The UK Economy shows signs of slowing down whilst the Federal Reserve should take no action today

Yesterday was a day which saw strong rallies in equity markets. It started in the Far East with the Nikkei 225 rallying 116 points and carried on around the world. The UK FTSE 100 surged nearly a hundred points to over 5600 and the Dow Jones Industrial Average rallied some 145 points to 10753. This meant that the Nikkei can still not get within 1000 points of the Dow Jones in spite of its favourable response to the Bank of Japan’s currency intervention to try to weaken the Yen of last Wednesday. Indeed as this morning the Nikkei slipped slightly to 9602 the spread now stands at 1151 points. At the same time the US government bond market rallied too with the ten-year yield falling by 0.04 to 2.71%. To me these rallies look as though there still may be some hope that the Federal Open Markets Committee which meets today will launch the so-called QE 2. For the uninitiated QE 2 means a resumption of asset purchases which are likely to be US government bonds and would be an expansion of the current rate of purchases which will be some US $27 billion this month. The purpose of this is to put more money into the economy in the hope of leading to looser credit conditions and encouraging economic growth. Although there is a theoretical inconsistency as the requirement for QE 2 means that QE 1 which spent some US $1300 billion failed. 

Moving onto currency markets this morning has seen a slight weakening of the Yen as it now stands at 85.30 versus the US dollar and 111.69 versus the Euro. Perhaps we are seeing the first challenge to the intervention by the markets and the Bank of Japan had better be alert and those who had for some strange reason called the intervention a success already might be a little more willing to let time pass in future.We have not even had a week yet. 

Commodity Prices 

These continued what seems to be an inexorable march upwards yesterday with the Commodity Research Bureau’s spot index rising by 3.23 to 478.72. Indeed there was a strong “agflation” element to the rise as the fats and oils component rose by 20.96 to 460.26 for a move of 4.7% on the day,and the livestock component rose by 15.91 to 512.63 for a rise of 3.2% on the day. So we are seeing sustained rises in food products at this time which will feed into prices and are likely to contribute to retail price inflation, this of course sits oddly with disinflation fears. 

The UK Economy: is it slowing down? 

After a very strong performance in the second quarter of 2010 where economic growth was measured at 1.2% more recent evidence on the UK has shown signs of a slowdown. Some only takes us back down to what in themselves are solid numbers for example the most recent growth estimate from the NIESR suggested that we were growing at a quarterly growth rate of 0.7% which would have led to smiles at the beginning of the year. The European Commission has raised it forecast for UK growth in 2010. 

In 2010 as a whole GDP is expected to increase by 1.7%, up by ½ pp. when compared to the spring 2010 forecast.




I quote from it because in their usual regard for the rules of mathematics they project growth in the third and fourth quarters to be 0.5% and 0.6% which of course leads to a much higher number than 1.7%. It does say 2010 as a whole…. 

So the forecasts remain okay but some of the underlying data is more troubling and of course the forecasters records are patchy at times,for example the European Commission has just raised its forecast for Germany from 1.2% to 3.4% for 2010 so really the forecast does not inspire great confidence in itself. 

UK Money Supply: M4 and bank lending 

These figures are important because they go to the heart of the credit crunch and all the talk about lack of bank lending and liquidity etc. They are one of our better windows into what has been happening in this area. There had recently been some signs of an improvement and for a while the Bank of England was using it as an example of how its asset purchases had helped the economy although they soon tired of this for some reason.Improving credit conditions would be seen as perhaps a return to normal times and all that entails. 

Unfortunately the provisional figures for August tell a disappointingly weak tale. If we look at M4 growth because it is one of our widest measures of the money supply we got the following.Seasonally adjusted M4 decreased by £4.1 billion (0.2%) in August, compared with an average monthly increase for the previous six months of £2.2 billion. The 12-month growth rate fell to a new low of 1.8% from 2.3% in July. The month on month rate dropped from 0.4% to -0.2%. 

If we move onto M4 lending we find that this decreased by £18 billion (0.7%) in August. The 12-month growth rate fell to 0.6% from the 1.5% recorded in July.  Indeed the Bank of England’s preferred measure which is M4 lending (excluding the effects of securitisations etc.) decreased by £18 billion (0.7%) in August as well. Its 12-month growth rate fell to -0.5% from 0.5% in July. 

