British Manufacturing Slumps As Bank Of England Raises Interest Rates

On August 2nd, the Bank of England announced that its Monetary Policy Committee had unanimously voted to raise interest rates. This recent decision by Britain’s central bank saw its key ‘base rate’ of interest rise for only the second time since the 2007/8 crash. The 25 basis point hike brought the base rate up to 0.75%, its highest level since March 2009.

This is likely a reflection of the Bank of England’s growing confidence in the strength of Britain’s economy. Despite relatively slow GDP growth, Britain’s present record highs of employment had led to concerns that failure to tighten monetary policy would lead to “domestically generated inflation” through “excess demand”. Simply put, this refers to the widespread concern amongst mainstream analysts that maintaining low-interest rates in a full-employment environment would induce employers to raise wages in order to attract scarce labor, which would, in turn, lead to price inflation when those workers start spending those extra wages. The Bank’s new rate hike is likely also intended to slow the pace of CPI inflation in the British economy, which has been consistently above the Bank’s 2% inflation target since the beginning of 2017.

The key place of interest rates in the framework of the Austrian business cycle theory lends a special significance to events such as this. This theory, developed by both Ludwig von Mises and F.A. Hayek, highlights the ability of central banks to stimulate unsustainable economic ‘booms’ by pushing down interest rates to artificially low levels. Although Austrians often focus on how low-interest rates fuel the boom, the role of interest rate rises in triggering the ‘bust’ is equally important.

After a period of artificially low-interest rates — such as the one the world economy has been experiencing for nearly the past decade — central banks will eventually have to slow down the printing press and raise rates again, to avoid plunging their currencies into severe inflation. When interest rates rise again, the marginal business ventures which had only appeared profitable at the previous temporarily lowered interest rate, will now no longer find themselves able to remain in business at the new, higher cost of borrowing. While this effect does not always cause an immediate crash, the added strain of newly-raised interest rates will eventually necessitate a painful and widespread reallocation of resources away from the projects which had only been able to survive thanks to the previous period of temporarily low-interest rates.