Yesterday’s inflation news poses quite a problem for the Bank of England. There are plenty of caveats in the inflation data as I discussed then but officially it finds itself in a position where it has to aim at an annual rate of CPI inflation of 2%. That is rather awkward when the actual level has fallen to 0% and should oil prices not rebound has a fair chance of going negative next month. Only a fortnight or so ago Bank of England Governor Mark Carney closed down a few options on himself.
Our job is to achieve a 2% rate of growth in CPI inflation……it’s a job given to us by the democratically elected representatives of the British people. We are mandated by Parliament to do that and we have an operational independence in order to accomplish that.
He had the opportunity to express the view that CPI was not the only measure of inflation, He could have pointed out about high house price inflation and the fact that the gap between the current targeted measure and our previous one RPIX (Retail Price Index less mortgage costs) has widened to 1%. This matters when the gap between the old and new target was set at 0.5%. As an aside I argued against it back in the day as I felt it was a policy loosening and if anything the situation is worsening. But returning to his speech an opportunity was missed if he wanted to avoid pressure for a policy easing.
What about the UK Price Level?
The reason I raise this is that we see a tsunami of economists emerge from their cubbyholes if inflation is below target for a period claiming we should catch-up. On the other side of the argument for intellectual and logical symmetry they should be arguing we need a period of below target inflation to slow down to where we should be. You have not heard it? Well nor have I! There is a clear inbuilt bias in the system.
In reality if we go back to the levels of 2008 and calculate where the CPI should be if we had hit our inflation target then it should be at 121. As it is instead at 127.4 then the deflation mania in the media should move from obsessing from monthly and annual changes to the bigger picture. In fact it would be good for all sorts of measures in the UK if we undershot our inflation target for a while. For example it would be much easier for us to establish a consistent pattern of real wage growth if inflation was low or even negative for a bit. Lower prices and costs would help our exporters at a time when we do have serious issues with our balance of payments so we could find ourselves in something of a win-win situation and I will leave it to others to explain why they reject this.
Just to be clear there is the possibility of a deflation/depression scenario but there are many other alternatives especially if we consider that we are where we are because oil and commodity prices have had a sharp reverse. Unless they fall forever that effect will fade and we will then return to an economy which left to its own devices does have inflationary pressure.
The CPI all services index annual rate is 2.4%, unchanged from last month.
Dr Shafik Speaks
One of the group of Carney’s cronies that has been appointed to the Monetary Policy Committee has given an interview to the Kent Business Newspaper. What insight does she offer?
Dr Shafik said the “central expectation” of the Bank of England’s monetary policy committee, which sets interests rates, is that the next move will be up…….The monetary policy committee has rightly said we shouldn’t change interest rates in response to something that is temporary……..we have the option to lower rates.
So interest-rates might go up or they might stay the same or they might go down. That about covers it! Still she did say something unlikely to come out of the mouth of the other Carney Crony Kristin Forbes.
Kent is interesting
You see Ms Forbes has not bothered much with coming to the UK leading me to wonder if she knows where Kent is? Still as a music fan let me air the possibility that she resides in Massachusetts because she is a fan of the Bee Gees.
Let me make it clear I am attacking these women as Carney’s Cronies because of their background and not their sex. There are plenty of British female economists that could and indeed should feel slighted by what has happened here. Why wasn’t one of them appointed?
UK Monetary Policy Has Tightened
We now have a Base Rate which is higher than current inflation as 0.5% is of course more than 0% so we have a unique situation for the UK in the credit crunch era which is a real interest-rate. In spite of the fact that Gilt yields have been falling some of them have a real interest-rate too now. For example the five-year yield at 1.11% will have one at least for a while and even longer-dated Gilts will have one. Of course for the latter the strict definition is over the life of the bond but lets face it this is a period of time where any such longer-term calculations are a fantasy.
The Pound £
This has risen overall since its nadir of March 2013 and has been tightening UK monetary policy ever since. More recently the rise has been shrouded in mist due to the strength of the US Dollar forcing the UK Pound lower against it but overall it has been strong. Back in March 2013 the trade-weighted index fell at one point to 77.9 as opposed to the 89.2 of yesterday. Over the past year the rally has been equivalent to a 1% rise in UK Base Rates.
Funding for Lending Has Faded
From its inception the Funding for (Mortgage) Lending Scheme or FLS gave quite a boost to the UK housing sector and prices via the downwards pressure it applied to mortgage interest-rates which approached 1%. This has now ended so let us look at how it is helping businesses.
Net lending by FLS Extension participants to all businesses was -6.9bn in the fourth quarter of 2014.
So it continues to be a complete failure which is my financial lexicon definition for a counterfactual success which no doubt it will be claimed to be.
However one area did benefit from the FLS in the last quarter of 2014.
Of these, 14 participants made drawdowns of £8.5bn in total.
Remember when we were promised that the banks would only get cheap liquidity if they increased lending. Well up is the new down yet again!
There are a lot of factors at play here but regular readers will be aware that I have been warning about the dangers of an interest-rate cut from the Bank of England since December 2013. In my opinion the protestations about an interest-rate rise are like the boy (girl) who cried wolf for the majority of the Monetary Policy Committee to establish their credentials and mean little if anything. As I have described above there are several grounds for arguing that UK monetary policy has tightened.
The template has been provided by the Riksbank in Sweden which on the day of the UK Budget Statement cut interest-rates to -0.25%. Yet according to it the state of play is as below.
GDP growth is relatively good, the labour market is strengthening gradually and there are signs that inflation has bottomed out, although it is still low
If interest-rate cuts are the new fashion for central bankers replacing forward guidance well we know from the comments section that Governor Mark Carney is this.
They seek him here, they seek him there,
His clothes are loud, but never square.
It will make or break him so he’s got to buy the best,
‘Cause he’s a dedicated follower of fashion.