Why I now expect more Quantitative Easing in the UK by the Bank of England

The UK economy finds itself in an all too familiar position of rising inflation with the Consumer Price Index currently rising at an annual rate of 2.7% and falling economic growth with the Governor of the Bank of England recently suggesting in the latest Inflation Report that it may even be negative in the fourth quarter of 2012.

indeed output may shrink a little this quarter

If we stop for a moment to consider the position we see that some four years or so into the credit crunch this is quite a disappointment. In past recessions even the sharp ones we would be at least on the road to recovery and more usually entering a period of sustained economic growth. Instead we have the Bank of England saying this.

the economy has barely grown over the past two years.

I expect this to cause quite a few disagreements over monetary policy at the Bank of England in the months to come and as I type this I am awaiting the latest minutes for signs of them. However the bottom line is that it has enacted an extraordinary amount of monetary easing with base rates at 0.5% and £375 billion of Quantitative Easing and what does it have to show for it? The answer is the opposite of those give to the famous Monty Python question of what have the Romans done for us from the film Life of Brian

This will be put another way by Monetary Policy Committee member Martin Weale today in a speech.

The last few years have, in terms of real GDP, seen sharp contraction, weak recovery and then stagnation while GDP remains some three per cent lower than at the start of 2008

What else did Martin Weale have to say?

Intriguingly he has tried to make older people who he characterises as complaining about lower annuity rates feel better by telling them that the young are doing badly too!

Also he discusses the “output gap” so it looks as those this outmoded and failed theory still has supporters at the Bank of England. No wonder they are getting things wrong. But if we move to the central point Martin Weale suggests he has moved to the hawkish camp by this section.

I think it is more likely than not that inflation will remain above target for much of the next two years. My analysis suggests that additional stimulus would, without any corresponding improvement in productivity, add to inflation.

He is however what Americans characterise as a flip-flopper and so we should also notice that he has already given himself a possible excuse to change his mind.

The Monetary Policy Committee Minutes

These have just been released and have not disappointed.

For one member, the case for undertaking additional asset purchases at this meeting was nonetheless strong.

One member of the Committee (David Miles) voted against the proposition, preferring to increase the size of the asset purchase programme by a further £25 billion to a total of £400 billion.

Why do you think that this is important Shaun?

This is because the MPC were made aware of this.

The Committee had been briefed on the Government’s intention to normalise the cash management arrangements for the Asset Purchase Facility (APF) by transferring the gilt coupons received by the APF, net of interest costs and other expenses, to the Exchequer.

Which they felt would lead to this

That was likely to have an effect essentially similar to that of purchases of gilts by the APF, and so the transition

to the new arrangements would imply a small easing in monetary conditions.

So the crucial point here is that David Miles voted for more QE knowing that a boost was already being given. Such outliers in voting as usually joined by others at subsequent meetings and if fourth quarter economic output is negative there may be enough for a majority. So the theory that UK QE is now over has taken a severe knock today and I suspect it may not be too long before the “More,more,more” theme is back in play.

The MPC are not keen to reduce base rates

Actually they and I agree on this bit but for completely different reasons. I think that we are in a liquidity trap where interest-rate cuts will make things worse whereas they worry about this.

Staff analysis had concluded that a further cut in Bank Rate would be likely to cause a reduction in the profitability of some lenders, especially building societies

As you know we must not hurt the banking sector! Still at least for once they have come to the right answer albeit for the wrong reasons.

the Committee judged that it was unlikely to wish to reduce Bank Rate in the foreseeable future.

The MPC gives itself a slap on the back

You might think that above target inflation combined with a disappointing growth performance that is near to contraction might be a reason for humility if not sackcloth and ashes. Apparently not.

While views differed over the exact impact of the MPC’s asset purchases, the Committee agreed that demand and output would have been significantly weaker in their absence.

I would like to see them give such an explanation to Roman Abramovich! How many times would he have sacked them by now?


So I remain of the view that upcoming MPC meetings could be quite stormy. Even in the fantasy world in which they inhabit it must occur to them from time to time that their policies are not working. Both inflation and economic growth are ongoing disappointments. However if I look at their track record and like at the likely trajectory for the UK economy today’s MPC minutes mean that more QE is not only on the agenda it looks probable.

To put it another way take a look at this from the supposed “hawk” Martin Weale

There is, nevertheless, an argument for a further stimulus

Paper tiger alert I think.

UK Public Finances

A regular theme of this blog in 2012 has been that the UK public finances have been a disappointment and this has continued today.

Public sector net borrowing was £8.6 billion in October 2012; this is £2.7 billion higher net borrowing than in October 2011

Not inspiring and if we look for more perspective we see this.

