After a day dominated by what the People’s Republic of China had not done in response to rising producer and consumer prices in China we saw the trends from which she suffers continue. For example the Commodity Research Bureau spot index rose to 506.12 a new high for this year and it is now up just under 22% on an annual basis and the West Texas Intermediate crude oil benchmark rose by0.5% and is now priced at US $88.80. So there was little relief from rising commodity prices for China or indeed anyone else.
The European Central Bank buys more bonds and may ask for more capital
The first issue of the day was the announcement of the amount of Euro zone peripheral bond buying it had settled in the week ending the 10th of December. Please note the use of the word settled as the ECB may yet be manipulating what we are told.
A variable rate tender with a maximum bid rate of 1.00% will be applied and the ECB intends to absorb an amount of EUR 72 billion. The latter corresponds to the size of the Securities Markets Programme, taking into account transactions with settlement on or before Friday 10 December, rounded to the nearest half billion. As the SMP transactions which settled last week were of a volume of EUR 2,667 million, the rounded settled amount – and the intended amount for absorption accordingly – increased to EUR 72 billion.
So we find that the ECB looks like it purchased fewer bonds than many thought ( with the caveat placed above). This may be because markets are very quiet at this time of year and there is little activity. So the ECB may be acting in something of a lull for bond markets. If we look at what has happened in the US government bond market then timing is not the full answer as it has made a major move recently so I think that circumstances have also played a part with too volumes declining waiting for the next move by Europe’s politicians. On this subject they are meeting on the 16th and 17th of this month, but they have met a lot recently and if anything seem further away from an answer than ever. So the ECB looks as though it is likely to have to keep buying these bonds in spite of the fact that more and more members of its Governing Council are either against it or publicly expressing reservations about it.
The SMP and other bond buying causes a problem for the European Central Banks capital level
Regular readers will be aware that I have written often about my concerns for the balance sheet of the ECB. I wrote this on the 6th of December.
As the SMP buys ever more bonds that one day will need some form of restructuring or even default then the balance sheet of Europe’s central bank looks ever riskier to me and it is quite conceivable that we could be in an era where central banks as well as private-sector banks need bailing out. In a strategic sense the ECB is in a hole and it is digging rather than trying to get out of it
If we examine the ECB ‘s actions it has purchased assets in its covered bond and Securities Markets Programme that are likely to be at a loss before we even get to the quality of collateral placed against its other liquidity operations. Yet against this it only has a capital subscription of amounting to €5,760,652,402.58. As it is a bit short I thought I would put in every cent! Now as the two asset purchase programme have purchased around 133 billion Euros of assets then we can see that only a relatively small percentage of losses would leave the ECB with no capital at all or even negative capital. However not all the capital has been paid so the ECB in fact only has a paid up capital of 4.142 billion Euros.The Euro zone central banks have paid all their capital but the ones inside the EU but outside the Euro have only paid 7% of theirs. So if we just consider its bond buying then a loss of just over 3% would leave the ECB under water.
There was a discussion in the comments section as to why the ECB values its bonds on a “marked to maturity” basis. My contention is that with its capital levels it probably cannot afford to mark them to market.
For those frightened for today let me offer some reassurance.
Net profits and losses of the ECB are allocated among the euro-area NCBs according to Article 33 of the Statute.
So the tab would be picked up and for those in the non-Euro countries let me offer some reassurance as.
The non-euro area NCBs are not entitled to receive any share of the distributable profits of the ECB, nor are they liable to fund any losses of the ECB.
As someone who is in a non-Euro country I think the correct response is phew!
I think it is fairly plain that if the ECB was a private-sector bank it would be calling in its central bank (itself?) for help! This is the reason for their being talk of an increase in its capital subscription. In my view if you marked it to market you would shut it down. I did write a while ago that all the bailouts of private banks could lead to central banks needing to be bailed out and it looks as though that day has arrived. I wonder if any traders have asked them if they have the funds to make their bond purchases? This is not as light a question as it sounds as the Bank of England and the Federal Reserve for example have their national treasuries backing them whereas the ECB has no national treasury.
Mr Bean speaks
For those who are unaware Charlie Bean is a member of the UK Monetary Policy Committee and has a habit of giving speeches which give the impression of being out of touch. If you will forgive the pun he can indeed be a right Charlie!
In his recent speech he does again demonstrate similar traits. For example he said this.
And though continued tight credit conditions may restrain the investment spending of small and medium-sized enterprises, the bulk of capital expenditure is carried out by large businesses. They appear to be less credit-constrained and also have better access to the capital markets. ………….So the availability of finance is unlikely to be a major brake.
