Why I now expect more Quantitative Easing in the UK by the Bank of England

The UK economy finds itself in an all too familiar position of rising inflation with the Consumer Price Index currently rising at an annual rate of 2.7% and falling economic growth with the Governor of the Bank of England recently suggesting in the latest Inflation Report that it may even be negative in the fourth quarter of 2012.

indeed output may shrink a little this quarter

If we stop for a moment to consider the position we see that some four years or so into the credit crunch this is quite a disappointment. In past recessions even the sharp ones we would be at least on the road to recovery and more usually entering a period of sustained economic growth. Instead we have the Bank of England saying this.

the economy has barely grown over the past two years.

I expect this to cause quite a few disagreements over monetary policy at the Bank of England in the months to come and as I type this I am awaiting the latest minutes for signs of them. However the bottom line is that it has enacted an extraordinary amount of monetary easing with base rates at 0.5% and £375 billion of Quantitative Easing and what does it have to show for it? The answer is the opposite of those give to the famous Monty Python question of what have the Romans done for us from the film Life of Brian

This will be put another way by Monetary Policy Committee member Martin Weale today in a speech.

The last few years have, in terms of real GDP, seen sharp contraction, weak recovery and then stagnation while GDP remains some three per cent lower than at the start of 2008

What else did Martin Weale have to say?

Intriguingly he has tried to make older people who he characterises as complaining about lower annuity rates feel better by telling them that the young are doing badly too!

Also he discusses the “output gap” so it looks as those this outmoded and failed theory still has supporters at the Bank of England. No wonder they are getting things wrong. But if we move to the central point Martin Weale suggests he has moved to the hawkish camp by this section.

I think it is more likely than not that inflation will remain above target for much of the next two years. My analysis suggests that additional stimulus would, without any corresponding improvement in productivity, add to inflation.

He is however what Americans characterise as a flip-flopper and so we should also notice that he has already given himself a possible excuse to change his mind.

The Monetary Policy Committee Minutes

These have just been released and have not disappointed.

For one member, the case for undertaking additional asset purchases at this meeting was nonetheless strong.

One member of the Committee (David Miles) voted against the proposition, preferring to increase the size of the asset purchase programme by a further £25 billion to a total of £400 billion.

Why do you think that this is important Shaun?

This is because the MPC were made aware of this.

The Committee had been briefed on the Government’s intention to normalise the cash management arrangements for the Asset Purchase Facility (APF) by transferring the gilt coupons received by the APF, net of interest costs and other expenses, to the Exchequer.

Which they felt would lead to this

That was likely to have an effect essentially similar to that of purchases of gilts by the APF, and so the transition

to the new arrangements would imply a small easing in monetary conditions.

So the crucial point here is that David Miles voted for more QE knowing that a boost was already being given. Such outliers in voting as usually joined by others at subsequent meetings and if fourth quarter economic output is negative there may be enough for a majority. So the theory that UK QE is now over has taken a severe knock today and I suspect it may not be too long before the “More,more,more” theme is back in play.

The MPC are not keen to reduce base rates

Actually they and I agree on this bit but for completely different reasons. I think that we are in a liquidity trap where interest-rate cuts will make things worse whereas they worry about this.

Staff analysis had concluded that a further cut in Bank Rate would be likely to cause a reduction in the profitability of some lenders, especially building societies

As you know we must not hurt the banking sector! Still at least for once they have come to the right answer albeit for the wrong reasons.

the Committee judged that it was unlikely to wish to reduce Bank Rate in the foreseeable future.

The MPC gives itself a slap on the back

You might think that above target inflation combined with a disappointing growth performance that is near to contraction might be a reason for humility if not sackcloth and ashes. Apparently not.

While views differed over the exact impact of the MPC’s asset purchases, the Committee agreed that demand and output would have been significantly weaker in their absence.

I would like to see them give such an explanation to Roman Abramovich! How many times would he have sacked them by now?

Comment

So I remain of the view that upcoming MPC meetings could be quite stormy. Even in the fantasy world in which they inhabit it must occur to them from time to time that their policies are not working. Both inflation and economic growth are ongoing disappointments. However if I look at their track record and like at the likely trajectory for the UK economy today’s MPC minutes mean that more QE is not only on the agenda it looks probable.

To put it another way take a look at this from the supposed “hawk” Martin Weale

There is, nevertheless, an argument for a further stimulus

Paper tiger alert I think.