For the period April to October 2012, public sector net borrowing (excluding the capital payment recorded as part of the Royal Mail Pension Plan transfer in April 2012) was £73.3 billion; this is £5.0 billion higher net borrowing than in the same period the previous year

So we see that yet again austerity apparently means a higher deficit and that up is the new down. Also whilst given the appearance of a level playing field by excluding the Royal Mail pension transfer financial alchemy the ONS has forgotten the over £2 billion gained from ending the Special Liquidity Scheme. Or to put it another way.

public sector net borrowing has risen by 7.4%, which compares to a forecasted 1.2% decline for the full year.

If we look for why this has happened we see familiar features. Firstly the government is struggling to get a grip on spending.

For the period April to October 2012, central government accrued current expenditure was £364.5 billion, which was £8.3 billion, or 2.3%, higher than in the same period of the previous year

And that this issue got worse in October.

In October 2012, central government accrued current expenditure was £52.8 billion, which was £3.6

billion, or 7.4%, higher than October 2011

Taxes are helping but by not enough

For the period April to October 2012, central government accrued current receipts were £301.4 billion, which was £1.2 billion, or 0.4%, higher than in the same period of the previous year

So as you can see we have a problem which seven months into the current financial year has not gone away. Also we can link today’s two sections as a partial reason for higher expenditure is this.

movements in the Retail Prices Index produced increases in the interest paid by government on index linked gilts

The idea of the government blaming the Bank of England’s failure to control inflation as a cause of fiscal deficit problems? Far-fetched perhaps, but we know that in these times what was considered far-fetched keeps happening.

I have presented that data today using the numbers excluding financial interventions as the ONS does its main analysis on them and has downgraded the ones that I like which include them. I raise this for two reasons. Firstly the numbers I liked already covered the QE accountancy reshuffle between the Bank of England and HM Treasury. Secondly as they are showing a much better trend for the fiscal deficit we may see them promoted from the equivalent of the Championship to the Premiership before too long!

Support from an unexpected quarter

I have been vocal in my opposition to the proposed “improvement” -otherwise know as a change leading to a reduction in the recorded numbers- to the Retail Price Index. Take a look at this from Martin Weale’s speech.

Chart 17 shows the same analysis applied to RPI

inflation (the CPI series is too short for this analysis)

A track record is another reason for not meddling.

Also let me give you a section where in my opinion Martin Weale is 100% wrong.

Movements in the gilts market suggest that expectations of RPI inflation have, if anything moved down in

the last few months

No Martin they highlight fears that the RPI is about to be debased.

Has Moodys downgrade of France confused bond yields with creditworthiness and risk?

Yesterday gave an interesting example of market behaviour. After a series of falls we saw equity markets surge in a pattern which usually defines a bear market rally. My metaphor for such an event is a summer shower of rain which may be heavy at the time but within a few hours there is often no evidence of its existence. No rule of thumb works every time but a 207 point rally in the US Dow Jones Industrial Average to 12,796 certainly fulfills part of the criteria. I found it particularly fascinating to watch the equity market in my subject of the day Italy surge by 3% as measured by the FTSE:MIB index on a day where she had produced poor industrial turnover and new orders numbers.

I have to say that I found the fact that we saw such surges followed later by a downgrade of France by Moodys (from Aaa to Aa1) particularly fascinating. After all the nation itself is informed of such ratings moves twenty-four hours before. I would imagine that I am not the only person wondering if the aggressive headling about France in the latest Economist magazine was influenced by some form of what is called “the early wire”?

What did Moodys say?

I covered the position of the French economy myself on the 9th of November and will discuss here only new thoughts. Mind you I do find the first point a combination of bizarre and maybe a perversion of the role of a ratings agency so let’s get straight to it!

A rise in debt service costs would further increase the pressure on the finances of the French government, which, unlike other non-euro area sovereigns that carry similarly high ratings, does not have access to a national central bank that could assist with the financing of its debt in the event of a market disruption.

The section that I have highlighted is a description of Quantitative Easing where a central bank buys the debt of its own country in return for providing the previous owners with what in effect is newly minted cash albeit of the electronic variety.

Are Moodys correct with this bit?


In my opinion Moodys are confusing credit risk with bond yields. In general the use of QE tends to reduce a country’s government bond yields but this is by no means the same as reducing the risk overall. There is a gain from it in terms of reducing debt financing costs as the recent shenanigans between the Bank of England and the UK Treasury have highlighted. However there are also costs in terms of inflation, feeding the too big to fail strategy and thereby stopping what is called “creative destruction” and the exchange rate. Ratings agencies should reflect risks rather than only prices and yields and Moodys have failed to do this here.

