Yesterday saw some action on what are considered to be the fringes of the European Union and the euro zone. We saw Ireland downgraded by Moodys but as this in the main only brought it in line with the other ratings agencies and only had a small impact with her ten-year government bond yield rising only a little to 5.59%. However she does have some bond issuance planned for today. Hungary however had a much more difficult day after her government ended up suspending negotiations over terms for further tranches of funds from the IMF/EU. By the end of the day the Forint had dropped from 281.25 against the Euro to 291.88, and against the Swiss Franc it fell from 207.14 to 213.81. So if you are a Hungarian with a Swiss Franc mortgage ( one of the 1.7 million) your mortgage rose by 3.2% in one day. If that does not show how risky such mortgages were and indeed are I do not know what will. I am still amazed that this was ever allowed, were the relevant regulators asleep again? Also the BUX equities index fell by 2.9% so let us hope that any repayment vehicles were not invested on the Hungarian stock exchange.
Panorama and bank behaviour
I was intrigued by this programme when I saw the trailers. The subject of a hidden transfer of money to the banking sector via allowing banks to overcharge for loans and overdrafts whilst of course the official ZIRP ( Zero Interest Rate Policy) keeps savers returns low. This allows the middleman or bank to make rather nice profits. Combining this with the way central banks around the world have supplied cheap money to banks which has allowed them to invest it in higher-yielding assets and again make a profit. Quite how this is considered a punishment for past misdemeanours is baffling to me. Of course it is much more likely that having poured so much taxpayer money into the banking sector politicians in general want to show us a profit even if it is financed by a another transfer to the banks from the same taxpayer. Politicians really do have a low regard for their voters.
Implications for Monetary Policy
In one of my first posts (15th December 2009) I wrote about the difference between official and unofficial interest rates in the UK. I thought then that by losing control of interest rates in the early part of the credit crunch the Bank of England had in effect made it worse.
In the UK we had a sustained period of market interest rates exceeding the official ones. This lasted in its most severe form from August/September 2007 to September 2009. This has some interesting implications for what has happened I believe.
1. UK monetary policy was tighter than intended and was in fact contractionary for much of this period.
Having failed to do much about a very contractionary effect on our economy led the Monetary Policy Committee to then follow an over expansionary approach in my view which has helped create our inflation problem. However these extreme cuts from over 5% to 0.5% then took official interest rates away from market ones again.
Until this weekend it was possible to invest money on a one year basis with National Savings (backed by the UK government) and get a gross return of 3.95%. Some savings institutions are offering rates of around 3% on instant access. Now if we look at mortgages tracker rates are around 3% for new mortgages at best,and the average 2 year fixed rate according to money facts is at 4.86%.
To try to normalise the situation (which if you think about it is related to Keynes’ idea of a liquidity trap) and also to look to try to head off an incipient inflation problem (remember this was last December) I suggested the following.
Accordingly I remain of the view that raising interest rates to 1.5% will be a beginning in us negotiating our way out of our current difficulties.
Back to Panorama and our banks
If one could fight ones way through the way that the BBC chooses to present programmes these days there were some useful insights. For example a bank which is nationalised in all but name HBOS now charges £1 per day for overdrafts which on a £10 overdraft leads to an annual interest rate of 3650%. On the comments page to this programme I noticed this “I got charged £156 last month for going overdrawn twice in one month by £30 and this month I have gone overdrawn again because of the charges.” According to the programme authorised overdrafts cost an average of 32% which it compares with advertised rates of 19%. Personally even 19% seems a very long way from the official 0.5%.
So to my mind the programme highlighted an important area even if it was a little short on facts. On this subject I have question for readers about the BBC. I watched coverage of the Open Championship over the last few days. In many ways the BBC’s coverage is very good but it has an obsession with having its “star” presenters chatting (two hours on saturday and 1 1/2 hours on Sunday) when golf is being played. I also noticed that a skill which existed 10 or 20 years ago which is the ability of a cameraman to follow a golf ball in flight has declined in a much higher tech era. I have started to feel that the BBC’s celebrity obsession is affecting basic skills. Am I alone in this?
Back to the subject of unofficial and official interest rates I wrote this on the subject on the 21st January
I have written before on the difference between official and unofficial interest rates in the UK. On this subject I notice that the Skipton Building Society is going to raise its standard variable mortgage rate from 3.5% to 4.95% on the 1st March.