UK Public Finances

A regular theme of this blog in 2012 has been that the UK public finances have been a disappointment and this has continued today.

Public sector net borrowing was £8.6 billion in October 2012; this is £2.7 billion higher net borrowing than in October 2011

Not inspiring and if we look for more perspective we see this.

For the period April to October 2012, public sector net borrowing (excluding the capital payment recorded as part of the Royal Mail Pension Plan transfer in April 2012) was £73.3 billion; this is £5.0 billion higher net borrowing than in the same period the previous year

So we see that yet again austerity apparently means a higher deficit and that up is the new down. Also whilst given the appearance of a level playing field by excluding the Royal Mail pension transfer financial alchemy the ONS has forgotten the over £2 billion gained from ending the Special Liquidity Scheme. Or to put it another way.

public sector net borrowing has risen by 7.4%, which compares to a forecasted 1.2% decline for the full year.

If we look for why this has happened we see familiar features. Firstly the government is struggling to get a grip on spending.

For the period April to October 2012, central government accrued current expenditure was £364.5 billion, which was £8.3 billion, or 2.3%, higher than in the same period of the previous year

And that this issue got worse in October.

In October 2012, central government accrued current expenditure was £52.8 billion, which was £3.6

billion, or 7.4%, higher than October 2011

Taxes are helping but by not enough

For the period April to October 2012, central government accrued current receipts were £301.4 billion, which was £1.2 billion, or 0.4%, higher than in the same period of the previous year

So as you can see we have a problem which seven months into the current financial year has not gone away. Also we can link today’s two sections as a partial reason for higher expenditure is this.

movements in the Retail Prices Index produced increases in the interest paid by government on index linked gilts

The idea of the government blaming the Bank of England’s failure to control inflation as a cause of fiscal deficit problems? Far-fetched perhaps, but we know that in these times what was considered far-fetched keeps happening.

I have presented that data today using the numbers excluding financial interventions as the ONS does its main analysis on them and has downgraded the ones that I like which include them. I raise this for two reasons. Firstly the numbers I liked already covered the QE accountancy reshuffle between the Bank of England and HM Treasury. Secondly as they are showing a much better trend for the fiscal deficit we may see them promoted from the equivalent of the Championship to the Premiership before too long!

Support from an unexpected quarter

I have been vocal in my opposition to the proposed “improvement” -otherwise know as a change leading to a reduction in the recorded numbers- to the Retail Price Index. Take a look at this from Martin Weale’s speech.

Chart 17 shows the same analysis applied to RPI

inflation (the CPI series is too short for this analysis)

A track record is another reason for not meddling.

Also let me give you a section where in my opinion Martin Weale is 100% wrong.

Movements in the gilts market suggest that expectations of RPI inflation have, if anything moved down in

the last few months

No Martin they highlight fears that the RPI is about to be debased.

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20 thoughts on “Why I now expect more Quantitative Easing in the UK by the Bank of England

  1. Hi Shaun
    I think Mr Abramovich is thinking how wonderful the BoE and all the CBs are. They have done wonders to protect capital , allow commodities to inflate and created all that lovely money to speculate with. The CBs are doing exactly what they are designed to do, protect the commercial banks; the fact that governments keep giving them extra levers to do this , isn’t their fault is it? And these same governments keep telling the ‘great unwashed’ how independant the CBs are and how its best for the CBs to look after the clever financial stuff for the real economy. Oh yes the likes of Mr Abramovich must be laughing all the way to their bank.Bonusses all round I think. Shame getting football managers to do what they’re told isn’t as easy!

    • Hi JW

      It kind of defines “hire and fire” does it not?

      Also we see all sorts of rules for money laundering applied to small amounts and yet apparently vast sums can swirl in and out of South West London without an apparent by your leave!

  2. Can anyone enlighten me on what the output gap is and how it affects the BoE thinking, please? I understand that the output gap measures the actual GDP and the potential GDP. But what does that mean? How, or what, is the potential GDP? Is it that if you have 5 million unemployed, but they were actually working, they are the potential GDP? But who’s to blame for not employing the unemployed? You can see the circles I’m going in and sorry if this is a basic question, but it’s got me foxed. Thank you.

    • forget output gap – its a work of fiction created by the BoE to explain why their forcasts are always wrong !

      Think of how many Unicorns you can get on a head of a pin

      see?