If we look at M4 lending from May 2010 to August we now have had growth figures of -13.8,-3,-12.6 and -18 billion respectively which is troubling. 


If these provisional numbers are repeated in the revisions then we are seeing weak numbers which imply weak economic performance going forwards. There is something of an irony in economic growth forecasts being revised upwards as the broad measure of money supply weakens but in truth monetary changes like this usually do not have an immediate impact and are more likely to be felt in 2011 than 2010. Combining this with the governments cuts in public spending may make for an unhappy mix in 2011. 

UK Housing Market 

One of the main subjects which touches on money supply and bank lending levels is the UK housing market. For those unaware the UK has a higher percentage of owner-occupiers than its peers and most borrow the money to do so. However the market has suffered from low volume levels in terms of transactions for a while now, and indeed this has been a clear feature of the credit crunch as well as a drop in prices followed by a rally which took them back to 2007 levels at least where I live.  

Yesterday gave us some further data on this matter as the number of mortgages granted to first-time home buyers fell in July to 19,400 from 19,700 in June and 20,100 a year earlier the Council of Mortgage Lenders reported. It also reported that approvals for loans to buy homes made by Britain’s six biggest lenders  also fell to 45,000 in August from 47,000 in July, the lowest since April 2009. The total amount of borrowing for mortgage purposes was £11.4 billion in August which is a ten-year low for August and is down 14% on July. 

Added to this there is more and more evidence that house prices in the UK are falling. We appear to be turning downwards and in my opinion this has been due for some time but has been delayed by a lack of liquidity and volume combined at least in London with the emergence of foreign buyers as the fall in the pound versus other currencies made UK property look cheaper in their home currency. Most of the surveys are showing this now although the proliferation of these surveys often leads to more confusion than clarity. 

The UK housing market compared with Ireland’s 

This is a matter which has troubled me for some time. I understand that Ireland had more of a property boom than the UK and so is likely to have more of a bust. My point is that in the UK we were in danger of having no bust at all in terms of residential property and even though commercial property did have falls I am not sure it fell by enough. Here are the thoughts which trouble me. 

1. Some UK banks were players in the Irish property market but we hear little about this and in particular the likely losses.One of the features of the credit crunch is the lack of transparency from banks and indeed often from their regulators too. 

2. Irish banks were involved in the UK commercial and residential property markets and on the latest figures out this week it would appear that 21% of the loans that have gone into NAMA were on the mainland UK and 6% in Northern Ireland. These will have to be sold over time. 

3.The problems in the Irish economy will impact on the UK in the end if they carry on as they are as there is a lot of trade and travel between the two countries. 

UK Public Finances: the price of higher inflation 

After an improving recent trend the figures for August which have been released by the Office for National Statistics are disappointing. Net borrowing was 15.3 billion pounds  compared with 13.5 billion pounds a year earlier and this is the highest figure for August since records started to be kept in this format in 1993. The figures I quote here include everything as I feel that is the right measure,the official figures are attempting to emphasise those which exclude financial intervention in a disappointing attempt to spin our level of national debt. Unless I am very much mistaken we have borrowed money to prop up our banks and they have not yet repaid it. 

These figures exceeded forecasts too and this will be disappointing for the forecasters. I have examined the breakdown of the numbers and the factor which mainly caused the rise was debt interest which rose from £1.1 billion to £3.8 billion. This reminded me that August is the month where the figures for index-linked gilts are a strong component and if anyone is aware that inflation has been higher than last year it should be the economists doing the forecasts. Accordingly index-linked gilts which are linked to the Retail Price Index on a lagged basis are more expensive to finance than last year. 

So there is an element for once of a genuine one-off influence for now anyway but even so the figures will be something of a warning shot for those who felt that our public finances could improve on their own. 


Whilst 2010 has so far been a much stronger year than expected for the UK economy there are some worrying cross-winds developing which means that 2011 may open with a few challenges to it. Our housing market looks as though it is finally starting to turn downwards and that carries quite a few implications for the wider economy. We return yet again to the question is this a normal lull in a recovery phase or something worse? I suspect that I will be typing that sentence more than a few times in the months ahead! 

