Another failure for the Forward Guidance of the Bank of England

Today completes the business surveys which will give us our best indication so far about economic life so far in the UK post the leave the European Union vote. Of course Brexit has not actually happened but some things have changed in response to its likelihood and the Bank of England’s policy changes. Financial markets can move virtually immediately in reply to changes in events in the way that the real economy can although they are far from always right as those who pushed the UK Pound £ above US $1.50 on the night of the referendum will know. It then dropped 7 cents as the Sunderland result came in and later fell further.

The UK Pound £

The UK Pound was hit hard by the leave vote and quickly fell into the low US $1.30s and indeed for a brief spell into the high US $1.20s. A similar move was seen against the Euro where the low 1.30s were replaced with a fall to 1.16. More recently the UK Pound has recovered a little of the lost ground to above US $1.33 and Euro 1.19 as a bear squeeze grips the number of short sellers looking for a one-way bet which is apparently a record.

Regular readers will be aware that I saw March 2013 as a change in UK monetary policy as from then the UK Pound strengthened. Well at the nadir in mid-August we fell back to below the 77.9 recorded then on the trade-weighted or effective exchange-rate as we saw 77.14. But the recent bounce has seen us back up to 79.8.

This means that if we use the old Bank of England rule of thumb the economic effect of the currency fall is equivalent to a 2% reduction in Bank Rate. This bazooka completely dwarfs the 0.25% peashooter that Bank of England Chief Economist Andy Haldane called a sledgehammer and is a reason why I think it was a bad move. This will have a stimulus effect on UK GDP which is good but also a stimulus effect on UK inflation which is bad. Back on the 19th of July I gave an estimate of the likely inflationary impact.

Applying the Draghi Rule would see an increase in inflation of 0.3% to 0.4%. If we look at the way that the UK economy is relatively more open than the Euro area and the fact that our fall was more against the US Dollar in which many commodities are priced I expect a larger impact on the annual rate of inflation than the Draghi Rule implies and estimate one of say 1%.

UK Gilts

The UK Gilt or government bond market took off like those North Korea rockets fired this morning after the leave vote. Let us look at the 5 year maturity because it has the most impact on fixed-rate mortgages. If we look back to the summer of 2014 when Bank of England Governor Mark Carney was using his Forward Guidance to hint at Bank Rate and hence mortgage rate rises this nudged above 2%. This had already gone very wrong before we had the leave vote as it had dropped to 0.84% leaving those who had taken his advice looking up the definition of miss-selling. Now the whole position is completely different as it has fallen to 0.24%.

Indeed the Bank of England is attempting to drive price higher and yields lower today as it looks to purchase £1.17 billion of UK Gilts in this maturity sector.

UK stock market

It is hard to believe that the UK FTSE 100 fell below 6000 on the referendum night with it now at 6883. For a while we had a whole raft of economic tourists telling us that the FTSE 250 was more important as it dipped below 15,000 in late June. However when I looked to see when it had been last mentioned on Twitter last week there was silence which I presume is associated with the fact that it is now above 18,000.

For my purposes I think that there are genuine concerns how the Bank of England “sledgehammer” of Bank Rate cuts ( one made and another promised) plus more QE have boosted asset prices again. If that was a cure for our economic ills we would not be where we are.

Business Surveys

Unlike my subject of Friday – the ongoing Greek economic depression – the UK economy has shown a V-shaped response to the early fears.

The UK service sector returned to growth in August, according to PMI® survey data from IHS Markit and CIPS……..The month-on-month gain in the index, at 5.5 points, was the largest observed over the 20-year survey history, following a record drop of 4.9 points in July.

This added to what we were told last week.

August saw solid rebounds in the trends in UK manufacturing output and incoming new orders. Companies reported solid inflows of new work from both domestic and export sources, the latter aided by the sterling exchange rate. ………….UK construction companies indicated a sustained reduction in business activity during August, but the pace of decline was only marginal and much softer than the seven-year record seen during July.

The overall picture is show below and it comes with the sound of screeching tyres as Markit does a U-Turn.

there’s plenty of anecdotal evidence to indicate that the initial shock of the June vote has begun to dissipate.

There is also some straw clutching as they try to suggest that the Bank of England policy change have had an impact which would mean that the old theory that policy moves take 18 months to impact now has switched to more like 18 hours.

Adding to the theme was this from the Society of Motor Manufacturers and Traders or SMMT.

The UK new car market achieved modest growth in August, as registrations rose 3.3% against the same month last year, according to figures released today by SMMT. 81,640 new cars were registered in the month, with year-to-date performance remaining positive, up 2.8% to 1.68 million units.

This feeds into the strong numbers for unsecured lending we have seen in 2016 which I believe includes car finance. Sadly we do not get a breakdown on this from the Bank of England although we do get a clue from the SMMT.

attractive finance deals

Also the retail sales numbers were strong and offered hope for domestic consumption.

In July 2016, the quantity bought (volume) of retail sales is estimated to have increased by 5.9% compared with July 2015; all sectors showed growth

Not everything is rosy today though

I noticed this earlier and whilst in some respects it is welcome – buyers for the UK Pound- the larger influence is on house prices which are already far too high.

The pound’s devaluation following the EU referendum has triggered a spending spree in London’s property market from foreign investors. But these overseas buyers are no longer just targeting prime central locations.

