the past several years and we’ve had some volatility as well in macroeconomic activity data, market output, GDP, these sorts of things. So that volatility also has implications for our terminal rate. In my view, the terminal rate is higher because of an inflation premium that is associated with volatility in markets, especially volatility in inflation. So in that context, monetary policy is not as restrictive as you might think.
Soumaya Keynes
OK. So just to say some of that back to you, so is what you’re saying that the recent volatility is kind of part of a broader trend towards greater volatility. And all else equal, that will tend to raise the level of interest rates that is desirable. And so actually it should push central bankers more hawkish than they would otherwise be.
Catherine Mann
Well, if we think that we’re into a world where there’s more commodity volatility, where there’s more real-time volatility, where there’s more, in this case, spillover volatility from other places, we have to acknowledge that volatility adds to the situation with inflation. And so we would have to lean against that.
Soumaya Keynes
I guess just one follow-up on that. You know, the context of the most recent bout was, people can debate this, but many thought that the trigger was the slightly disappointing jobs market numbers in the US. So how does a British monetary policymaker look at that and think about, OK, how that’s gonna feed through to their decision-making process?
Catherine Mann
Well, there are two channels really. There’s the real side, which is if the US economy prospects are less robust than we thought, then they have less, you know, exports going to the United States and, everything else being equal, that would have downward bias for the UK economy.
But really, two elements being more important. One is if the UK economy looks a little bit more robust, then that supports the exchange value of sterling, which normally, we would say an appreciation of sterling would put downward pressure on inflation because import prices are lower. In fact, the research that we have shows that if there is relatively stronger demand in the UK, which is something that we’re observing now, in that environment where you’ve got relatively stronger demand than people thought, that gives firms more pricing power than we thought. And so import prices do not fall. The appreciation does not put downward pressure on domestic prices because demand is relatively stronger than we thought.
Soumaya Keynes
OK. So this is another, you know, I guess, link between actually the recent effects could be forcing British policymakers to be more hawkish.
Catherine Mann
Could make us more hawkish. Yes.
Soumaya Keynes
OK. Well look, why don’t we now talk about that whole column a bit more centrally. So, you know, you did vote to hold in the end. Why did you do that?
Catherine Mann
My remit is 2 per cent inflation sustainably in the medium term. So I look a lot at data about inflation at the granular level. And I look at research that informs how I should be reacting to these data in making a monetary policy decision. So yes, there’s been a deceleration in goods and that has been associated with the energy prices coming down. And that’s very positive. But in fact, the goods prices haven’t really come down enough to match up with kind of what they were in historical period.
But services is the even more important issue. And in the sort of pre-Covid days, 15 years prior to pre-Covid, you know, you had services running at about 3 per cent, you had goods running at about zero, and that added up to 2 per cent. And nothing was happening with energy at that point. So where are we now? Well, goods are about zero. So we’re kind of doing OK on goods, but services are running at more than five on an annual basis. And actually what’s even greater concern is on a three-month, three months . . . So we’re looking at . . . There was a bounce. There was, everything, on an annual basis actually hit a low in the first quarter of ‘24, and near starting to rise, both goods and services are starting to rise again. And so that makes me worry about upside risks. So there’s upside risks to goods coming through shipping and transportation and all the issues in the Middle East, which only intensified. And services are very importantly related to wage developments, and wage developments continue to be more robust than any of our models would predict.
In our monetary policy report, which we put out four times a year, one of the observations is that although wage growth has decelerated, it continues to be outside the model predictions. And one of the things that appears to be important in why our models miss is because there’s not long enough lags.
Soumaya Keynes
Sorry. When you say lags, you mean you got this pressure and the speed with which wages respond to that pressure. And that’s quite slow?
Catherine Mann
It’s quite slow. And it takes multiple years for wages to catch up to all these desired real wages that workers want to have. And when it takes a long time, that means going forward, it’s going to take a long time for wage deceleration to move us into a position where services will decelerate, services prices will decelerate down to 3 per cent.