So we see risk as measured by a rating agency diverge substantially from credit worthiness in a repeat of the way they helped plunge us into the credit crunch by mispricing mortgage-backed securities. I suppose you could say that they are being consistent except that in this instance I do not mean it as a compliment, quite the reverse!

Emergency Liquidity Assistance

This is something available to the Bank of France although to do it then it theoretically requires the permission of the European Central Bank. I say theoretically because I have wondered if some of the users of ELA such as Greece and Ireland have in effect “bounced” the ECB into agreement. Whilst it is not QE it is something which in effect has quite a few similarities to it as a central bank takes assets (bonds) in return for freshly created cash. The assets are collateral -usually at the dodgy end of the spectrum- rather than being purchased but if you think about it there are quite a few scenarios where the central bank ends up with them. If we apply the sovereign-bank loop to this we see that whilst it is not the same it may well turn out to be  to use one of the buzz-words of recent years fungible in its concept.

How much impact has the downgrade had?

One of the regular themes of this blog is that these downgrades have lost their impact on financial markets. We are seeing an illustration of this so far today as the French ten-year government bond yield has risen by only 0.03% to 2.1% and 2.1% is hardly a threatening yield is it? It is in fact not far from the lowest it has been in recent memory and the Euro era. The main French equity index the CAC 40 is down some 11 points at 3428 and when we consider that it too rallied nearly 3% yesterday we see the scale of the (non) response so far.

The oil price

Today’s topics are somewhat entwined as France is one of the countries most hurt by a rising oil price as she is not a producer of it on any but a minor scale and is 71st on a list of oil reserves by country. Yesterday’s equity market surge was accompanied by a surge in the oil price as  what is called a “risk-on” day also had the political/war issues of what is currently happening in Israel/Palestine added to it.

The price of a barrel of Brent Crude Oil is above US $111 again but because on Friday the futures market switched from December to January it looked as though it lost three dollars when it did not! However even so it is now some 3% higher than it was at this point in 2011. So just when many economies least need it we are seeing a rising oil price which has both inflationary-via its role as a fuel and also input in many types of production- and deflationary -in a relatively cash-strapped era spending more on it means that other spending is likely to be cut-. Oil producing countries at least have the extra revenue but countries like France do not even have that as a counterbalance.

West Texas Intermediate

This has been rising too recently but it’s behaviour has over the past year illustrated one of the themes with which I started this blog. This was that in many ways it is getting ever harder to know what prices are as we face so many different tariffs which are designed to confuse. But with the oil price we have the issue that the price of West Texas Intermediate has fallen by 9% over the past year compared to the 3% rise for Brent Crude.

So as European and other readers frown American readers can permit themselves a smile! If we consider the theory the way that WTI has behaved should be the reality in a weakening world economy but we also know that these days theory and reality are like friends who meet infrequently.

Exchange Rates

Whilst there are challenges to it these days the oil price is still pretty much in US dollars so for most the exchange rate with it matters. For UK readers you can relax a little as a year ago we were here. Actually I exaggerate slightly as we have moved from 1.58 to 1.59 and a bit! However the Euro has dropped by 5% so oil costs in it will be driven up by that amount too. Even something which will be welcomed by many Euro nations has a drawback at times and in a way that is another theme of the credit crunch era.

Italy’s economic weakness contrasts sharply with Prime Minister Monti’s hyperbole

One of the issues in the Euro area situation has been that a range of countries have come under pressure. The situation started with the smaller economies but then showed signs of spreading to the larger and hence more systemically important ones. This poses an obvious problem in itself but has been added to by the way that the so-called rescue systems of the Euro area depend on the stronger nations bailing out the weaker ones. As the list of weaker nations increases the number of stronger nations to support them reduces too in a system I have labelled an unstable lifeboat.

The European Stability Mechanism

This is an improvement on its predecessor as it has some capital behind it even if some of the capital is supposed to be provided by countries who plainly have no ability to do so. For example Greece will have to borrow the money to pay her share in an example of the type of financial engineering which got us into this mess rather than one which may help us out of it. The dangers of this are illustrated from an EFSF Newsletter.

The ESM will have a total subscribed capital of €700 billion comprising paid-in capital of €80 billion and committed callable capital of €620 billion.

If we feel extremely generous and allow that the weaker nations have capital to pay in which in some cases they do not ,how will they have “callable capital”? The only route for some will be to borrow it if they have to make the commitment described below.

against an appropriate amount of the authorised unpaid capital, which shall be called in accordance with Article 9(3).

The problem is that they will find themselves borrowing the money from the supposedly stronger nations which may tip them over the abyss too.

One of the nations in this situation is my subject of today which is Italy. Her capital share of the ESM is some 17.91% which as you can see is quite a potential exposure before were even allow for the fact that she may have to lend to others so that they can pay their share. On her own account this leads to a potential exposure of just over 125 billion Euros.

