Yesterday afternoon I went into a meeting and was asked on the way in what I thought the Brent crude oil price was. As I had been busy discussing other matters I was pleased that my guess of US $110 per barrel was only wrong by 25 cents as the actual price was US $109.75! However this already represented quite a surge on the day. This morning the surge has carried on in Asian markets with the price at one point going as high as US$ 119 per barrel in what must have been a trading frenzy and not far off panic. We also saw a strong rise in the price of the West Texas Intermediate benchmark which touched US $100 per barrel yesterday before retracing a little. It too has surged this morning and is now US $101.65 per barrel. As you can see from the two benchmarks the oil market,as I have reported recently, has something of a disconnect between its two benchmarks but one matter is not in doubt and that is that oil prices are rising fast.
When such things happen one then often gets estimates which rather than cool analysis represent the trading frenzy. For example Nomura have said that the oil price could go to US $220 per barrel. It has gained them some publicity ( was this the real intention?) but is no more likely than any other number plucked out of the air. It does appear that the political unrest in Libya and other nations will continue in which case the oil price will remain elevated until it ends. On Tuesday the 22nd of February wrote about the effect of a sustained rise in the oil price on world economic output and inflation. As it happens there is also a large transfer to the OPEC states which of course is something of an irony in their present position. Perhaps with its US $36 billion “bribe” to its people the House of Saud is spending some of its (ill-gotten) gains already.
What is not happening as we might expect?
Usually such unrest has the characteristic of a flight to quality/safety and what I sometimes refer to as the “military dollar”. This time round whilst there has been something of a move in this direction with US Treasury bond yields falling for a while it has been less than I expected and the yield on the ten-year maturity headed back towards 3.5% yesterday. The dollar has if anything headed lower rather than higher and if we use the trade-weighted dollar index as a benchmark then at 77.1 it is not that far off its 52 week low of 75.63 from mid-April last year.
One oddity I have spotted. The Japanese Yen has been very strong through this phase with it looking like she is seen as a safe haven. The exchange rate against the US dollar has risen to 81.84. Somewhat odd you might think for a country which for once even had a trade deficit in January and a deficit of some US $5.7 billion does make me wonder if even Japan’s exporters can cope with such an inflated exchange rate. A worrying event in an exporting nation. Let me be clear I am not expecting a rush of deficits but there are one or two signs that some of the factors which have made Japan survive even the “lost decade” are weakening.
Even odder if you remember who is the world’s largest importer of oil……
The UK Monetary Policy Committee is approaching meltdown
Regular readers will be aware that in my opinion the Monetary Policy Committee has made several policy mistakes. I would have liked to have been at the recent press conference when the Governor asked if anybody would have made different decisions to the ones the MPC had made. I would have pointed out that he was in my view 0 for 3. He failed to do anything about the surging asset-price boom in the last decade, he failed to respond to rising Libor which meant that rather than the official interest-rate of 5 or 5.25% the actual one was 7% (which in my view was a major cause of this crisis) and finally he has done nothing about rising inflation.
If we move on and consider what the committee thinks itself we can see that these problems have led to it being split four ways. We have Adam Posen who sees no inflation (and in a recent speech apparently no rising inflationary expectations either) and votes regularly for more Quantitative Easing. We have a middle group of five who vote for no change in interest-rates or Quantitative Easing. We now have two voting for a 0.25% increase and one voting for a 0.5% increase in interest-rates.
The main move if there is gong to be one will come from the middle group of five and accordingly I read carefully a speech given by one of its members David Miles to the Centre for Economic Policy Research yesterday. I was looking for clues and insight.
David Miles’ Speech
My first thought goes back to a lecture I went to at the LSE last week where the discussion was around economic models and part of a question I asked was around the issue of using “reasonable assumptions” in economic models and the fact that they led to one answer or curve on a graph so this sentence immediately attracted my attention.
I think a reasonable view is that growth over the next three years is about as likely to be above as below the long run average rate
My opinion is that this is one of the areas where economic theory goes wrong. If you think about it David Miles is actually saying he does not know and tried to dress it up with a type of economic psychobabble. Let me break it down. If you are arguing that we have been through quite an economic shock it is then unwise to think we will perform at an “average rate” is it not? My view is that looking forwards 3 year at this time we can be sure of nothing and it would be more honest and lead to better policy results if this was admitted.
Others may wonder at a man who is part of a group with a shocking record of forecasting events giving us a reasonable view on events 3 years ahead. For example this time last year inflation was forecast at 1%.
David Miles also reverts to type and gives us some more “output gap” theory as he then asks the question.
But for a moment I want to step back and ask a simple question about inflation: Why isn’t it higher?
If all you knew about the past few years was the inflation rate and the setting of monetary policy – and nothing else – you might conclude that monetary policy has been set so as to generate inflation.
Although he later tells us that this would be a “bizarre interpretation”. Really?
We also get a confession about the impotence of monetary policy at this time and the difference between official and unofficial interest-rates.
The weighted average of mortgage rates,bond yields for corporates, rates on household unsecured credit and the cost of bank borrowing for companies is probably down by about 150basis points since then; Bank Rate is down by 450 basis points
As I first wrote on the subject of the difference between official and unofficial or market interest-rates back on the 14th of December 2009 I welcome this belated realisation but I do not feel that David Miles draws the correct conclusion from it which is that the policies that he has supported have put us in a type of liquidity trap.
We also got a section which I am not sure whether to file under hyperbole, boasting or just plain fantasy. It is also eerily like a recent claim by the Chairman of the US Federal Reserve Ben Bernanke.
Indeed I would go further and say that inflation could probably be brought back to target very fast, perhaps even over a few months.
You might think that this is an odd thing for a man who has let inflation go above target as he has and done nothing about it and you would be right.
I think that this speech represents the sort of intellectual confusion that the main core members of the Monetary Policy Committee have. In essence if you take the sum total of the speech, David Miles is presenting a theme that policy has been set correctly but what Harold MacMillan called “events,dear boy events” has and have torpedoed it. He is saying that things have happened outside its control. My problem with this is that when you act as they have and you have in effect used what weapons the Bank of England has virtually to the maximum by cutting interest-rates by 4.75%% and spending some £200 billion on asset purchases then you have been extraordinarily interventionist. Accordingly it is then hard for you to blame events because some of them are the consequence of your own actions……
The claim that he could quickly cure inflation is not far off pure fantasy.
The Outlier: Adam Posen
The man least likely to vote for an interest-rate rise is Adam Posen. He remains more likely to vote for a cut. I wrote an article on a speech he gave back on the 29th of September 2010 where I highlighted what I feel is incorrect about his approach. Since then the inflation situation in the UK has deteriorated further.
Adam has responded to some criticisms in a way. If you look at figure 2 in his speech you can see that he uses CPI not only adjusted for indirect taxes but now also for energy prices! I have two main thoughts on this. Firstly if you keep changing your reference index you may confuse some but not all. Secondly if we look at 2009 on the chart it shows inflation at 4% so surely we can see if we look at the records evidence of Adam arguing for an interest-rate rise? I tease but hope you get my point.
Even Adam cannot avoid this point.
The issue that I have identified for policy depends upon the assumption that the central bank makes a good unbiased forecast for inflation, and that it is not tricking people about its intentions.For understandable reasons, that assumption is being questioned with regard to the MPC’s forecasting track record of late.
Some may think that this is a guilty conscience speaking. That may or may not be true I prefer to concentrate on two of the words which are good and unbiased and even the biggest fan of the Bank of England cannot say that these are accurate and true.