Yesterday at 4 pm the Governor of the Bank of England spoke to the nation. I have to confess that before the event I wondered why? He had already made his post Brexit referendum statement where he had performed well and said the right things. At a time of crisis the central bank should do as he did and confirm it will supply liquidity and continue to perform its duties. It was only yesterday that the issue of bank funding costs was raised in the comments section so this move was sensible.
As a further precaution, reflecting the possibility that heightened uncertainty may last a while longer, today the Bank of England is announcing that it will continue to offer Indexed Long-Term Repo operations on a weekly basis until end-September 2016. This will provide additional flexibility in the Bank’s provision of liquidity insurance over the coming months.
So in looser language it is willing to splash the cash in liquidity terms for three months and this should help to keep the UK financial system from any danger of freezing up. This adds to the back-stop he put in place with his first speech.
And as a backstop, in order to support market functioning, the Bank of England continues to stand ready to provide more than £250bn of additional funds through its normal facilities.
I also have some sympathy with him on this front.
In Tim Geithner’s famous dictum, “plan beats no plan.”
As currently he is dealing with a UK political establishment which is in flux represented by a combination of hiding,backstabbing, denial and disarray. So far so good for Governor Carney.
The model of a modern central banker
These days they respond to events with ever lower interest-rates and extraordinary monetary policies and we got a hint with a large pointed arrow on it from Governor Carney.
the economic outlook has deteriorated and some monetary policy easing will likely be required over the summer.
This was immediately translated as being a signal for a lower Bank Rate and additional Quantitative Easing to the £375 billion stock that the Bank of England currently holds. Before I say what I think he will do I would like to show the financial market reaction to it.
There were two very strong market moves in response to the speech. The first fits in with one of the themes of this blog which is the worldwide push to lower interest-rates and yields. Mark Carney’s words lit the blue touch-paper as UK Gilt prices rose like a rocket. There are reports that the UK 2 year yield went negative briefly which would be the first sighting of such a thing in the UK I can recall. I wonder if that is a misprint but the surge saw our 10 year Gilt yield fall to 0.8% this morning and the 30 year to 1.7%.
The UK FTSE 100 surged also and ended the day above 6500 where it remains. So it is higher than before the Brexit result due to two main factors. The first is due to the lower UK Pound £ as so many of the companies have foreign earnings. The second is the fall in yields above which make any reliable dividend stream look increasingly attractive. As Governor Carney had met the banks the day before an awkward possible “early wire” perspective is provided as the FTSE 100 rallied over 200 points that day in what was then a surprising move. A little care is needed as outside the top 100 the performance is weaker shown by the fact that the FTSE All Share is up only 1% since the pre Brexit close.
By contrast the move in the UK Pound £ was relatively sedate. Yes it fell but then it rallied again as knee-jerk responses met the view that this was what most people expected him to want to do. So the UK Pound fell by around 1%.
Will this help?
In theory yes but then we hit the issue of the fact that the Japanese and European experience has been patchy at best. Yes the Euro area has been putting in a better performance in 2016 but much of that in my view is due to lower oil prices and inflation leading to higher real wages. However if we return to the central banking play book the higher equity prices will stimulate the economy via wealth effects and the lower bond yields will make more economic activity viable.
If that was a magic wand we would not be where we are would we? Also whilst the central bankers may claim that people can borrow cheaply we cannot be sure that the funds will go to the right places. After all the much trumpeted Funding for Lending Scheme (FLS) which started 4 years ago can be measured by the large number of times official sources use the word “counterfactual” in response to it.
On that subject I expect the FLS to be fired up and boosted again probably sooner rather than later.
This is where life gets a lot more awkward for Mark Carney as his Forward Guidance predicted higher interest-rates and the UK moving towards a Bank Rate of 2.5% or so. The road to this was signposted at the Mansion House speech just over 2 years ago.
It could happen sooner than markets currently expect.
That was a clear hint to which financial markets responded. There are costs to that but even if that does not bother you much what about those with mortgages and businesses who locked in borrowings to take advantage of interest-rates which he was telling them were good? Instead they have been left far behind as mortgage rates have plunged.
In reality Forward Guidance Mark 20 is for Bank Rate cuts presumably to 0% which I note is at the time horizon of policy action ( around 2 years) during which no interest -rate rises took place and Mark Carney never even voted for one.
This was another awkward bit for Mark Carney yesterday so let is consider his mission statement.
Promoting the good of the people of the United Kingdom by maintaining monetary and financial stability.
Now let us see how that fits with these words.
Uncertainty over the pace, breadth and scale of these changes could weigh on our economic prospects for some time……economic post-traumatic stress’
You might have thought with his and the Bank of England’s dreadful forecasting record he might have shown some discretion. After all claiming certainty of a sort is what got him into his Forward Guidance mess. Also a central bank should act to reduce issue around uncertainty and not feed it whatever the Governor’s own personal views.
It was hard not to have a wry smile at the Governor of the Bank of England hinting at something that I have predicted for so long which is a Bank Rate cut! Let me be clear that down at these levels such moves have so many unintended consequences they may even be contractionary in my opinion. Also there is the issue that whilst he tried to say he was giving his own opinion Mark Carney was in effect tying the hands of his Monetary Policy Committee colleagues behind their backs.
In my view, and I am not pre-judging the views of the other independent MPC members, the economic outlook has deteriorated and some monetary policy easing will likely be required over the summer.
Yes you were pre-judging them Mark because you had told us this.
As required by our remit, the MPC identified that the most significant risks to its forecast concerned the referendum.15 This was the view of all nine independent members of the MPC.
I would not be pleased if I was one of the other eight. A better approach would have been to call an emergency meeting and actually vote. This way around all we have are more Open Mouth Operations as we wonder how many of them are in fact Carney’s cronies. The more I am officially told that someone is “independent” the more I wonder about the reverse.
As to analysis there was this from Kristin Forbes back in October 2014.
Over periods longer than one quarter, however, a stronger real exchange rate is correlated with a significant fall in total exports……..a 10% appreciation of sterling – holding all else equal – is predicted to cause a 3.1% fall in export volumes over the long term.
In conclusion she told us this.
I discussed how sterling’s strength has created some drag on the trade balance, and thereby aggregate demand, growth, and employment.
Now currently we have pretty much the reverse due to sterling’s fall. I would be thinking of that right now.
Also there is fiscal policy when you can borrow for a long time very cheaply. There are possibilities there which did not exist before. Back on June 10th I discussed the issue here as the perspective on fiscal policy has shifted considerably with Gilt yields where they are. I have sympathy with Governor Carney in the sense that there is no one in authority to discuss this with but going forwards it is an option and of course his promised interest-rate cuts would only really work in say 18 months time so too late for any immediate issues.
But let me leave you with my song for Mark Carney with thanks to the Kinks.
And when he does his little rounds
‘Round the boutiques of London Town
Eagerly pursuing all the latest fads and trends
‘Cause he’s a dedicated follower of fashion
On The Radio
I will be on Share Radio ( which is on UK DAB plus the internet) from 1 pm to 1:30 pm today and it is a sign of the times I was on the Morning Money show as well earlier.