So these are upside risks. And these upside risks may well be more structural. In so far as the conduct of the labour market, right now, one of the aspects of the UK economy that differentiates it from the US and from the Euro area is that labour force participation continues to lag pre-Covid. And so even, you know, there are a lot of vacancies. There’s a lot of desire to employ people, and there don’t seem to be workers out there. And of course, that is part of the wage-setting process.
Soumaya Keynes
OK. So is your view essentially is that, that’s something strange is going on with labour force participation. It’s pushing up wages and that’s contributing to the rate services inflation?
Catherine Mann
Yes. Yep. It’s an important ingredient in thinking about the long-term capacity of the UK economy to grow.
Soumaya Keynes
Can I ask about the Taylor Swift theory of inflation? Now OK. I don’t mean literally that Taylor Swift is the reason that services inflation is elevated. But, I guess the bigger point that actually some are arguing that it’s, that a lot of the recent services inflation is being driven by volatile components, right? And so there’s a risk that you’ve got lots of temporary things and that’s making it seem elevated. But actually you shouldn’t interpret those as sort of persistent pressure on services inflation. Actually, all of these factors are gonna wash out quite soon.
Catherine Mann
So the deep dive, not on Taylor Swift hotels, although we did do that too, to kind of lay that . . .
Soumaya Keynes
Very jealous of that . . .
Catherine Mann
So there are two aspects. And one of the particular aspects that is — again, these are risks, these are upside risks to inflation but it may well be structural in the, you know, three-year context — is CPI micro data. This is the individual transactions at individual locations, from individual stores. So it’s very detailed. In the sort of pre-Covid period, you had about 5 per cent of services prices increasing each month, 95 per cent of prices didn’t change at all. Well, more recently it’s been 10 per cent, increasing. And yes, there’s been a little bit of an improvement. But most prices on services continue to be increasing. And by and large, services prices never fall. This is part of this upward ratchet on services prices. That is an underlying risk to achieving the 2 per cent objective in the medium term.
An important component of that ratchet is the desire to maintain certain wage relationships. And I think this is going to be an important issue next year. Again, why did I hold now? Well, I see next year. There was a lot of new wage agreements in April this year. There will be wage negotiations next year, which will be in relationship to the negotiations that just happened. So some people at the bottom got quite a bit of an increase, rightfully so. But the ones above them didn’t, which means next year they will, because it’s important to keep relative wages within a hierarchical structure, kind of in relationship to each other.
But exactly the same thing happens with prices. Firms look at their competitors and their competitors raise their prices a little bit. Maybe they’re more efficient. They raise their prices a little bit, and their competitors raise it too. We do not see that behaviour on the downside. So there is the upward ratchet to both the wage-setting process and price process. And that is the upside risk that I think is in, and may well be structural, having been created during this period of very high inflation over the last couple of years, that ratchet up will take a long time to erode away.
And so my job is to get to 2 per cent in the medium term. And if there’s an upward ratchet, an upside bias, and it’s accentuated by some of these issues with regard to inflation volatility, asset price volatility that’s in the world, then that means I have to be more restrictive for longer than is suggested by our models.
Soumaya Keynes
Can I ask about the mechanism of monetary policy here? Right, because I think one thing that you’ve discussed in the past is that actually, you know, we have this situation where many people are on fixed rate mortgages, and so you’re raising rates or keeping them elevated, and that’s meant to depress demand. But the concern is that that’s happening on the backs of quite a narrow group of people. Can you talk a bit about that? Is that something that the bank thinks about?
Catherine Mann
So there are two things I think it’s important to think about here, is mortgages are the most sort of obvious place that monetary policy affects consumers. But it’s actually, it’s a relatively small group — 30 per cent have a mortgage. And so going back to Taylor Swift and discretionary components, whether it be restaurants, cultural events, recreation, those prices are ones that I look at really very carefully to see whether or not the pressures that are coming into this certain part of the population that has had a lot of discretionary income in the past, sort of middle, upper-middle income now are being constrained by their mortgages. It hasn’t yet really hit the prices. I think it’s hitting discretionary consumption, but it hasn’t yet disciplined the pricing behaviour of the firms involved. But that’s actually a small group in comparison to the much larger group of people for whom monetary policy affects housing costs. And that’s renters.