This matters for Italy because as she stands she is one of the most indebted Euro area nations if we look at her national debt to Gross Domestic Product (GDP) ratio.The latest numbers from Eurostat showed this ratio to be 126.1% and that it had risen by 4.4% over the previous year. So high and rising. However as well as her own problems Italy is finding that the “rescue” effort is adding to her public-sector debt just as she needs that least. Her share so far of the effort has been 1.9% of her GDP and we know that this will rise as we see today debate about yet another Greek bailout for example and one day the Euro area funds for Spanish banks will have to be paid.

How is the Italian economy doing?

Last week the Italian statistics office told us this.

In the third quarter of 2012 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) decreased by 0.2 per cent with respect to the second quarter of 2012 and by 2.4 per cent in comparison with the third quarter of 2011.

This was perceived as good in the circumstances as it was an improvement on the second quarter. However it was a negative number and showed her economy to be firmly in decline compared to a year earlier. One of the reasons that her public-sector debt burden is rising is that what it is compared to -her economy- is shrinking.

Less well reported was this about her construction sector.

In September 2012 the seasonally adjusted index decreased by 8.0% compared with the previous month

So we can see that at the end of the third quarter it was still in decline and furthermore with an underlying seasonally adjusted index at 74.7 (2005=100) it is declining from a very weak starting point.

 Italy’s industrial performance

This morning has give us an update on the state of play here and it is not a happy one.

In September 2012 the seasonally adjusted (industrial output) turnover index decreased by 4.2% with respect to the previous month (-3.7% in domestic market and -5.3% in non-domestic market).

If we look at this numbers one matter leaps out of the page at me and that is that the export performance is worse than the domestic one. As so many nations are claiming improved export numbers we see a potentially disturbing issue here. There is potential for the fact that this September had 20 working days as opposed to last years 22 to be an issue but if we check we see this.

With respect to the same month of the previous year the calendar adjusted industrial turnover index decreased by 5.4 %

If we look at the underlying calendar adjusted index we see a reading of 111.4 where 2005=100 however this will mislead the unwary. This is because turnover indices include price changes or inflation. In September for example Italian Consumer Price Inflation using Europe’s standardised measure was running at an annual rate of 3.4% so as a rough guide we need to subtract that from the September 2012 annual comparison if we are looking to look at an estimate of volume trends. When you do that we see that the numbers are genuinely poor.

What about future trends?

There is a gauge for this as we have industrial new orders numbers too.

In September 2012 the seasonally adjusted industrial new orders index decreased by 4.0% with respect to August 2012 (-1.4% in domestic market and -7.4% in non-domestic market).

Again we see a weak number that is compounded by the fact that overseas markets are leading the decline. We can also compare the situation with last year for some more perspective.

In September 2012 the unadjusted industrial new orders index decreased by 12.8% with respect to the same month of the previous year.

As you can see the future does not look too bright when considered in that context. Interestingly for those looking for a calendar adjustment the Italian statistics office does not consider it to be relevant or useful. However it does produce an underlying index for the series which is at 97 where 2005=100. As we mull Italy being back to pre 2005 levels overall we see that external orders (-8.1%) are now falling rapidly and that for 2012 as a whole they are some 4.1% below the levels of the same period in 2011.


Today’s economic figures for Italy show the weakness that was evident at the end of the last quarter and if we look at industrial new orders we see that matters look likely to deteriorate as we move towards the end of 2012. If we move to unofficial measures such as purchasing managers indices we see that her services sector was at 46 in October (here below 50 indicates contraction) and her manufacturing sector was at 45.5. So we see that official and unofficial measures are pointing in the same direction which is downwards.

If we bring this message to Italy’s public-sector debt problem we see the scale of the challenge which faces her. In fact the danger is for something of a “blowout” as further economic weakness leads to higher fiscal deficits which are divided by a lower GDP. This will be compounded as the latest austerity package of 30 billion Euros bites ever more. So far we have a clear map of where that leads from the countries that have tried it and ominously the one area where they have shown a gain which is trade is not working at the moment for Italy.

Added to this will be the fact that at best there will be a drip,drip,drip of funds from Italy to some of her Euro area colleagues. Almost everyday the numbers change (aka rise) for Greece and it will not be too long before Portugal needs another bailout too. This is before we get to the more systemically important Spain. If the unstable lifeboat I have described above starts to founder then the drips will become a flood and may be too much for Italy.

The main hope is that she can mobilise her black economy but that has been an apparently insoluble problem for many, many years.

I found it interesting that President Monti confirmed my views over the weekend. The hyperbole and what I call anti-truth reached new heights.

Perhaps today, without the austerity measures brought in by the government, the euro zone would be no more

And yes it was backed up by a claim that Italy will not need a bailout. We know what usually happens next after that!

