Today sees the latest meeting of the Monetary Policy Committee of the Bank of England and it is likely that two of the members will vote again for an increase in UK Base Rates. However in spite of that fact I believe that we have moved further away from an interest-rate increase in the UK rather than nearer. That may seem odd with an economy growing at an annual rate of around 3% but then the credit crunch has been full of oddities has it not? I think that we have reached the stage that tearing chapters out of economic textbooks will no longer do as that completely new ones will have to be written.
I have form in this particular area as I wrote this back on the 27th of December last.
So should we see any slowing of the UK economy in 2014 and the exchange rate of the pound continues to be strong there are factors pointing towards a base rate cut. This would be reinforced if the pound strength actually pushed inflation to below its target. The MPC would be likely to ignore the years of inflation being above target and concentrate myopically on the immediate figures in such a situation. After all if eight people can wake up one day and discover that they all suddenly support Forward Guidance cutting base rates in such a situation might seem logical to them.
Actually I was being a bit unfair on Martin Weale who did at least express some doubts on Forward Guidance but not on the other seven. Since then we have seen a strong pound overall which has helped push the annual rate of Consumer Price Inflation to 1.5% comfortably below its 2% target. The actual exchange rate picture is complex especially after the US Federal Reserve Minutes talked down the US Dollar overnight but the effective or trade weighted index has risen from just below 85 when I wrote that piece to 88 now. So it remains a disinflationary influence although in a world where we can add the US Federal Reserve to the Bank of Japan and the European Central Bank wanting their respective currencies lower we face an unpredictable future.
What about future inflation?
This is of course the crucial issue as the Bank of England is supposed to be targeting inflation two years out. What we see right now is an oil price which has headed substantially lower and is now technically in a bear market with the price of a barrel of Brent Crude Oil below US $92 as I type this. Other commodities prices are weak too particularly the price of Iron Ore as it rattles around the US $80 per tonne level. Overall the Commodity Research Bureau (CRB) Index has fallen from a peak of 504.52 in early May to 472.8 now. So we are seeing disinflationary pressure from this area.
Adding to this has come this from the United Nations Food and Agriculture Office this morning.
The FAO Food Price Index averaged 191.5 points in September 2014, down 5.2 points (2.6 percent) from August and as much as 12.2 points (6.0 percent) from the corresponding period last year. The September slide, which represented the sixth consecutive monthly drop, brought the value of the index to its lowest level since August 2010. The decline in September marks the longest period of continuous falls in the value of the index since the late 1990s.
Actually the category which has reduced the fall has been the price of meat (up 11.6% on a year ago) but even it barely registered a rise in September.
Added to this is the apparent weakness of our trading partners in Europe. It was only on Tuesday that I analysed the apparent slow down in the German economy and this morning has seen exports in August fall by 5.8% compared to July (seasonally adjusted). August was a bad month for the German economy with a lot riding on the impact of the change in the timing of school holidays. We got a central banking viewpoint on this from the US Federal Reserve last night.
economic activity stagnated in the Euro area…..indicators of
economic activity in the euro area remained weak
Some participants expressed concern that the persistent shortfall of economic growth and inflation in the euro area could lead to a further appreciation of the dollar and have adverse effects on the U.S. external sector.
If this is a matter of concern to the United States then imagine what an issue it is to the UK! Whilst the US has large volumes of trade relatively it trades much less than the UK does and of course Europe is the major partner for us. The currency situation is slightly different as until last night the US Dollar had been pushing the pound lower but it is hard to avoid the thought that the Bank of England will be mulling this issue.
This section is relatively simple at least according to the official numbers. So far it is the dog that has not barked and if anything it has gone into reverse. It seems so contradictory and wrong but then so much of the credit crunch era has felt like that. With average earnings being reported as rising at an annual rate of 0.6% there is little case for an interest-rate rise being made.
These continue to rise and as I reported yesterday the latest numbers from the Halifax are just below a double-digit annual increase. However there were some hints of slowing here and these have been repeated today by the Royal Institute of Chartered Surveyors (RICS).
Demand and supply are looking a little more balanced, which is removing some of the upward pressure in prices, particularly in London…….Next year, we expect the house price outlook to be far more subdued.
Some care is needed as the level remains far too high but a central banker wishing to avoid raising interest-rates is likely to focus on the apparent change in trend. After all if the surges we have seen were not a reason for a Base Rate rise why would a fading be?
Bank of England policy itself is less expansionary
We have experienced a phase where the Bank of England actively pumped up the UK banking and housing markets via its Funding for Lending Scheme. That has now faded and is only supposed to be available to smaller and medium-sized businesses. So whilst this was an off-balance sheet activity its impact should now weaken going forwards.
These have adjusted over recent weeks as these two twitter updates indicate.
@JediEconomist 50 points of hikes out of Short Sterling there has been in 2 weeks. Always further and faster than ever we expect L goes.
For those who do not follow the futures markets the one for UK interest-rates is called Short Sterling and has the code L.
Back when I started this blog just under five years ago I established the viewpoint that central banks would delay raising interest-rates until they were absolutely certain that the recovery was in place and thriving. Does anybody actually believe that right now? I thought back then that this would lead to problems and it would appear that the IMF has caught up with me.
At the same time, a prolonged period of low-interest rates and other central bank policies has encouraged the buildup of excesses in financial risk-taking. This has resulted in elevated prices across a range of financial assets,
If we move to shorter-term tactical issues then a Base Rate rise by the Bank of England might lead to another surge in the value of the Pound on the foreign exchanges. This would be reinforced if the US Federal Reserve continues to insist that an interest-rate rise there is in the distance.. Also imagine what would happen if the UK raised Base Rates and the Euro area continued to weaken and pulled the UK with it.
Please do not misunderstand me I would prefer that UK Base Rates were higher and argued back in 2010/11 that we needed to nudge them higher to help deal with the inflationary episode we suffered. Right now it is the getting them there that I have problems with and it could remain some months away as we go forwards….