UK inflation rises again on all measures, what is the Monetary Policy Committee doing about it?

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.


20 thoughts on “UK inflation rises again on all measures, what is the Monetary Policy Committee doing about it?

  1. Hi Shaun, I enjoy reading your blog, I just wonder what you think about the news that Portugal have sent someone to China and then onto Brazil to try and get them to buy their bonds,wouldn’t this seem a desparate measure to a scared market and indeed cause it to stuggle to sell for the sort of rates it needs in order to remain solvent. Considering that Portugal once owed (or leased) Macau and Brazil it does to have a poetic feel to it. Belgium are going to be in trouble though if they need the Congo to help them out.

  2. I sometime think the only inflation measure the BoE is looking at is the housing index – that leads me to beleive its the Banks themselves who are guiding the interest rates and the BoE. If the housing market tanks ( which it has to to make housing affordable to average wage earner ) then they loose an awlful lot of money and will effectivly be bankrupt.

    so the banks need to be saved again ….


  3. Hi Shaun
    I read somewhere that, according to Deutsche Bank, about 80 per cent of banks’ eurozone sovereign positions are accounted for on a hold-to-maturity basis. The CEBS stress tests only stress tested, on that basis the article suggested, the 20% held in the banks’ trading books. I also read that you could only use this rule in the UK if you have a positive ability and intention to hold to maturity. The European Financial Stability Fund is, supposedly, the foundation of these accounting policies in Europe, presumably because it provides a backstop for default risk. So, are we saying that financial stress calculation is avoided by the use of accounting policies and the creation of the EFSF and the ECB have committed to hold all covered bonds and SMP securities to maturity? Do we contrast this with the Bank of England Asset Purchase Facility Fund Ltd which only holds QE gilts and securities at nominal value with losses/profits indeminified/earned by UK taxpapyers because the stated intention is to sell QE gilts through monetary policy?

    • Hi Shire
      The essential problem was the view that sovereign nations in the Euro zone will/can not default. Once you start with that it seems perfectly reasonable to hold to maturity and then account in that fashion. The idea was a fantasy at the time and now as nations weaken it looks more of a nightmare as plainly several nations will have to have some form of default before the game is over. So the Euro zone has trapped itself as its various vehicles had the same philosophy and as I pointed out today if you asked me to guess I would guess that the ECB has a negative and not a positive value….

      For the UK care is needed. Our real gain is that our Treasury stands behind the Bank of England so that it does not have to follow such a route. However as taxpayers we may yet have a cost as I expect the QE programme to make a capital loss and as part of its liquidity operations the B of E took some sub-par collateral too and it called them phantom securities which does not sound entirely reassuring!

  4. Hi Shaun.. do you think the ECB will expand/extend the SMP despite the risk to solvency ? I’m wondering aloud who will be purchasing Club Med bonds this next year if not the ECB. As I understand it, at risk nations need to pedal over $300bln in 2011. The EuroBond proposal seems to be dead upon arrival..

    • Hi Mr.K
      Unless something dramatic happens then the ECB should be able to get us into the New Year with its SMP.However even at this time of year there are dangers such as Spain’s bill auction today which unsettled things. There is obviously the danger of politicians saying something silly at the end of this week, or rather let me put that another way they probably will say something silly it is only a matter if the markets are interested…
      January is different as various nations have substantial amounts of debt to issue. I would expect more and more Members of the Governing Council to be speaking to their own politicians saying enough is enough. After all who wants to be the first to run a central bank towards bankruptcy? Not so hot for the CV……. although these days…

  5. Apologies for two comments. Just on the SME position, I get a little tired of the BoE line. Mr King, I notice, gets very combative with politicians who ask him what he is doing for SMEs. He says that’s not his game, he isnt there to favour or support particular sectors – that is a matter for government, he says. And yet, banks, pension funds, overseas investors, issuing investment grade companies and The City are all being supported by special measures and QE. The BoE’s real position is that they dont wont grubby SME credit risk on their books.

  6. Ultimately however, this period of elevated inflation should prove temporary.”

    Hilarious. A real triumph of doublethink.

    Shaun, I have two questions –

    1. How do you explain the BoE’s failure to act on inflation?

    2. Who would you like to see electing MPC members?

    One final thing, a reminder of the Bank of England’s Core Purposes as summarised on its own website:-

    Core Purpose 1 – Monetary Stability
    Monetary stability means stable prices and confidence in the currency. Stable prices are defined by the Government’s inflation target, which the Bank seeks to meet through the decisions delegated to the Monetary Policy Committee, explaining those decisions transparently and implementing them effectively in the money markets.

    Core Purpose 2 – Financial Stability
    Financial stability entails detecting and reducing threats to the financial system as a whole. Such threats are detected through the Bank’s surveillance and market intelligence functions. They are reduced by strengthening infrastructure, and by financial and other operations, at home and abroad, including, in exceptional circumstances, by acting as the lender of last resort.

    • Hi Graeme
      I have given an answer to Robert which covers point 2 I think. As to your first question I have partly answered that too, the output gap orthodoxy got too strong on the MPC. Accordingly they believed theory over evidence and then, in my opinion, endgamed themselves in that they probably feel it would be too embarassing to reverse course now. Not all as Andrew Sentance has chnaged his view but there are 8 others.

      • Thanks for your answers – so you blame dogmatic adherence to the output gap theory for the MPC’s actions, and you would like all adult members of society to vote on election of MPC members?

        I don’t mean to be argumentative, but are you sure output gap theory is the reason, rather than the excuse, for the MPC’s laxness over inflation? I think there is at least an element of worry over ‘financial stability ‘ (i.e. asset price anxiety) involved here.