If you are a small or medium-sized business it appears that if you cannot get finance it doesn’t matter much.”Thanks Charlie” I can hear the politer members of such companies saying.
He has finally spotted that inflation is well over target but feels that this is not a problem.
The MPC’s view is that the current elevated level of inflation is likely to persist in the near term – indeed our central expectation for inflation is somewhat higher than that of outside commentators. Ultimately however, this period of elevated inflation should prove temporary .
Unfortunately the words ultimately and temporary do not go together as they imply quite different time periods. Of course as time has gone on we have realised that for Mr Bean the definition of temporary is somewhat flexible. Also he rather contradicts himself because his explanation of why he has not responded to price rises is this.
In the light of that outlook, I believe we have made appropriate use of the “constrained discretion” granted to us in the Chancellor’s remit, looking through the temporarily elevated inflation to the medium term in order to avoid unnecessary volatility in output.
and yet he expects us to believe that he will.
So we shall be watching these indicators, and their impact on wages and prices, like proverbial hawks
with the implied suggestion that he might do something but would this not be at the cost of “unnecessary volatility in output”?
The Reality our inflation figures disappoint once again: where is our “hawk” Charlie Bean when we need him?
Producer Prices disappoint
You may be surprised by this headline but let me explain. The Office for National Statistics has recently recalculated our producer price figures as I reported on the 19th of November. This has allowed it to present output price inflation for November at 3.9% whereas using the old basis as best I can the old figure would be approximately 4.5%. Reducing inflation is easy this way is it not? Only six or seven more goes and it would be at zero! For those doubting how this works let me quote the adjustments made.
This seems innocent enough but I have looked at the numbers for 2010 and this is its impact on the headline output number for produced price inflation for the months of this year so far. They are -0.3%,-0.4%,-0.5%,-1%,-0.5%,-0.7%,-0.8%,-0.5% and -0.6%.
In spite of such manoeuvering the input price figures rose from 8.2% on an annual basis in October to 9% in November. Rather oddly the ONS produced these statistics a day late so that they did not get much publicity. Those of a more cynical disposition than me will wonder if the fact that a reported fall was on time and a reported rise was not may not be a coincidence. The 8.2% itself was revised upwards by 0.2%. Using the same system my estimate of input price inflation based on the old numbers is 9.8%.
Consumer Price Inflation
Unfortunately for Mr.Bean and the other members of the MPC who have adopted something of a mantra in telling us that inflationary trends are “temporary” the Office for National Statistics produced these figures today.
CPI annual inflation – the Government’s target measure – was 3.3 per cent in November, up from 3.2 per cent in October……RPI annual inflation was 4.7 per cent, up from 4.5 per cent in October. The main factors affecting the CPI also affected the RPI. RPIX inflation – the all items RPI excluding mortgage interest payments – was also 4.7 per cent in November, up from 4.6 per cent in October.
So the problem continues to deteriorate and we are well into the period when the temporary influences should have gone. If anything inflation is showing signs of picking up and I would remind readers of the commodity price trends I discussed above. Our targeted inflation measure has been 1% or more above target for all of 2010 so far. If we look at our previous target we see an even worse trend. RPI inflation at 4.7% is some 2.2% over its target and shows no inclination at all to come back to it. The main upward influences on our numbers were, food and alcoholic drinks, clothing and footwear (echoing China in both), and furniture household equipment and maintenance.
As 2010 has progressed we have seen that the UK does have a persistent inflation problem. This is not on the scale of some of the problems we have had in the past but when you consider that we have just had a severe recession and you allow for that it is troubling. This is because should the economy begin to pick up and grow on a more sustained basis it is likely that inflation will pick up too and it will be doing so from a relatively high base. We also have a MPC whose credibility is shot to pieces by continual claims that inflation is “temporary” when it has proved not to be and attempts at spinning by claiming in Charlie Bean’s case that he is a “hawk” watching prices and in Spencer Dale’s case that his priorities are “inflation,inflation, inflation.” If you analyse this then if what they say is true then you can only conclude that they are not very competent and if Mr.Bean were transformed into a bird of prey he would go rather hungry if he demonstrated the same degree of success!
The Monetary Policy Committee
As we have one more month of failure I would like again to repeat my policy prescription for the UK as we plainly need a change. I emailed my Member of Parliament on this subject back on the 29th of September but I guess that she must be busy with more important matters.
Also I have a further thought and it does indicate quite a change. As the role of the Monetary Policy Committee has changed and expanded more than could have been forecast when it was introduced in 1997 there need to be new checks and balances on its power. My suggestion for a change is that MPC members should stand for election as they are currently much more powerful than many of our elected representatives and their record is becoming increasingly poor.