How will the Bank of England respond to slowing growth and higher inflation?

After considering the issue of Helicopter Money which is generating ever more column inches yesterday there comes the issue of when and why it might be applied in the UK? At first it seems unlikely as the Bank of England targets an annual rate of Consumer Price or CPI inflation of 2% per annum and unless the price of oil continues to fall we will head back up towards that over the next year or so as services inflation is in fact above the 2% target.

However this ignores two factors the first of which is that the Bank of England looked the other way when both CPI and Retail Price Index or RPI inflation pushed above 5% in the autumn of 2011. This has posed a question to the Forward Guidance of Mark Carney and the Bank of England which itself has undergone continual changes and is now around version fourteen. The reason why it did not act in 2011 was based on another part of its remit which has been strengthened since then and the new version is below.

Subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment …….

There have been clear signs that the inflation target has become subject to the growth objective meaning that the Bank of England has become more like the US Federal Reserve. Also the definition of government policy poses a challenge for those who claim “independence” for the Bank of England as the description of the government’s economic objective opens with a clear implied direction for it.

Monetary activism and credit easing, stimulating demand, maintaining price stability and supporting the flow of credit in the economy;

As to QE and other similar policies well there seems to be even less “independence” here.

I shall expect the Committee to work with the Government to ensure the appropriate governance arrangements are in place to ensure accountability in the deployment of such instruments.

Also this bit seems to allow the Monetary Policy Committee to bring inflation back to target over an unspecified time period that it defines.

In exceptional circumstances, shocks to the economy may be particularly large or the effects of shocks may persist over an extended period, or both. In such circumstances, the Monetary Policy Committee is likely to be faced with more significant trade-offs between the speed with which it aims to bring inflation back to the target and the consideration that should be placed on the variability of output.

UK economic growth

The reason I raise this is that there are more and more signs of a fading in the economic growth achieved by the UK economy. The NIESR started this around a month ago.

Our monthly estimates of GDP suggest that output grew by 0.3 per cent in the three months ending in February 2016 after growth of 0.4 per cent in the three months ending in January 2016

They blame this on a weak December and think that the rate may be 0.4% now on a quarterly basis. Only this week we saw that the Purchasing Managers Indices or PMIs calculated by Markit came to a similar conclusion.

An upturn in the pace of service sector growth in March was insufficient to prevent the PMI surveys from collectively indicating a slowdown in economic growth in the first quarter. The surveys point to a 0.4% increase in GDP, down from 0.6% in the closing quarter of last year.

They also pointed out that this was affecting an area of the economy which has in the credit crunch era been the strength of it.

Across the three main sectors of the economy, firms reported the smallest increase in demand for just over three years, which in turn fed through to a reluctance to take on new staff. March saw the weakest rate of job creation for over two-and-a-half years.

A Bank of England with a growth objective will quickly be mulling a reduction in economic growth combined with for the first time in a while weakness in employment growth. Especially if this bit becomes true.

In contrast, the survey data suggest growth is more likely to weaken further in the second quarter. With the PMI already in territory traditionally associated with the Bank of England choosing to loosen policy………

There is a clear hint there and would the Bank of England use the fears it has contributed to over a possible Brexit from the European Union to ease policy and cut the Bank Rate? It would be Forward Guidance version fifteen if it did.

Monetary Policy has been easing

One area where UK monetary policy has seen an easing has been in the exchange rate of the UK Pound £. The strength of the US Dollar pushing us back to US $1.41 has been joined by the Euro pushing us below 1.25. My subject of earlier this week Japan comes back to the fore as the Yen rises to 155 to the Pound. If we look at the trade-weighted or effective exchange-rate it has fallen over the past year by the equivalent of a 1.5% reduction in Bank Rate. We are reminded once again that these days movements in exchange-rates are the major player in monetary policy. Actually the UK Pound £ rallied gently in 2015 so using the old rule of thumb you can argue that the equivalent of a 1.75% Bank Rate cuts has taken place so far in 2016.

We also see that Gilt yields have fallen so far in 2016. Of those the most significant is the 5 year Gilt yield because of the way it influences fixed mortgage-rates and it has fallen from 1.35% to 0.78% in 2016 so far. Thus we see that without the Bank of England doing anything monetary policy has eased in the UK in 2016.  Indeed this makes its Forward Guidance look about as effective as King Canute’s effort with the tide.

There is inflation if you look

This morning we have received another taste of the UK house price boom.

House prices in the latest three months (January-March) were 2.9% higher than in the preceding three months ……. Prices in the three months to March were 10.1% higher than in the same three months a year earlier.

This is of course around 5 times the increase in real wages over this time period which is why first time buyers need so much “help” these days. Also according to the official data those renting are having problems too.

Among all renters, the proportion of household disposable income accounted for by rents has risen from 12% in 1986 to close to 20% in 2014. Among private renters the fraction is higher still: close to 25% on average in 2014. This ratio was highest in London in 2014 – where more than one-third of disposable income in privately renting households was absorbed by rent.