      Forbin

      • yah, that reminds me of my uncle salesman, you can say what you think the price of an item is , but its only worth what you can get for it!

        economic output gap is the same them – the economy is what ever value it is – the BoE can invent all it wants to what it should be ……

        so the unicorn output gap theory is just as valid!

        disagree if you want but the market aint payin’ more 😉

        Forbin

    • it is a theory that claims higher unemployment and reduced factory usage will exert a downward pressure on inflation. I disbelieve this theory as the RPI data is higher over the past 5 years than predicted by Mervyn King and the BOE.

    • Hi Robert

      Zak has kindly given you a definition so let me embellish it with what is the Bank of England view. If we start at 2007 for example we see that since this peak the UK economy has shrunk by 3% according to the Martin Weale speech I quote from today.

      Is that the ouput gap? Nope, because they also add in the growth they feel we have missed or trend growth so we also have say 2.5% a year for fives years. As you can see the gap is then a bit over 15%.

      So with such a gap surely inflation will not gain any traction….

      Meanwhile in the real world

      1. It is apparent that in 2007 some of the GDP was an illusion
      2. In the credit crunch era so far we have not been remotely capable of that osrt of GDP growth.

      Suddenly we are much nearer to full capacity for 2012 and any effect is much weaker and sustained inflation is much more possible.

  3. As I have observed previously hereon, debasement is like an irresistible drug to profligate politicians. When they see what a quick fix it is to their immediate fiscal difficulties, resulting directly from their failure to control their spending according to their revenue, once tried a few times it becomes like heroin to them! They cannot resist a continuous repeat – it worked so well last time with fiat currency. The admission today that government spending has continued to rise significantly again supports Shaun’s point that there will be yet more QE; and now that he has come to accept that the BoE is undertaking this under command from the Chancellor, not as an independent body, it is clear that this government just like the last is now an addict!

    However there does come a point as in Zimbabwe when more becomes too much. Also as we see now, the biggest problem with debasement is that it increases all the costs which the government itself then has to subsequently bear, as well as all the costs borne by the public/taxpayers. As the results of their incompetence and stupidity come back like a whiplash to hit them in the back, there is only one practical option to pay for it all – more debasement! Eventually this leads to complete fiscal and economic collapse, and that is what we are heading for unless they change course.

    There is one real way only out of this disaster: drastically cut public expenditure, probably by one half; (yes it would mean hardship, but it is the only way, to suffer the pain for the final gain). This has to be balanced by drastically cutting overall taxation, probably by 40%, to stimulate the economy; that is the only stimulus which will now work.

    But of course none of this will be done, so we are inevitably heading to fiscal and economic collapse! (Soon more will understand that you cannot have Economics divorced from Politics; they are now inextricably linked and interdependent, because more than ever Politics has now become almost entirely about Economics – the way in which the national cake is shared out and distributed.) It is almost as if the present politicians are intent upon destroying the UK economy and fiscal structure, and the question then needs to be asked: if that is so, then under whose command is this being enacted?

    • Completely agree.

      Only one way out of the disaster… is what we would have done, be doing, if that was what we, sorry – they, wanted to acheive.

      Under who’s command? Its the bankers, to bust the economies and therefore allow the bankers to be the saviours of our troubles caused by the bankers with a new centralised currency.
      To my mind the die is cast by the UK and the USA ‘special relationship’ that
      extended into Iraq and certainly goes much further back in history. We are ‘fiscally aligned’ with the USA by employing QE and outside of the Euro. Therefore our alignment will focus on ultimately joining or being brothers in arms with the USA while the Euro zone bombs out under the debt of central banks.

      The otherway out of the troubles is that we do not accept the debts imposed on us by the banks and further that we, as the people, seek out financial options outside the mainstream funding sources, aka, Bitcoin and Crowd Sourcing finance.

      The time scale to Zimbabwe economics is what I would like to know. The Fed has gone QE $40 billion a month to infinity and beyond so it is not a news worthy item any longer and therefore is no longer in the peoples minds – its just over a billion dollars every day of the month since September.
      The uk however is still wrapped in indecision in their announcement since we all seem to agree here that we know they will even if they haven’t said as much. Shaun knows more about what they are doing than they do.

      Gold and silver seem to have a Glass Ceiling no doubt manipulated by those that manipulate the market.

      I fear Forbin and I will grow fat on pop corn at this rate of collapse.