The Federal Reserve and Ireland 

There are two significant events today. As I stated earlier the Fed is meeting and just to be absolutely clear my view is that with such an unclear picture they should stay their hand and do nothing. However they have buckled under pressure before and perhaps a saving grace on this front is that the pressure on them has declined recently. 

As I reported yesterday Ireland has two bond issues and in her current circumstances these will be watched closely. Just to add to the mix Spain will also be issuing some bonds and Greece some Treasury Bills.


10 thoughts on “The UK Economy shows signs of slowing down whilst the Federal Reserve should take no action today

  1. Hi Shaun,

    “The figures I quote here include everything as I feel that is the right measure,” Not sure that is correct? I do not believe this includes all the off balance sheet debt, such as PFI and Public pension liabilities, and as you seem to observe later all the funds loaned in one form or another to initially bail out the banks, and then that additionally subsequently made available to them by the BoE.

    To arrive at a true total of UK Public debt I feel in addition the loans to the banks by the BoE at the artificially-low interest rate of 0.5% should be included since they are in effect loans subsidised out of the Public purse. Independent assessments of the real total of Public debt now exceed £2 Trillion I believe.

    • Hi Drf
      Apologies, there was a missing “as the Office for National Statistics records the numbers” in the sentence. A bit like the way they are emphasising CPI and de-emphasising RPI in the inflation bulletin they issue they are emphasising our debt and borrowing numbers excluding financial interventions in their relevant bulletin. Presumably on the grounds that they feel they are “temporary”. They may or may not prove to be temporary but that is besides the point as if we owe it then it should be in the numbers until it is repaid. Once it is repaid then the numbers will be the same.

      As to PFI etc I agree that they should be included too but in reality they are not in these figures.

  2. I’m an amateur economist and have been reading, with much interest, your blog for some time.

    To be honest I have some confusion over the current situation with money supply and how it is being affected.

    To try to illustrate here is a simple example:

    Bank A has a deposit of £100. Bank A can now lend £97, as they only have to hold 3% in reserve. They lend this money to Bank B, who now have £97 on deposit and can lend £94. So there is £100 of ‘real’ money and debts of £191.

    This then continues, with someone creating CDO’s and what have you and before you know it every pound is responsible for a lot of debt. Someone realises this and you have a credit crunch as everyone tries to unwind all those debts and get back to some real pounds.

    This causes a problem for the banks who don’t have any real money and the government gives them some. The problem still exists and the BoE creates some fiat money and gives it to the banks to help them out.

    Now as I understand it this is what has happened, simplified for brevity.

    So at the moment banks are still trying to get back to a more sensible position but they are faced with several challenges.

    1) The must hold greater reserves. I think this was decided at a meeting of central banks / senior financial regulators. Every pound must now be responsible for less debt than before. This means a reduction in money supply.

    2) A possible split between storage and fractional reserve style banking. (video, 8:14). This could also lead to a reduction in money supply.

    3) They must pay back the money to the government by ‘making’ it. This means they will charge more for loans, pay less for deposits and pocket the difference. This will also lead to a reduction in money supply.

    To illustrate further, the Banks in China have been required to hold greater reserves. This was supposed to reduce money supply and ‘cool off’ the economy, which was accelerating too fast (it was deemed).

    Finally what should be done to rectify this situation? The only way through this, that I can see, is for the central banks, in particular the BoE, is to create fiat money. This needs to be equal to the amount money supply is being reduced by, otherwise deflation will occur.

    I can understand the reduction in M4 lending, and I believe that this will continue as long as the banks are still obliged to increase reserves and pay back obligations. This will of course have the effect mentioned on the property market as very few individuals have enough real money to be able to buy a property outright it becomes a question of how much people can borrow. With lending reducing, this will also fall. As the property prices fall the assets which the banks hold, here or in Ireland, will also fall. This again will mean less lending. I will say again the only way to counter this is for the BoE to increase the money supply.

    I should point out that I think it is wrong for central banks to be printing money but the current politiconomics means that this is the most likely route.