It seems to have all got more expensive without there apparently being any inflation or something like that.


As I have demonstrated today the Bank of England has in fact presided over quite an easing of UK monetary policy in 2016 so far. It has had an opportunity to actually deploy some of its Forward Guidance in response yet it has not. In fact with the talk of Helicopter Money we seem to find ourselves being led to another round of easing which is as I pointed out yesterday rather odd in a claimed boom, Perhaps it is worried what will happen when the beneficial impact of lower oil prices on domestic demand starts to wear off.


25 thoughts on “How will the Bank of England respond to slowing growth and higher inflation?

  1. I seem to remember that we were also guided to expect interest rates to rise when unemployment reached some magic figure (was it 6.5%?). Of course, that never happened and, IMHO, you are right to point out the importance of the number of Forward Guidance changes, because they reflect the fact that the bank of England is struggling (failing?) to find any coherent policy, other than the eternal can-kicking…

    • Hi James

      You are right except that the level was an unemployment rate of 7%. It was something of a record speed for a U-Turn as the surge in employment pushed the rate below it! Carney did not expect it to happen for a couple of years which is embarrassing to say the least for a policy badged as Forward Guidance.

      As to coherent policy I think that central bankers were unwise in their belief that they could make things happen by making promises .Sadly they duped some such as those in the UK who remortgaged only to see mortgage rates continue to fall. But in general it had little impact which is why we see ever more Open Mouth Operations as the central bankers double down.

  2. hello Shuan,,

    “Perhaps it is worried what will happen when the beneficial impact of lower oil prices on domestic demand starts to wear off…”

    more like HMG is worried it won’t be getting elected !

    ref, so called independence of BoE 🙂

    BoE remit has been one of targetting wage inflation ( as can be seen by its total inaction on prices ) , this is perverse as the people of the UK ( and for the Western economies ) actually need more spare cash in their pockets to boot the consumer based economy .

    and also the BoE will surprised at any detrimental changes but “fully on track ” for ones that are good .

    you’ve gotta laff really


    • Hi Forbin

      If we stick to a system of fixed term parliaments then it is quite a while to the next election although I have to confess I am unsure what would happen if the government lost a vote of no confidence. But as we have discussed on here many times the Bank of England is not independent and may even be anti-independent as it has been able to do policies which the politicians may not have been able to.

  3. Hi Shaun

    I don’t think the BOE will raise rates even if inflation goes very much higher for the simple reason that they can’t. I don’t think they will ever raise rates voluntarily; they will be forced to at some stage, probably via the exchange rate.

    Raising rates would not only snuff out any growth in the economy which, as you have pointed out, is already going south, it would have a substantial effect on house prices and these have to be maintained come what may; repeat come what may.

    If house prices fell by even a small amount, say, 5% the government would be in great difficulty as the property fetish has taken hold with a vengeance and people are under the total illusion that they are wealthy if house prices are high. All those people who have been sucked (or suckered) into the market in the last few years (whether as OO or BTL) would be sitting on negative equity and they would blame the government with consequent effects on their electoral prospects. You cannot deflate a Ponzi.

    They may be worried about what happens when the oil price effect wears off but they will continue as they have done in recent years, that is with a policy of malignant neglect.

    • I could not agree more, but would add that there might be a REAL problem (as opposed to your correct view as to property fetish!) when people cannot pay their mortgages as interest rates rise.
      Then, the proverbial will hit the fan, as the banks are hardly pillars of strength.

      • Actually James I’m not sure abut that. I think the banks would come under tremendous pressure to exercise “forebearance” to mortgage holders to prevent repossessions.

        • I agree that foreclosures would be really tightly controlled, but there is no way (I speak as an ex-auditor) that they would get away without write-offs on non-performing mortgages. Those losses would then eat into capital, which would mean that they were even more broke than now…

        • Being a retired chartered accountant myself I know where you’re coming from but I think the rules would be bent somehow. Let’s face it the Dodd Frank mark to market rules were relaxed into mark to whatever you think is expedient.

    • You haven’t much to worry about Bob, despite Shaun’s NIESR quotes of doom (when were they ever right?) and Markit’s feedback, the indicators I follow suggest a re acceleration for the UK into the Summer and beyond – expected growth around 2.5% pa by year end, certainly above current gloomy 2% forecasts.

      On your comment about the BOE never raising rates voluntarily, that is exactly the way it should be. Central Banks should be raising/reducing rates as events unfold, ergo they never do anything voluntarily but are/should be pragmatic responding to developing circumstances and their forecast as to how they think those circumstances will evolve in the future..

      • I forgot the caveat to “expected growth around 2.5% pa by year end” which is unless the electorate do something foolish like vote in favour of Brexit, then all bets are off!