Will Japan be the first country to have negative official interest rates?

Often these days I find that the themes of this blog come together as a job lot rather than singly which I take as a compliment. One of my contentions over the past 18 months or so is that negative interest-rates and bond yields are spreading and we will be seeing more and more of them as time progresses. Regular readers will recall that I took this message to the Reform think tank last September and may also be interested  to know that “think tank” is now in my financial lexicon. Meanwhile in the land of the rising sun or Nippon there has been a further development.

Let me illustrate from a speech by the head of the Japanese LDP Shinzo Abe.

We want to conduct monetary policy boldly, by taking into account the possibility of revising the Bank of Japan Act

Some care is needed here as “bold action” from Japanese politicians and officials is in my financial lexicon but revising the central banks legal structure had my antennae on full alert.Then Abe san explained. From the Japan Daily Press.

Shinzo Abe, the leader of the opposing Liberal Democratic Party (LDP) and most likely next Japanese Prime Minister, made a statement on Thursday that he wants the Bank of Japan to encourage lending by setting its interest rates to zero or sub-zero.

He has also called for “unlimited” monetary easing from the Bank of Japan which is an interesting concept for an organisation that is in the middle of so-called  Quantitative Easing number 9 which replaced the former QE8 after only about six weeks. Apparently the extra 11 trillion Yen represented by QE 9 is not enough for Abe san who has called it “meaningless”. No wonder he also wants to change the Bank of Japan Act!

However he was not finished as Abe san also added this according to the Financial Times.

the central bank and government should agree on an inflation target of perhaps 2 or 3 per cent.

So we end up with something of a concerted plan which goes as follows. To escape the ( so far two) Lost Decades that Japan has suffered Abe san feels that she needs higher inflation (currently the Bank of Japan is aiming at 1%) which he feels will require both negative interest-rates and unlimited QE.

Put another way we are now on the ground of one of my other themes which is that proponents of extraordinary monetary measures will in extremis -a situation they invariably find themselves in sooner or later, usually sooner- take the “More,More,More” route.

Put another way these are the sort of policies that might have come out of the mouth of the Japanese economist Richard Koo. He is treated by so many people as near to an economic saint which might lead the unwary into thinking that his policies must have been tried and found to have worked! As I have not yet actually heard Mr.Koo approve I will call the plan Koo-like as his view on such matters was summarised in my view some years ago by Luther Vandross.

never too much, never too much, never too much

How did we get here?

The years since 1990 have been difficult for Japan but she also has strengths and the debate has raged as to how well or badly she has done. However the Great Eastern Earthquake of last March gave those wanted more of a fiscal stimulus at least some of what they wanted and led some to predict that her economy would then pick up. However on Monday we learnt this.

Japan’s Gross Domestic Product had fallen by 0.9% in the third quarter of 2012 compared to its predecessor and it was only 0.1% higher than a year ago. Those trouble by her domestic demand  issues which include me so little respite in private consumption falling by 0.5%. To continue the Talking Heads quotes “same as it ever was”. However even more worrying was the fact that exports had fallen by 5% on the previous quarter. Whilst the islands dispute with China will have influenced this it was still a large drop. We can also add in that there was still some evidence of fiscal action as public investment was 4% higher than in the previous quarter.

What has happened since?

Japan’s Cabinet Office calculates a consumer confidence index which since the third quarter ended has fallen (from 40.4 in September to 39.7 in October on the unadjusted series). Also the machine tools orders index fell by 6.7% in October on a year earlier. This is a number which is closely watched due to fact that we receive it early and also due to the fact that it gives us a guide as to what developments we can expect from Japan’s manufacturing sector. With Japanese industrial production having slumped by 8.1% in September compared to the same month in 2011 this is an even more moot point than usual.

What about surveys?

The Markit Purchasing Managers Index told us this.

In contrast, manufacturing output declined to the sharpest degree for 18 months as volumes of incoming new orders fell at a marked pace. The Composite Output Index (covering manufacturing and services) therefore continued to post below the 50.0 no-change mark and signalled a modest rate of contraction. The index registered 48.9, up from a reading of 48.4 in September.

So as you can see there was still a slowdown albeit at a reduced pace.


There are a lot of issues here but if we stop for a moment and consider whether they are likely to build we see that they are as there is little sign of any improvement in the economic outlook in Japan. Also the LDP is by no means guaranteed to win the Japanese election. But over the credit crunch we have found that suggestions of further easing tend by a process of osmosis seep through a political class over time. It would also appear that financial markets are of the same view as the Yen has weakened against the US dollar since the pronouncements were made and is now at 81.12. Also the Japanese stock market has had a good couple of days in response to this and has got back above the 9000 level on the Nikkei 225 at a time when other stock markets have fallen.