Let us see what happens as the anecdotal evidence I have received is of price falls for central London property.


Regular readers will be aware that I was sanguine about the economic impacts of a leave vote. Or to be more precise that the major impact for me would be the rise in inflation caused by the lower level of the UK Pound which would slow the economy over the medium-term via lower real wages and higher import costs. That will impact over time and there are of course issues over the actual Brexit deal which we simply do not know. So far we have seen that the UK economy has had a short-term shock and then rebounded leaving much of the media with their faces covered in egg. Some are so desperate that they are claiming that the Bank of England has driven the rebound which of course would be the fastest policy response in history. From Katie Martin of the Financial Times.

How do good PMIs “prove” the BoE over-reacted? Surely they’re better partly because of the BoE?

If we move to Bank of England policy we see that yet again it has wrong-footed itself. In response to the leave vote it has cut Bank Rate and expanded QE which will have adverse effects for both savers and pension funds. On that road a claimed stimulus may yet turn out to be exactly the reverse. When we get the details of the Term Funding Scheme  then we seem set to find out that the “precious” otherwise known as the banks will yet again get special status. How has that worked out so far?

For the rest of us there is no special status and we face the likelihood of both good days and bad days ahead and today was a better day in that sequence. Looking forwards let us muster some humility and sing along with Bob Dylan.

Come writers and critics
Who prophesize with your pen
And keep your eyes wide
The chance won’t come again
And don’t speak too soon
For the wheel’s still in spin
And there’s no tellin’ who
That it’s namin’
For the loser now
Will be later to win
For the times they are a-changin’.






15 thoughts on “Another failure for the Forward Guidance of the Bank of England

  1. another failure of mark carney

    when will we be free of this buffoon ?

    the longer he stays the more damage to the BoE and the UK


    currently raining on my popcorn 🙂

    • Hi Forbin

      Yes the weather has been a disappointment in Battersea too, we were promised nice weather yesterday whereas it remained cloudy then rained later. Corn prices have rallied a little too over the past few days….

      As for Governor Carney he has at least been consistent.

  2. I note that the MSM has tried to ignore this biggest rise in the PMI in 20 years unlike when it fell in July and they plastered it all over the front page (looking at you BBC & FT). The FT goes a stage further and hints this down to the recent action taken by the BOE (just choose the quotes you want to publish).
    One has to wonder at the agenda of these organisations especially as they claim to be independent, well maybe not the FT!

    • I spotted an article in Saturday’s Times by their economics editor, Phillip Alldrick, which raises some questions about BOE policy and its effect on pensions schemes and asset prices. It has taken a long time, but maybe a few in the MSM are beginning to worry. The trouble is that while such stuff is tucked away in the business pages it will have no impact. It needs the BBC and the front pages to cover it, which they won’t.

    • Radio 4 said a few hours ago that ‘it was possible there might be some improvement in parts of the economy’ talking about the PMI numbers.

      Isn’t this the sort or reporting that you get in Russia and China…and North Korea?

  3. Hi Shaun,
    The group of people in a dark room seem to be moving further away from the door handle, not nearer. Wouldn’t you think some of them would stop listening to the man telling them which way to go?
    What a very expensive and time consuming shambles.

    • Hi Eric

      Yes they are rather like Zaphod Beeblebrox from the Hitchhikers Guide To The Galaxy who had sunglasses with would go jet black at any sign of danger. Some of them are so institutionalised I am do not think it even occurs to them that there is another way.

  4. How can people pontificate on the outcome of Brexit,we are not even under starters orders yet.
    It seems Mrs May’s strategy is starting to show cracks the Japanese and US started to turn the screw at the weekend.
    Therefore I was amazed that pound rose today perhaps US Labor Day holiday had some impact.
    There were demonstrators outside Parliament today demanding Article 50 be triggered immediately ,the pressure has only started to increase.
    I am amazed at how some of these people and some politicians believe that Brexit is as simple as a ship untying and leaving port.

  5. Hi Shaun, better late than never, just got in from an emergency call out.

    So this is what I was talking about on 24 June when others were saying the indicators were downwards. The indicators I follow continue to be upwards but with the grenade of Brexit vote and delayed invocation of Article 50 thrown in the cesspit causing uncertainty which may derail the current growth.

    On bonds I see some signs of significant inflationary pressure building, likely to arrive next summer, but it’s too early to make a %age prediction yet as these pressures may yet recede. If they don’t, I think the Pension funds will be able to begin to sit back and relax next Autumn whilst the BOE does it’s all to try to drive prices up again but it will be to no avail unless it chooses direct debt monetisation.

  6. Nice blog Shaun. One for me to now watch out for.

    The way I see things is that Carney has one thing in mind, and everything else falls by the wayside. That one thing is “house prices”.

    I believe that he thought that international investors would look away from London after Brexit, and thus there was a perceived threat to London house prices and by extension the UK property bubble that he has inflated just like he did in Canada. He sees his “stimulus” as a success because the sum of the valuations of all UK properties has or will exceed the QE stimulus, and of course it minimizes any risk to the banks as a bonus.

    Nothing else seems to matter with Carney but a housing bubble, and I can no longer look at an image of him without seeing one eye of his bulging out at UK housing market valuations while spinning plates with his hands, desperate to keep it afloat.

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