Hamish McRae: Don't blame MPC for steering rates up, global liquidity is the backseat driver

So there will be yet higher interest rates in the UK - that we can deduce from the Bank of England minutes yesterday. But don't entirely blame the Bank, or indeed any national monetary authority. The rising pressure from inflation is a global phenomenon and if, as is possible, things get out of hand in the next couple of years, it will require global co-operation to cap it.

Here in the UK the Bank's monetary committee has started to show the concern that some of the rest of us have felt for several months. The fact that some members considered a half-point rise in rates, not just a quarter-point, this month is testimony to that, even if they did, I think, rightly reject that. When late last year I suggested in these columns that rates might go to 6 per cent I did so pretty tentatively. Now that is completely accepted as something close to an evens bet and people are starting to think that they might go higher still.

But if they do, this will be as much the result of pressures from places such as China as they are from British workers and British home-buyers.

The magic expression is global liquidity. There is an unprecedented amount of money washing round the world and it has to try and find a home. Those funds have in part been created by the long period of very low interest rates in the US, Japan and Europe. With loans costing borrowers less than the rate of inflation it is hardly surprising that individuals, corporations, hedge funds and so on should gear themselves up, borrowing money to buy whatever assets they could lay their hands on.

But it was not just low interest rates in the West and Japan. It was also demand for commodities and energy from the fast-growing economies of Asia, most obviously China. The first graph shows how commodity prices were flat or even negative right through from 1980 to 2004. Since then they have risen by 50 per cent. The oil price, as we all know, is also around record levels (next graph).

More recently this inflation has spread to food prices, which are also shooting up, partly as a result of ill-conceived subsidies for bio-fuels. Sounds great to be able to use a bio-fuel mix and hence cut carbon emissions. But people who do so might be a little less smug if they realised that this was pushing up the price of staple foods in Mexico and other relatively poor countries. That is not an argument against bio-fuels. It is simply to point out that if you take food crops and turn them into fuel you will increase the price of food.

There is a further element, however, that goes beyond low interest rates in the developed world and demand for commodities. It is Asian, Middle Eastern and Russian savings. You can see that in the next graph the rising current account surpluses of China and the Middle East. Those savings have to be invested somewhere.

A further twist came this week with the news that China was investing in Blackstone, a US private equity group. For some time the Chinese authorities have been fed up with the low returns they have received from investing in US government securities and have been seeking to do better. But China has been dissuaded from buying US companies: the last time it tried to buy an oil company it was blocked by Congressional pressure. So with a stroke of genius, it hit on the idea of giving its money to that quintessential example of US capitalist acumen, a top private equity group.

It tells you how far the global market economy has come over the past two decades. People in China who spent their early years in a country where everyone wore blue boiler-suits, now happily hands over the country's savings to the sort of institution that British liberals feel at best vaguely uneasy about and at worst downright hostile.

But while we can allow ourselves a certain wry amusement at this, we should be very aware that something like 80 per cent of the flow of net savings in the world comes from Asia, the Middle East and Russia. It will be those owners of capital that will increasingly determine where investment funds are placed. In a world where the supply of assets rises more slowly that the supply of investment funds, this will determine to a large extent what happens to the price of different classes of assets.

An example close to home would indeed be the London property market. Foreign owners choose to buy homes in a few specific areas in West London. So the differential between prices in these favoured locations increases relative to places where the principal buyers are British, such as Islington. Tony Blair would have done well to have hung on to his Islington home but he has not done too badly by buying his new pad near Marble Arch, because that is an area that attracts Russian and Middle Eastern money and prices have shot up since he bought it.

So asset prices are inflated by global liquidity. Asset prices matter socially because any rise in them tends to increase inequalities: the haves inevitably benefit more than the have-nots. In economic terms they matter partly because in some measure they are likely to feed through into current prices, and because an asset bubble (if that is what we are seeing develop) pops when the liquidity is withdrawn.

As far as current prices in the UK are concerned, there have been two forces that have held things down. One has been cheap goods imports: you can buy a toaster from China for not much more than a sandwich. But now goods prices are no longer falling, partly because China has to pay global commodity and energy prices like the rest of us, and partly because other costs are rising there, too.

The other is immigration. The increase in our labour force from Eastern Europe (and incidentally also from older people returning to work) has kept the lid on British wage rises. But earnings now seem to be rising a little faster than they were a year ago, insofar as the figures accurately tell us what is happening to underlying wage pressures.

VAT receipts have shot up, which suggests that people are certainly spending a lot more, so presumably they must be earning more, too. At any rate, the Bank seems to be more concerned about these underlying pressures than it was even a couple of months ago; and rightly so. At least it is now on the case and that is good. The next concern, still over the horizon, will be what happens when global liquidity is withdrawn.

A paper by Stephen King of HSBC (who writes in these pages on Mondays) looks at this whole phenomenon: the extent for example that Japanese monetary policy has increased liquidity in the US and Chinese foreign exchange reserves are boosting liquidity in Europe. His conclusion is that while policymakers have to recognise that they have less domestic monetary sovereignty they also will have to accept they have more of a global role. The Fed (or the ECB) may have to place more emphasis on its role as an international monetary anchor rather than as merely a guardian of domestic inflation.

That must be right. Meanwhile, though, they all need to be aware that when the tide of money flows out again they will have to co-operate to limit the damage.