Let me give you some thoughts on the likely outcome.

Can Japan raise her inflation rate to a 2-3% range?

This is an often much misunderstood debate as the Bank of Japan has in recent times reaffirmed its commitment to a 1% inflation rate and beefed up its efforts to achieve it as I have described above. However it is failing to make any real progress. So a plan to hit a 2% or more target would to my mind involve a real surge in QE and official interest rates pushed below zero too, possibly significantly so. One more time Japan’s economy will become the world’s crash test dummy.

What will this mean for the Bank of Japan’s independence?

It will not have any. This may provoke a wry smile as for many years it was not considered to have any but one of the changes of the credit crunch era has been that at times it has resisted political pressure. Furthermore I read quite a bit into the words of Deputy Governor Nishimura.

and in its maturity has come to fit itself perfectly to the new age.

He was in literal terms discussing the architecture of the Bank of Japan’s main building but I think we can translate the code.

Oh and it will probably lead to one more change as one of the curious implications of the credit crunch era is that it is the nations who have central banks buying their own countries bonds who have not have negative bond yields! Quite contrary in a way is it not? I am excluding Switzerland because she is buying other countries bonds. But as I consider Japan’s “currency twin” I can only shake my head at a ten-year government bond yield of 0.45% and wonder if it may yet be a race between the currency twins as to who takes their countries official interest rates into the negative zone.

And once one of them decides “To boldly go where no one has gone before” to use a famous phrase, how long do readers think it will be before we join them?

Just for the avoidance of doubt I am discussing negative interest rates acrosss the board as opposed to taxes which mimic that effect or rates just for foreign players.

As Portugal falls further into a double-dip depression, what is going on in the Netherlands?

Today is the main season so to speak for updates on Gross Domestic Product growth in the Euro zone. We had two updates yesterday and on my way to describing them let me cover off a question which I was asked in quite a few places. Having called the Bank of England the second worst forecasting organisation in the world there were natural enquiries as to who I felt was the worst. Let me explain.


Here are her latest official numbers.

in the 3rd quarter of 2012, the Gross Domestic Product (GDP) at constant prices of year 2005 decreased by 7.2% in comparison with the 3rd quarter of 2011.

These are as bad as I feared and are even worse than before. But if we take Kylie’s advice and Step Back In Time we see that in the Original bailout forecasts back in the spring of 2010 the International Monetary Fund on behalf of the troika forecast growth of 1.2% in 2012! Yes -7.2% instead of +1.2% and it means that the total error is on its way to the mid 20 per cents I think as past numbers were revised down too. I think that the best way to review their forecasts is to take the advice of Diana Ross.

 http://www.youtube.com/watch?v=4GtyMeEcPPE … 


Here too we saw  very weak numbers.

The Portuguese Gross Domestic Product (GDP) registered a year-on-year change rate of -3.4% in volume in the 3rd quarter 2012 (-3.2% in the previous quarter).

So we see that the annual rate of fall in Portugal has accelerated and the specific quarterly numbers were weak too.

Comparing with the previous quarter, the Portuguese GDP diminished 0.8% (change rate of -1.1% in the 2nd quarter).

If we look into the detail we see a fading of what has been up to now a bright spark for the Portuguese economy.

the positive contribution of the net external demand decreased significantly, determined by the less intense reduction of Imports of Goods and Services and by the deceleration of Exports of Goods and Services.

These numbers mean that this is now the eighth quarter in a row that Portuguese GDP has been negative. In fact if one looks at the credit crunch overall this latest phase has had more of an impact than the original phase. We hear of the phrase double-dip recession but what we have here looks more like a double-dip depression to me. If we recall that Portugal had an economic growth problem as in lack of before all this began you see the fix she is in.

Unfortunately going forwards there are two more problems to throw into the mix. Firstly unemployment is high and rising as the latest figures show it going from 15% to 15.8% with employment falling. Also we see that more savage austerity measures are planned to be inflicted on a weakening economy in 2013 and we know from Greece’s experience where that road leads.

So excluding Ireland who produces her figures late in the cycle we see that the bailout nations are in the mire. What about those on the edge?


There has been an improvement in the third quarter here compared to its predecessor.

In the third quarter of 2012 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) decreased by 0.2 per cent with respect to the second quarter of 2012 and by 2.4 per cent in comparison with the third quarter of 2011.

However if you hold onto the thought of a -2.4% year on year comparison let me add in an extra perspective. In the third quarter of 2008 Italy had a real GDP of 367.4 billion Euros and this year it was 348.7 billion. So instead of hoped for growth it has fallen by 5% and again please remember this is on the back of a weak pre credit crunch growth performance like Portugal.