    • Hi Kentish Mike and welcome out of lurkdom

      Here is a thought for you. The wider measures of money supply are really measuring money demand. For narrow money one can measure a supply as in notes,coins and deposits at the central bank,for wider ones you are really measuring demand. It is not like a physical product where you could say that Ford has made too many cars there aren’t any fields full of loans…

  3. Hi Shaun
    Thinking about QE/M4 for a moment, and its transmission mechanism, I wonder if you could explain the effect of BoE lending its gilts to the DMO Gilt Repo Facility. The BoE creates £200bn money and buys gilts from institutions. Institutions use that £200bn to either buy another asset or more gilts or keep on reserve at the banks, increasing liquidity or funding government cash flow. BoE then lend the £200bn worth of gilts to the Repo gilts market where those are used to create additional liquidity for gilt borrowers when swapped for cash, keeping costs of funds low becase they are virtual cash. Is that the way it works?BoE/DMO/Intermediaries/repo users can make margins on their repo deals and use them as a means to cost effectively refinance wholesale funding from week to week.Is that it. Just interested in finding someone who can throw some light on this as I cannot recall this being explained to the public.

    • Hi Shire
      There is a lot that the Bank of England is doing at this time and some of them are different concepts. In essence the asset purchases known as QE were an attempt to supply money to the economy to raise the money supply and hopefully improve the economy. So some £200 billion of cash was given in return for £200 billion of gilts. Whilst this is a relatively simple concept it raised the money supply and for now is a permanent boost to the stock.

      For those unaware of the situation there is also a repo market. This is short for a sale and repurchase agreement. This is defined as a combined transaction providing for the sale and subsequent repurchase of (in this context) a gilt. It allows you to go short of a gilt for a period and is usually associated with hedging of other risks including an old stomping ground of mine the LIFFE long gilt futures market. So whilst such measures help with liquidity for the gilt market they are not explicit creators of cash in the same way.They began back in the mid-90s way before QE was even a twinkle in Mervyn King’s eye!In this market the Debt Management Office does trade but according to its own figures it does not repo in large size, to give an example of this the last press release I could find was for back in July and it was for around £35 million.

      However it is not that simple (sadly it rarely is!) the Bank of England separately undertook long-term extended- collateral repos which began in December 2007. The size of this market is certainly significant as it peaked at £180 billion in early 2009 and is in fact still going on. This market is more troubling to me as the collateral the Bank of England took on has shown signs of being dodgy. The definition here “is ‘Narrow’ (sovereign and supranational) collateral plus ‘extended’ collateral, including AAA-rated collateral. RMBS, covered bonds and certain asset-backed securities (ABS); widened further in September 2008 to include securitisations of commercial mortgages and corporate bonds and loans.” Here rather than gilts if you met the criteria you can get repo cash for other assets and this is the real area for worry in my view as even the Bank is worried as to the quality of assets it has received in this programme.

      However repos come with an explicit time for them whereas so far QE does not…

      I also forgot to add that the Bank of England has a repo agreement with the US Federal Reserve which rose to some 86 billion US dollars in October 2008 so someone was desparate for cash in US dollars then. This deal ended but the agreement was reinstated in May so watch this space as they say…

      • I would like to understand how the BoE will extract the liquidity created by QE when the market turns? Assuming the main way will be to issue further gilts then the yield required will have to be higher than the yield the banks will get from investing the money in the market. Thus interest rates will have to rise much higher than anticipated???

        • Hi Ian
          When you look at QE and an exit strategy then one alternative espoused by a former MPC member is that the gilts can be held to maturity in a type of alchemy. I would like the opportunity to ask him if that is so why he did not perform the same operation for every gilt that was issued during his period of tenure…..

          In terms of your question then yes and in another form it has been done before. Back in the Thatcher era in a policy called overfunding we issued more gilts than we needed to in an attempt to reduce the money supply and hence inflation which was a problem at the time. It is curious how so many have apparently forgotten that if overfunding helps to control inflation then underfunding may feed it. All other things being equal it is likely to raise longer-term interest rates at that time but by how much depends on the circumstances. In my view the current bond friendly situation is only likely to persist if economies slow further in which case we will not be reversing QE. However what state long rates will be in and how it will be taken cannot be accurately predicted. But as I have written on here before there are many dangers, what if we struggle to sell them?

  4. I think the policy-makers are making it quite clear that gilt-selling to reverse QE would only be undertaken after interest rates have been raised first to a more normal level ( presumably when we return to trend growth). To my mind, that might well lead to market losses arising on gilt sales in the future. Perhaps they will alter financial regulation again to force banks to buy them back!?

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