We’ve looked at the implications for renters very carefully as well. It is a larger group of people. It tends to be people who are at the lower income levels. That group tends to spend everything, and if they’re spending it on a higher rent, that means they’re not spending it on a discretionary item. So we look very carefully at the implications for renters of monetary policy, and we follow through the implications of a higher mortgage rate on to renting. There’s been research on this, which does show that there is a relationship between a higher policy rate, bank rate, with higher mortgage rates, with higher rents. But there are also a lot of other factors that intercede at each one of those junctures.
I mean, for example, one of the observations is on mortgage rates. Bank rates have been held fixed for almost a year before it was just cut. Mortgage rates went up and down by 100 basis points. You know, we were doing the same thing, right? Nothing happened to us in our shop. And the banks were competing with each other. Or maybe they weren’t. And that was feeding through the mortgage rates. And that was also feeding through to rents. So there were quite a bit of other factors that are relevant when thinking about the relationship between bank rate and rental rates.
Soumaya Keynes
OK. So I want to pin you down on something which is, you know, that there’s this idea that higher interest rates will lead to higher rents, right? And so in some sense, the Bank of England might be chasing its own tail by raising rates. And actually that’s causing inflation. It sounds like you’re quite sceptical that that’s the overall effect there.
Catherine Mann
I am sceptical that that is the overall effect. It’s an example of the need to understand the transmission mechanism of monetary policy through financial market behaviour. All we control is bank rate. Everything else is financial market behaviour. So banks competing for mortgages, other asset prices and how those change housing prices — all that is outside of our control. We pay attention to it, obviously, because it’s our transmission mechanism and we want to follow, well, we do with this with bank rate, changes all these other elements of financial conditions, and then those changes in financial conditions affect what consumers do. It affects what businesses do with regard to investment. It affects exchange rates. So of course we want to look at all of that. But understanding this important partner in the transmission mechanism of monetary policy, which is the private financial system, is incredibly important.
And I do think this brings back the importance of spillovers of other policy decisions in other countries. I wrote a speech about spillovers maybe a year and a half ago, that showed the importance of Federal Reserve decisions for the overall global financial markets and therefore obviously for the UK as well. And the relationship is very strong for the UK. Much stronger, for example, than what the ECB does for the UK, even though the two of them are pretty much the same size, really. But the Federal Reserve plays a very important role in the landscape of financial conditions to which we are responding. I’m not gonna say anything about appropriate policy for the Federal Reserve. That’s their job, not mine. But I can say that whatever decision they make at whatever time will have an important ingredient in the decisions that we make.
Soumaya Keynes
OK. Well, look, why don’t we cut to a break now? And when we get back, I’m gonna get us to go global and talk a bit more about the European and the American context.
[MUSIC PLAYING]
[UNHEDGED PODCAST TRAILER PLAYING]
Soumaya Keynes
We are back from the break. OK, so we’ve been pretty UK-heavy. A bit of chat about how the Fed affects the UK and those international spillovers. But can I ask how you think the position of the American economy is different to that in the UK? What are the key differences?
Catherine Mann
Over the last year or so, we have been quite surprised at the extent to which the UK yield curve and the US yield curve have looked almost identical in terms of having a near-term, high short-term rates and lower long-term rates in the longer run. And we’ve been surprised by that, sort of in a little degree mystified, given that the US economy, in terms of growth, employment and inflation dynamics, has been far more benign than the UK economy. Where the US economy up until quite recently has been growing more rapidly, inflation is coming down more, more quickly and employment has recovered really quite nicely. Going back a year, where was the UK? The UK was in technical recession, inflation was still quite high and the labour force participation was below pre-Covid, whereas of course in the US, above that. So very different under-the-hood, under-the-bonnet dynamics in the economies.
Where we are now, one year on, almost, is a bit of a reversal of fortunes, in that the US economy, it’s still doing quite well, but it has slowed and inflation is a little bit sticky, but not too bad. And the UK economy, by contrast, has come out of last fall’s technical recession with, I think the best word to use is a resumption of growth because it’s not robust, but it has resumed.