Meanwhile the other side of the balance sheet liabilities in the public-sector continue to grow. This weeks numbers for central government debt fell just short of 2 trillion Euros (1.995) but they are edging higher as Italy’s is weakening making for a toxic mix.


Again on an initial viewing these are an improvement on the previous quarter

The Spanish economy registered a quarterly decline of 0.3% in the third  quarter of 2012, a rate one tenth less negative than that recorded in the period  above.

However in annual terms it leaves Spain  in negative territory and heading downwards.

Annual growth stood at – 1.6%, two tenths less than in the second

If we look into the detail of this then after the bad above we have the good.

The contribution of net exports of the Spanish economy to quarterly GDP remains stable at 2.4 points. This result occurs because of an acceleration in exports……

And the ugly (my emphasis)

 This result occurs because of an acceleration in exports and a decrease in the decline of imports.

there is a negative contribution of domestic demand, which reaches -4.0 points compared to -3.8 points in the previous quarter

This allows me to explain Spain’s current position whilst also demonstrating one of the flaws of using Gross Domestic Product as an indicator. When an economy contracts it usually imports less which improves the net trade (exports less imports) section and leads to a higher GDP number for that component. As you can see being poorer and weaker leading to a recorded improvement is not a triumph to say the least! I still recall the quarter for Greece where she initially claimed a 0.8% GDP improvement which was due to this effect. We all know what happened next.

So looking at Spain we see that her domestic economy is very weak but that for GDP it has the offsetting effect that imports fall. She has improved her export performance as I recorded above but overall her position is weaker than the GDP numbers would have you believe. They will catch up in time.

The Euro Area as a whole

I guess these numbers came as something of an embarrassment to Euro area leaders.

GDP fell by 0.1% in the euro area (EA17) and increased by 0.1% in the EU27 during the third quarter of 2012,
Compared with the same quarter of the previous year, seasonally adjusted GDP fell by 0.6% in the euro area and by 0.4% in the EU27 in the third quarter of 2012, after -0.4% and -0.3% respectively in the previous quarter.

The mainstream media will be full of Euro area in recession headlines which may or may not be true as the figures are subject to revision. However my point is that the Euro area is doing worse than the most similar countries which are the EU27, so the extra ten are doing better. Lest we forget the Euro was badged as something which would improve economic performance.

If we look further we see that Germany managed some growth as apparently did France so their 0.2% on large economies mostly offset some falls. However we come to a subject which I have covered in detail only once if I recall correctly and the best summary I have seen of it was simply this from Matina Stevis on twitter.


You see economic growth in the Netherlands was -1.1% in the third quarter of 2012. If we look further we see that domestic consumption,government consumption,investment and exports all fell in something of a clean sweep. The real turnaround was in exports which is the opposite of the trends reported elsewhere today.


We see from these numbers that the supposedly rescued nations of Greece and Portugal continue to exhibit the signs of depression. In Portugal’s case we are seeing what now looks like a double-dip recession which sadly I see only getting worse in 2013. Bailout number two awaits her I think. There are signs of further problems ahead for Spain and Italy but for different reasons.

Just as Euro area leaders sigh with relief that Germany and France just about offset this at the macro level we see that the Netherlands is in rough water. An economy which is supposed to be core has now fallen by 1.6% over the past year. It is worth watching I think as it is easy to be lulled into a false sense of security by a number such as an unemployment rate of 5.4%. We get a little more perspective by noticing that it was 4.5% a year ago. I guess many more will be waiting for the numbers for the fourth quarter in the Netherlands than were watching the third.

Why is the Bank of England the second worst forecasting body in the world?

The last couple of days has seen me analyse both accountancy chicanery and yet another “surprise” rise in inflation in the UK. It has had the side issue of adding the word “spike” to my financial lexicon. Today we will receive the inflation report from one of  the worst forecasting bodies in the world which is the Bank of England. It is already being treated with far more seriousness than it deserves. For example Stephanie Flanders of the BBC   has pointed out that  the Bank of England could tell us that inflation might go up or down with the clear implication that it matters what they say. But taking these reports seriously like that is to make a mistake yourself. We do get a clue to likely Bank of England policy from these reports however we do not get any sort of guide to how the future will turn out unless you use it as an anti guide!

How bad is the Bank of England’s record?

It is simply shocking and I will illustrate by using the forecasting time period of two years and go back therefore to the Inflation Report of November 2010. Just to be clear the reason for the two-year period is that it is the period over which leads and lags operate before monetary policy changes operate at full power.

We see in the Governor’s introduction two regular themes

Over this period, the (inflation) projection is higher than in August

Yes they had underestimated future inflation yet again but in another regular theme (something Stephanie Flanders shares) we get this.

