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?
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.