    • “It is almost as if the present politicians are intent upon destroying the UK economy and fiscal structure, and the question then needs to be asked: if that is so, then under whose command is this being enacted?”

      It is under the command of those same “politicians”. They are self serving. Their only concern and ultimate aim is to be re-elected. Being re-elected allows them to carry on “fixing” the economy so that they can once again be re-elected. It is the age of the career politician after all. There is no other path for them to follow.

      To do the UK economy any long term good would necessitate the introduction of policies which would bring about serious short term hardship on the electorate.
      Thus, the Turkeys do not vote for Christmas.

  4. Base rates may be low-but the rates charged by banks to borrowers most certainly are not. And the rates saver get are also low.
    This together with the QE is just a ruse to try to prop up the banks. They should have been allowed to collapse with savers being guaranteed, not the banks themselves.
    Until the banks are re-structured-the economy will not recover in any meaningful way.

    • Hi MickC

      There was a little ripple today as Santander offered a 2 year mortgage fix at 1.99%. But as ever it was for 60% LTV which excludes many.

      On the other side of the coin savers are seeing interest rates fall which offsets the gain above.

      So for Funding for Lending the jury is out particularly as business lending still appears to be struggling.

  5. Hi Shaun,

    Another good post as the UK economic train heads towards a cliff. Still they will be able to fuel it with £50 banknotes soon instead of coal as they will be worth less (or even worthless)!

    “Intriguingly he has tried to make older people who he characterises as complaining about lower annuity rates feel better by telling them that the young are doing badly too!”

    That alright then, old people some of whom will be retiring due ill health, so have no chance of ever working again, will live in poverty and can take great comfort, while they are shivering in an unheated house that unemployed youth are trudging around the streets in the cold knocking on doors saying “Give us a job”. It wouldn’t be that they should stop decimating annuity rates through the artificial gilt market created by QE or that they should be reforming the national minimum wage to help youth unemployment.

    With the current system the longer a school lever is unemployed the less likely the are to get a job. Why? Because the national minimum wage is age related, so as they get older the differential between them and older unemployed with job experience gets less, until at 21, (which includes graduates) it is the same. So do you take on an experience worker or an inexperienced worker at the same rate. As a former employer, that’s a no brainier. Now if pay rates were experience based, with each of the age steps being years of experience steps, so they went up for each year of employment, then I would have to at least get my calculator out to work out the cost of training plus lower pay against the full pay rate for an experienced worker. It would also give that graduates with a pass degree in drama, media studies or leisure and tourism, a chance as they stand in the queue for an application form for a job at the local burger flipper.

    This would then stop youth age discrimination as it would be an inexperience discount, which has to be positive where the government is trying to remove ageism from the work place. They could also end their current system of unpaid work as the lowest pay rate is £3.68 and for apprentices £2.65, by making the totally inexperienced rate £2.65. As far as I’m concerned if the job is not worthy of a minimum of £21.20 for an 8 hour day then it is not a real job! Before lots of people call it slave labour, it is 1.5 times, the Job Seekers allowance, so they would be better off than sitting around doing nothing.

    Without rebalancing the economy by cutting public expenditure and taxes, the Government are floundering, where they are the wrong side of the Laffer curve in so many areas of taxation and not just the rich, as there were 2.6 billion less gallons of fuel sold in the first 9 months of this year compared to 2009. 3p a litre fuel tax rise in January anyone to increase revenue?

    With above target inflation and the continuing drop in real wages, what other outcome is there apart from stagflation and with a widening deficit and ever increasing debt pile to service, we are drifting into a Greek style economic death spiral. Any bets on how long we get to keep our AAA rating, or the confidence of the markets anyone?

    My bet is that we will lose both in 2013!

  6. Hi Rods

    Thank you. There are still 5/6 weeks in 2012 where the UK could lose its AAA rating!

    As to the oil price the Gaza ceasefire which is obviously very welcome on humanitarian grounds hasn’t done much as front month Brent crude is still above US$111 per barrel.

  7. Hi Shaun, so the BOE won’t be increasing their QE this side of Spring 2013 then. I still expect as I said a while ago on here that GDP will grow until Spring next year because of growing money supply 6 – 9 months ago.

    Time will prove me right or wrong but I don’t think the BOE will need worsening GDP figures to fire up the inkjets again. I think they do it just because they like to do it and anyway, what else is there to try?