Remember the official rate has not changed for quite some time and such behaviour I feel is shameful. But a combination of our finance sector and our politicians is letting it happen.
Our politicians and their behaviour
The new Coalition government claimed that it would be a breath of fresh air when compared with its predecessor although I am sure all new governments say that! One of the more respected members of it (in opposition anyway) Vince cable added this to the Panorama programme.
“One of the negative side effects of this crisis is that our banking system that was already very concentrated is now even more concentrated so there’s less competition, less choice and bigger temptation for banks to earn margins at the expense of their customers,”
I completely concur with that. However the day had another event in it. You see the part of the UK government which competes for retail savings, National Savings, cut its interest rates. There was a 0.25% cut in some rates and some savings certificates were withdrawn particularly the index-linked ones which have become “too popular”. The official reason is that National Savings has hit its targets. As the UK has enormous deficits to finance this really stretches credulity to breaking point. The true answer is that the banks desperately need retail funding and have been knocking on the governments door to stop National Savings competing so hard for funds. So not only can they charge what seem usurious rates to lenders they are allowed to offer lower rates to savers (an end of the spectrum Panorama ignored). So Mr.Cable’s government’s deeds do not match his words.
Not only is it quite plain in my view that our finance sector is getting another implicit bailout by being allowed to widen its margins but this policy is also affecting our underlying economy. The effects of this are many. Those paying high overdraft rates are hardly likely to be able to afford to consume as much. Firms are complaining that the banking sector is not lending to them. But instead of doing something about it we cross-subsidise the banks.
However in terms of the Bank of England’s control over the economy there are deeper problems. As it has a monopoly over money creation it can set any nominal interest rate it likes. However the way that official and unofficial rates have diverged has weakened it position and this has existed since late 2007. Its desired impact on the economy has played second fiddle to helping the finance sector. This needs to change. In some ways there are issues with this policy even for the banks. You see they make easy profits now but the retail deposits they so badly need are hardly encouraged by real interest rates which in the UK are negative. So a policy which is bending our whole economy is illogical in the medium-term to my mind.
UK Public Finances
The Office for National Statistics has published the following figures this morning, public sector net borrowing was £14.5 billion in June 2010, which compares with borrowing of £14.7 billion in June 2009. Public sector net debt, expressed as a percentage of gross domestic product (GDP), was 63.9 per cent at the end of June 2010 compared with 57.3 per cent at end of June 2009. Net debt was £926.9 billion at the end of June compared with £797.5 billion a year earlier.
These numbers are troubling in several respects. Firstly they are similar to last year’s when our situation had appeared to be improving and they are also worse than economists forecasts for them. Looking at the detailed breakdown is not reassuring either as we have reduced public investment since last year but the deficit has shrunk by less,so our public sector is consuming more and investing less. Just to add to the poor news the figures for April and May have been revised up by £1.4 billion in total. So for the financial year so far public sector net borrowing is £40. 3 billion which is only very slightly lower than last year’s £40.9 billion.
I always counsel caution on the reliability of economic figures and so will not over-emphasis these figures but I am concerned about the prospects for July as it is a month when self-assessment payments are collected and could be a time when we find out how the self-employed actually did in 2009. Of those I know there has been a clear trend to weaker performance and hence lower tax payments. I still also expect the 50% tax rate to have “transferred” tax payments into last year and to lead to a lower level of tax collection for that particular income group over the medium term. However caution is required again as past experience of UK recessions led me to over-estimate the UK’s likely borrowing in 2009/10.
National Audit Office
This institution has suffered some knocks to its credibility in recent times. However today it is back on form even if it adds to the gloom. It has in effect criticised the previous government for claiming spending cuts but not having any real plans to achieve them.Labour announced the target to cut spending by £35bn by the end of the 2010-11 financial year in 2007, but the National Audit Office said the government was currently not on course to meet it. Whilst the coalition government might see a chance for political advantage in this the NAO has also questioned its plans and found shortcomings.
“The scale of savings needed in the current financial situation means that departments will have to think more radically about how to reduce costs and how to sustain them in the longer term.”
In a way we are back to our (unsatisfactory) politicians again. I have written before that I question their resolve and ability to actually cut public expenditure and it appears that the NAO is joining me in such thoughts.