        As I’ve said before, I’m not sure the general public are qualified, or indeed interested enough, to vote in MPC elections. I guess for most people it would come down to a choice between high interest rates and inflation – you would have a majority of the population choosing the latter as the lesser evil, but less of these people would bother to vote. I would envisage it playing out a bit like the right/left choice people currently make in general elections. Since the party in office choosing MPC members at the moment is elected in this manner, I’m not sure an extra MPC election would really change things very much. On the other hand, separation of powers is a good model.

      • On the views of the MPC, having read a few of their releases:

        All on the MPC defend the first lot of QE including Sentance.

        On all other points the MPC is divided, usually they state some sort of average view.

        So far only I think King is the only one to mention the MPC decisions help the BoE mandates. Though he is quick to see it satisfying the MPC mandate of inflation in the medium term.

        On that Sentance seems to be less worried about inflation now rather than loosing long term credibility.

        But, yes, output gap is always mentioned.

  7. Inflation data from the various Statistical Offices throughout the world seems to be at odds with normal people’s observations. The problem seems to me to be that politicians have too great an influence, even a quiet one, leading to self censorship. In other words if there are two possible solutions the one that will lead to praise from the politicians will be the acceptable one. Was it not Lyndon Johnson as Pres of the US who requested a new set of more favourable statistics. My problem is that if this were true then never can a correct answer be arrived at by logic.
    You have suggested several times that some form of electoral process should be used for the Monetary Policy Committee. May I observe that unless you also suggest who the electorate should be and how candidates are selected this idea will not get off the ground. Should, for example, candidates be nominated by heads of depts of Economics in UK universities and should anyone in the UK possessing a degree or some job in economics have a vote in establishing them in the MPC for 4 yr, and that elections be held every 2 yr so that half of the committee has some experience. What role should the politicians play?

    • Hi Robert
      The simple answer is none. The system of having the Prime Minister pick candidiates who are then interviewed by Members of Parliament who specialise in the area such as on the Treasury Select Committee has failed to achieve anything good in recent years. In fact quite the reverse as it has coincided with a period where the quality of the MPC’s actions has deteriorated. Indeed the interview’s obsession with output gap theory has helped us into our current position with an MPC insisting that according to their thoeries there cannot be inflation and accordingly that the inflation has to end soon…..

      So we have the power of the MPC increasing at the same time as its competence has declined. So I would go the other way have a proper election with one person one vote. I believe in democracy and feel that on particular issues we could elect people to do a specific job. This would be different from current policies as they would be elected for a specific task and so what has recently happened with the Lib Dems would not happen.

      I understand that some would argue that many voters would not understand what is happening. I would reply to that with, and you think the Prime Minister and the Treasury Select Committee do? These days most politicians are only qualified to be politicians.

      So I feel this is a twofold gain. Firstly we reduce the power of out political class who in recent years have wielded it poorly to say the least and we would have MPC members elected on their manifesto/record. Obviously those on the MPC right now would, in my opinion, find this not so easy…

      • Your answer has very wide implications. For instance, the M P s represent the people who sent them there and cannot be ignored; it would not be democratic. Those M P s assume the responsibility for any failure by the MPC in that their jobs are at stake. Gordon Brown did lose his job.
        What might be implied also is that monetary power has slipped away from Parliament, or is that explicit, and into a group of economists, but how does what you suggest alter that? All that would happen is a different bunch of maybe equally incompetents would take over.
        One man one vote? Maybe if the second house were reconstituted you’d get away with that. A house made up only of economists and failed bankers. Guy Fawkes 2 anyone?

  8. When you look around at the various countries with debt problems, the truth is that it is so much easier for the politicians to erode the debt through inflation than to cut nominal costs of government. The only countries which are actually cutting salaries etc are those where the IMF/EFSF has insisted on it. Until that point arrives, the politicians are faced with electorates which simply hate any cut that affects them (child benefit cuts, winter fuel allowance to name but two absurd examples of government waste).
    If you can keep the bond markets calm through the use of QE, then you can achieve nirvana for politicians, i.e. a state where
    1. Interest rates do not reflect true inflation risk;
    2. Savers don’t seem to riot in the same way as those who have cuts imposed or fees increased
    3. The great public has no idea what QE is and they therefore do not hold politicians to account over it.
    I remember reading that, during the german hyperinflation of the 1920s, the problem was seen to be inflation and the solution was therefore to print enough money to keep the tills ringing. Only when the whole edifice came crashing down did people realise that the real problem was that the value of fiat money was falling, rather than prices increasing. The prescription for cure is rather different.
    I don’t see rampant inflation in Germany or Switzerland now.

  9. “If you can keep the bond markets calm through the use of QE”

    That is a very big if. Here in the States, QE2 was designed to do just this.. and the polar opposite has happened. Other than a crisis of some sort, I can’t really see how they’ll stop the slow upward trend in bond rates. This must’ve been quite a rude shock to Bernanke.

    • Hi Basil
      I have had a look at the underlying figures and there are three possible areas where I would need someone to tell me if they are realistic.They are
      1. If mineral production/mining has picked up
      2. If the manufacture of computers and related products has seen strong growth.
      3. Production of other non-metallic mineral products has also risen strongly.
      These are the main ups and there is also a large down which may influence the numbers by having dropped off the figures more than a year ago. Does Greece produce much oil and gas and if so has it dropped significantly? This could boost the numbers if say it was in very early 2009 and was now dropping out of an annual sequence.

  10. Come on Bank of England raise those interest rates so my mortgage payments increase on top of the increase in my food and fuel bills.

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