    They seem fixated on QE as the elixir to cure all ills, like Victorian charlatans travelling from town to town peddling all manner of harmless and harmful potions to the general public.

    I agree about the liquidity trap, but can also see that the BOE will not go to zero or negative rates until it considers itself in the last chance saloon, because it is worried about defending the Banks’ erm, “right” to rip off the public with extortionate loan rates and miserly savings rates. Lets face it, the Banks have to meet Basel 3 requirements somehow, so let the taxpayer pay again, only this time silently through insane loan and savings rates. You can avoid this silent tax by following Polonious’ advice in Hamlet of neither a lender nor a borrower be. The BOE still don’t get that no one takes any notice of minimum lending rate any more, at least not when it comes to retail offerings.

  8. Hello, Shaun:
    I’m not a monetary economist, so I don’t know who has the better ideas on quantitative easing for the UK, you or Mr. Weale. I do know a lot about the issues involved in inflation measurement for central banking purposes and Mr. Weale, who sits on the Consumer Prices Advisory Committee, has little credibility on this topic.
    I saw the slides from his presentation to the Royal Statistical Society on August 15 on “Housing and the Consumer Price Index”. He seems to have no idea why Eurostat is moving towards incorporating an owner-occupied housing (OOH) component based on net acquisitions approach in its inflation measures. While he admitted that this approach would treat OOH the same way as consumer durables in consumer price series, he argued that the “treatment of other durables is a simplification, not a desideratum”. This is flatly wrong, as regards the Harmonized Indexes of Consumer Prices. They stand on the principles that credit payments should be ignored, and all prices in an index should be actual transaction prices. The acquisitions approach to consumer durables isn’t some approximation of some ideal approach Eurostat would much rather use; it’s the approach it wants to use.
    He raised the old shibboleth that “net acquisitions of housing could be negative, meaning that rising house prices depress the price index”. This is maybe an honest mistake on his part, given that the ONS pilot OOH(NA) index used single-year expenditures to determine expenditure weights for home purchases, and not three-year pooled expenditures as mandated by Eurostat. With three-year (or maybe even five-year) pooled expenditures, there is absolutely no way a home purchase index would have a negative weight, anywhere, anytime, not even in present day Zimbabwe. However, if the UK did have a situation where new housing construction was essentially nil, and existing homes only changed hands, then even the most extravagant inflation in house prices would have little impact on a consumer price series with an OOH(NA) component because the home purchase weight would be negligible.
    Mr. Weale said that the only reason that an OOH(NA) series would rise with a housing boom, really a boom in land prices, would be that it failed to take land prices out of the index for housing prices. Even accepting his premise, primo, the ONS has never used dwelling prices rather than house prices either in the depreciation component of the RPI or in its pilot OOH(NA) series, so both ARE sensitive to housing booms. Secundo, Eurostat is wrong when it tries to base an OOH(NA) series on dwelling prices and expenditures rather than housing prices and expenditures. The ONS should work to persuade them of their error and calculate two different OOH(NA) series, one for Eurostat, and one for Bank of England use if they are unpersuasive.a separate OOH(NA) series with housing expenditure weights and housing price indexes to meet the needs of the Bank of England if they fail in their efforts.
    Finally, he said that “the question whether CPIH should replace CPI as the inflation target is one for the Chancellor of the Exchequer and not for the MPC”. Of course, this is true as a statement of power relationships but somewhat disappointing as a statement of principles. Governor King has groused about the replacement of the RPIX with the CPI as the target inflation indicator both before and after the run on Northern Rock, but has always retreated to the position that the Bank of England must accept whatever indicator the Chancellor of the Exchequer dictates. The Bank as an institution must, but its officials don’t. If they are strongly against a chosen indicator, they can always resign. I would have more respect for Mr. Weale, even though I wouldn’t agree with him, if he said that he thought that the CPIH proposed by his CPAC was a better target inflation indicator than the existing CPI, and if the Chancellor of the Exchequer didn’t ask the Bank of England to switch to it, he wouldn’t want to continue as a member of the MPC.
    Actually, I think all of the people shortlisted as successors to Mervyn King should be forced to declare what they would prefer to see as the target inflation indicator for the Bank of England. If they haven’t made up their mind, one way or another, I would say they are unqualified for the job. If they don’t want to move to a consumer price series with an OOH(NA) component, I would also say that they are unqualified for the job.
    I hope this winnowing process leaves a qualified candidate. What do you think, Shaun?

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