And if we look at consensus forecasts, for example, there has been a ratcheting up of . . . by private forecasters, there’s been a ratcheting up each survey month in the forecasters’ prospects for the UK economy for 2024 and into 2025. Inflation has come down but if we look underneath the headline, we should not be, in the UK — and I think that’s true in the US as well — we shouldn’t be seduced by headline inflation because of the role of energy and external aspects working through both directly energy as well as on the goods side. So the US economy has slowed, the UK economy has resumed growth. So it’s a bit of a turning of the tables comparison.
Soumaya Keynes
And what about the Euro area?
Catherine Mann
What’s interesting about the Euro area is the rather significant divergence in underlying economic performance within the Euro area, with Germany slowing and continuing to be exposed to both energy issues as well, frankly, as China slowing issues, whereas the southern European economies are actually doing quite well. And that divergence, of course, has always been a feature to some degree of the challenges facing the European Central Bank as single monetary policy, divergence in underlying economic performance and in terms of inflation as well.
Soumaya Keynes
Just thinking about the future now, I mean, obviously there’s the decision at the last meeting, but you’ll be making many more. What are you looking at most carefully when considering whether these risks are materialising?
Catherine Mann
So it’s always a little difficult to talk about the future until you get there. But it is absolutely required that we have a forward-looking assessment of the underlying dynamics of inflation, because our monetary policy transmission does take some time. I don’t think it takes 18 to 24 months. I think that the monetary policy transmission is much faster than that these days. But we do have to think about what would I be looking at now that would tell me about the future? And one thing is when we ask firms, what do you think your prices are going to be next year, right? And we can look at that, research on pricing and find, first, firms are pretty good at making their judgments on pricing. So if they say they think they’re gonna be able to raise their prices by 5 per cent, they’re pretty good at being right. And so if they say, I think I’m gonna be able to get 5 per cent next year, that says to me, I’m looking at a problem for next year.
We can ask, how often do you do wage negotiations? And firms tend, you know, during the high inflation period, they did wage negotiations or bonuses or top-ups more than twice a year. Now they’ve gotten back to once a year. So wages increased by a certain amount, by 6 per cent, 7 per cent in April this year. So what do you think you’re gonna be doing for next year? What’s your budget? Well, they’re saying, OK, 4 per cent. OK. So that tells us something about sort of the underlying prospects that firms have for what they think is gonna be happening next year. And those are really important things to look at. We have a very successful so-called decision-maker panel, and we can assess prospects going forward based on these surveys. And of course, this is something that the other central banks probably are doing as well. They also have firm surveys.
Soumaya Keynes
OK. Well, look. Final question. Earlier we were talking about the data point that you were watching to get a sense of how worried we should be about the UK’s outlook. What should American central bankers be looking at as their sort of risk gauge?
Catherine Mann
Central bankers, we all do look at the same things. We look at disaggregated elements of aggregate demand. How are consumers doing? Are there delinquencies? Are they credit-constrained? Different countries have different emphasis on these elements. But they’re, you know, they’re all gonna be similar data sets. They’re going to be looking at what are their firms saying that they’re gonna be able to get away with.
For example, looking at earnings calls, which is a very popular research direction to go to these days, the earnings calls from the United States companies have increasingly focused on how consumers are disciplining pricing behaviour. They’re just not gonna put up with these kinds of price increases going forward. That really tells you something about the positioning of companies against what they think they’re going to be able to do next year. I’ll note that earnings calls in the UK are not talking about that. So we have again a situation where that kind of forward-looking assessment by firms of their own possibilities is a very important ingredient for what we think might be happening next year.
Soumaya Keynes
OK. Well, look, if listeners haven’t moved up my silly arbitrary hawkishness scale from the beginning of the show while listening to this, I don’t really know what’s happened. Catherine, thank you so much for joining me.
Catherine Mann
Thank you very much for having me.
[MUSIC PLAYING]
Soumaya Keynes
That is all for this week. You have been listening to The Economics Show with Soumaya Keynes. This episode was produced by Tamara Kormornick, with original music from Breen Turner. It is edited by Bryant Urstadt. Our executive producer is Manuela Saragosa. Cheryl Brumley is the FT’s global head of audio. I’m Soumaya Keynes. Thanks for listening.
[MUSIC PLAYING]