  4. The vast majority of people in this country are oblivious to the economic disaster will be the outcome of three and a half decades of economic mismanagement.
    We have the largest level of private debt in recorded history the government debt has doubled to £1.6 trillion in less than a decade interest rates cannot go up as we know because the heavily indebted will go under.
    NIRP and ZIRP are supposed to support growth by encouraging borrowing but it is exactly this that caused the crisis so how can it be the cure?
    The manipulation of the debt markets through expansion of the money supply punishes the prudent.
    If as seems likely to me there is another 2008 event …Deutsche Bank? It will be too big to fail but too big to save.
    The debt bubble will explode what will be the detonator?A currency crisis?
    Sooner or later control of interest rates will be lost with catastrophic consequences.
    Those in power either cannot see this or refuse to see it.

  5. Hi Shaun
    My answer to your question is
    TPTB will find new ways to recalculate

    GDP and inflation to suit their needs
    Listened to a 5live piece this
    afternoon with Varoufakis using the
    phrase “Fiscal Waterboarding” to
    describe how the eurozone treated
    Greece and an off the record comment
    about a senior IMF person, clearly
    Lagarde, who agreed with his views.
    Hope that this link is of


    • Hi JRH

      Yes there has been an outbreak of discussion about the “sharing economy” which no doubt will be along to raise GDP and we will be told we are better off. Actually some elements of the sharing economy are true but before we can claim output rises we need to do much better with measuring inflation in animate goods such as bricks and mortar for example!

      As to Varoufakis he is right but if I was someone with his record of utter failure ( Greece got noticeably worse on his watch from a poor base) I might lie low. It is a sad sign of the times that failure and success seem to be treated the same by the media.

    • Thank you for the very interesting link, JRH. However, I am skeptical about Dr. Koblyakova’s remedy, mortgages with 30 year amortization periods. When he was Canadian Finance Minister , the late Jim Flaherty made it possible to get insured mortgages for 30 years and even 40 years, but he reversed himself later. Sure it would make houses more affordable for some Britons, but wouldn’t it just be one more thing pushing up demand and therefore house prices?

      • My answer to your question is that
        TPTB are not concerned with demand
        but only the continuance of rising house
        prices, or is that just old cynical me!

  6. A few examples of hidden inflation (and not so hidden!) from today’s shopping: The jar of coffee we always buy used to be 200gm but now same price and 190gm. Concentrated weedkiller -last year £11.40, this year £14 for same sized pack. Box tissues – same price but contents dropped from 100 to 80 (fortunately i had an old pack left to check this), A rose clear fungus spray – last year £6.25 this year £7.25. All of the above from exactly the same outlets as purchased last year. I do wonder if official statistics pick up this pack shrinkage in their calculations. As for the other, because it is an occasional purchase most people would not recall the price last season however i have the packs in my shed with the price stickers on them. I am also convinced that the brands of kitchen roll and cling film are pulling the same trick but dont have details to prove this. Anyone else noticing pack shrinkage or do I just need to get a life!!?

    • Hi Pavlaki

      Thanks for the stealthflation examples. The own brand razor blades I use seem to have disappeared so whilst I got a windfall as they sold some off I am expecting the next version to be at a higher price. As to your question yes product size changes are counted by the statisticians but producers and supermarkets are so sophisticated I wonder if they mostly do it on good which do not go into the RPI and CPI baskets.

      One rather disturbing change has been in rolls of toilet paper but I will leave that there and be grateful we are not in Venezuela.

      • Hi Shaun, long time daily reader/lurker. Great informative posts! Also noticed with the “own brand” razors – dropped on some “lady razors” which do the same job for money but also thinking they’ll be next to be removed. Can’t help thinking of 1984, where a razor blade was a prized possession.
        Keep up the good work and a good weekend.

  7. Hi Shaun,
    You mentioned the other day Abenomics is failing as the Yen rises and mentioned the “falling” pound sterling against the Yen today but I think I have a possible explanation for this phenomenon as the BOJ plumbs the depths of negative rates. In a word – Trade. I believe Japan trade position has been improving and is currently slightly in surplus which will help the Yen strengthen. This is not about a falling pound so much as a strengthening Yen no matter what the BOJ do. Their only way out if you could call it that is to export less and become net importers again in order to drive the exchange rate down, which will naturally happen anyway as their terms of trade deteriorate.

    • Hi Noo2

      Whilst Abenomics is failing here as the Yen rises rather than falls I think that it was always misguided and there will be two gains for Japan from it.

      1. Inflation will be pushed onto a lower trajectory and thereby we may actually see some real wage growth and higher domestic consumption which has been the holy grail for 20+ years.
      2. Energy costs will fall further which when you import more energy per head than any other major economy has to be a big gain.

      So a crisis for Abenomics but maybe a boost for the economy, oh what a tangled web etc..

  8. Private Eye has a map of UK properties anonymously owned by offshore companies. Such privacy is a gift to money launderers and tax evaders – and should be totally unacceptable in a first world country.

    And Iceland is yet again a shining example of accountability where the PM has stood aside due to Panama papers information.

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