Further ahead, CPI inflation is projected to fall back

Okay so they may have had and let’s be polite, a little bit of trouble as Frank Spencer used to say, with inflation what about economic growth?

Overall, growth is judged to be a little more likely to be above its historical average rate than below it for much of the forecast period

As you can see the discussion of historical averages gives the implication of say 2.5% economic growth per year over the following two years. Indeed they say over that which gives us 5% plus. Actually UK GDP has risen from 102.4 in the third quarter of 2010 to 103.0 in the third quarter of 2012, so unless we are going to see 5% economic growth in the fourth quarter of 2012 the performance in the economic growth area is even worse than the inflation one!

What did they forecast for now?

Having got the period between then and now completely wrong there is of course the possibility that we might now be growing as they thought. However when I see a “fan chart” showing 3% economic growth at its centre I am unsure whether to laugh or cry. Even worse this was predicated on £200 billion of Quantitative Easing and we now have £375 billion of it which apparently according to ex-MPC member David Blanchflower is the “lifeblood” of our economy. So if they had put that into their equation they would perhaps be forecasting 4% economic growth right now. Ooops!

Rather interestingly if we look back from November 2010 we see that the fan chart tells us that the Bank of England forecasting record up to then was excellent as the actual GDP line is pretty much slap bang in the middle. An outstanding effort! Now if anyone can send me evidence that the Bank of England actually predicted an annual rate of fall of 6% in UK GDP for a while in 2009 I would be grateful. You see if you follow the advice of Kylie Minogue and “Step Back In Time” and look at the Inflation Report two years previous to 2009 aka February 2007 then you see a fan chart centering on 2.5% economic growth. That is +2.5% as opposed to -6% which some might think is quite a divergence.

It is of course possible that someone has placed fake Inflation Reports on the Bank of England’s website to embarrass them but then you hit the issue of why? After all they do a pretty good job of that if left to their own devices.

If we move onto inflation we see that the Bank of England was predicting that it would fall to 2% at the beginning of 2012 and then drift lower to approximately 1.6% now. It is of course 2.7% now. So above rather than below target which is an important nuance as I will discuss below.

Did the Bank of England do any better last year?

Let me keep with the theme of a famous Australian pop poppet and use her songs to demonstrate this. Now Mervyn if you are reading not this one.

I should be so lucky Lucky lucky lucky

You weren’t! No I meant this one.

I’m spinning around Move outta my way

You see Mervyn told us this.

Inflation fell back in October to 5.0%.

This is technically true as it had been 5.2% the month before but perhaps he will explain how it fell back from  a forecast of below 2% to 5%.

But we have not even left the Governor’s opening statement and we have another glaring error.

Real take-home pay should gradually begin to recover after a period in which prices have grown faster than wages.

Yesterday we saw that CPI inflation is at 2.7% and RPI inflation is at 3.2% and today have been told this by the Office for National Statistics.

Total pay for employees in Great Britain rose by 1.8 per cent

Unless there is some alternate universe going on here where mathematical rules are different then we see that real wages continue to fall.

If we move onto the main detail we see yet again that the Bank of England’s forecasting record up to that point was superb! According to itself anyway! However this does not quite seem to tally with telling us that inflation would be about 1% now (more inaccurate than a year earlier) also it told us that we would have had 1% economic growth over the past year rather than none.

But never mind because according to it economic growth in the UK is just about to surge to over 3% by this time next year. It is time for a bit of Earth Wind and Fire I think.

Take a ride in the sky
On our ship fantasise
All your dreams will come true right away


I have in the course of today’s post said that I would explain why this mistakes matter. The answer is simple which is that UK monetary policy has been set according to these incorrect forecasts and so by definition it has been wrong. A clear example of this is the way that Quantitative Easing has been expanded to £375 billion in an attempt to boost inflation because the forecast has been for the level of inflation to be below the 2% target when in fact it has been above it continuously for nearly three years.

Also if we consider QE we keep being told that it boosts economic growth which might make you think that as we keep getting more of it economic growth would be going well. Instead it has done the reverse.

To my mind the choice that one has is between the Bank of England being actually incompetent – at which they are doing a convincing job- or whether these are deliberate errors as part of some unspecified policy.

Moving onto today’s effort let me give you some initial thoughts. Mervyn seems to have had a complete change of mind here.

output growth is likely to fall back sharply in Q4 as the boost from the Olympics in the summer is reversed – indeed output may shrink a little this quarter.

Although he does have a brief flash of self-analysis and hence insight.

It is difficult to discern the underlying picture.

Also Sir Humphrey Appleby’s critique applies here I think

This does not mean that the MPC is no longer in control of monetary policy.

For those who have not come across this before let me hand over to Sir Humphrey.

Never believe anything until it is officially denied