Yesterday the Bank of England announced an extraordinary package of policy measures even for these times. So without delay let us look at the consequences and indeed damage from such moves. But let us do so to a musical theme as we did indeed find out what Chief Economist Andy Haldane meant a few short weeks ago.
I want to be your sledgehammer
Why don’t you call my name
I’m going to be-the sledgehammer
This can be my testimony
I’m your sledgehammer
Let there be no doubt about it
Sledge sledge sledgehammer
There was something of a delay as the Bank of England website collapsed which I hope is not a metaphor for its knowledge of technology. Actually having just checked it the situation is worse than I thought as it is still down as I type this.
Here we saw pretty much the whole play book being deployed. Here it is.
This package comprises: a 25 basis point cut in Bank Rate to 0.25%; a new Term Funding Scheme to reinforce the pass-through of the cut in Bank Rate; the purchase of up to £10 billion of UK corporate bonds; and an expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion. The last three elements will be financed by the issuance of central bank reserves.
Okay so let us work our way through this.
Firstly the Bank of England has cut Bank Rate to as low as it has ever been in its 322 year history. Next we have yet another bank subsidy which I will analyse in a moment. Then rather oddly we have what might be called a “rave from the grave” as the Bank of England repeats a past ability to buy corporate bonds. The catch is that it did not back then apart from the occasional purchase of £10 million or so in the summer of 2013 which were usually quickly reversed. Perhaps as the ECB is undertaking such a program Governor Mark Carney saw an opportunity to live up to his description as “a dedicated follower of fashion”. Also you may note that the previous corporate bond effort was very badly timed as the UK economy was improving.
Then we got an announcement of more conventional Quantitative Easing amounting to an extra £60 billion. You might think that if £375 billion did not work then another £60 billion was unlikely to but remember Governor Carney kept telling us that such numbers had been “carefully crafted” . By who and how was left unasked! Anyway let me help out by using the Bank of England’s latest working paper on the subject.
Our focus in this paper, however, is on the second round of purchases between October 2011 and June 2012, when the Bank of England purchased £175 billion of gilts, about 11% of nominal GDP,
Okay so what impact did it have?
We find that the second round of the Bank’s QE purchases during 2011–12……..boosted GDP in the United Kingdom by around 0.5%–0.8%.
So a “carefully crafted” £60 billion will supposedly raise UK GDP by something of the order of 0.2% if the paper is correct. More of a pea shooter than a bazooka isn’t it? That is of course to ignore the side-effects like this.
(The) effect on inflation was also broadly positive reaching around 0.6 percentage points, at its peak.
If we skip over the central banker speak of higher inflation being a “positive” we see that inflation will be expected to be 0.2% higher as we already mull the side-effects that in my opinion could easily make the additional QE a subtraction from GDP rather than a boost.
The problem that is final salary pensions
These are valued in terms of the bond yields which the Bank of England is doing its best to drive lower, specifically AA Corporate Bond yields. So as you can see the only thing worse for this than ordinary QE is the Bank of England buying Corporate Bonds. Oops! Here is some analysis of the matter from the Financial Times.
The deficit of defined benefit pensions, which pay out an income linked to an employee’s final salary, jumped £70bn as a direct consequence of the decision to reduce interest rates by 0.25 per cent, according to Hymans Robertson, the consultancy.
Ah so a one for one ratio with the planned QE increase! At this point Mark Carney and the Bank of England are wearing a collective Dunces cap. Still they have a plan.
Many companies that saw increased pension deficits were able to extend the period over which they brought them back to balance, maintaining the existing level of contributions.
So kick the can into the future and hope that the problem somehow disappears is apparently the new “carefully crafted”. Also if you mimic an ostrich and stick you head in the sand the problem disappears.
At present, however, those effects appeared to be relatively limited.
Either the Bank of England does not understand final salary schemes – after all didn’t its Chief Economist Andy Haldane state that only recently? – or it is being rather economical with the truth here.
Yet another subsidy for the banks
The announcement of the Term Funding Scheme came like this.
the MPC is launching a Term Funding Scheme (TFS) that will provide funding for banks at interest rates close to Bank Rate.
At this point you may be thinking is this the Funding for (Mortgage) Lending Scheme or FLS in disguise? That will only be reinforced by this bit.
the TFS provides participants with a cost-effective source of funding to support additional lending to the real economy, providing insurance against the risk that conditions tighten in bank funding markets.
So a £100 billion of subsidy sorry funding to the banks. At that point please indulge me a little as I cut to this morning’s announcement from Royal Bank of Scotland (RBS) .From the BBC
Royal Bank of Scotland reports £2bn loss for the first six months of the year, blaming “legacy issues”
That is the same RBS which was fixed last year and the year before that and the year before that and the year before that…….
Oh by the way how is the culture of subsiding our banks going?
Of course the official version of the TFS is this.
This monetary policy action should help reinforce the transmission of the reduction in Bank Rate to the real economy to ensure that households and firms benefit from the MPC’s actions.
No doubt “should help” will be appearing in future versions of my financial lexicon for these times.
The impact of the fall in the UK Pound £
The trade-weighted index fell by around 1% or to put it another way equivalent to another 0.25% fall in Bank Rate to add to the 2% post Brexit fall that I discussed on Wednesday.
The Bank of England cuts its own income
The last three elements will be financed by the issuance of central bank reserves.
A little known fact is that the Bank of England charges Bank Rate on such issuance such that it got 0.5% until yesterday in what might be called “a nice little earner” by Arthur Daley. In a way it is analogous to seigniorage although there are differences. Now it will be 0.25% and presumably less later in 2016. Mind you that 0.25% will of course be levied on more,more,more.
Open Mouth Operations
The actual moves were added to by a lot of rhetoric about more in fact so much more that they should have been playing MARRS.
pump up the volume
pump up the volume
brothers and sisters
pump up the volume
we’re gonna need you
brothers and sisters
pump up the volume
pump that baby
We were left in no doubt that if necessary the volume will be turned up to 11.
On Wednesday I wrote that I would have voted for no further stimulus on two main grounds. Firstly the fall in the UK Pound £ at that point was broadly equivalent to a 2% reduction in Bank Rate. Secondly I feel that moves which are badged as stimulus have such side effects that the can easily turn out to be both deflationary for demand and inflationary for prices for the economy. That operates through businesses via pension schemes as I have looked at above and for the ordinary person in falls in real wages just like what happened when the Bank of England looked through an inflationary episode in 2010/11.
What we are in effect seeing are put options for the banking sector, house prices and the equity market.
Also if we move to the Bank of England press conference there was one glaring bit as Bank of England Deputy Governor Broadbent told us that they were looking at sentiment measures and downgraded “hard data” such as GDP. This was a complete U-Turn on past policy which has often been to wait for GDP data. Please do not think I am a sort of fan boy for GDP statistics, regular readers will have seen my critiques. But my point is that the Bank of England is now “cherry-picking ” the data to confirm its pre-existing view.
Actually Ben Broadbent seems to be in a state of distress. Here is the BBC’s view of what he said on Radio 4 Today earlier.
I have asked them if he has abandoned the long-standing view that interest-rate changes take 18/24 months to have full effect? If I get a reply I will let you know.
Never believe anything until it is officially denied.
Bank of England deputy governor Ben Broadbent says interest rate cut does not send out message of panic (The Independent).
I will be on Share Radio today between 1.10 pm and 1.40 pm covering these matters and the US Employment Report in the latter part. For those not in the UK it is online as well.