The UK’s central bank announces its policy decision today and it faces challenges on several fronts. The first was highlighted yesterday evening by the US Federal Reserve.
In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.
UK monetary policy is normally similar to that in the US as our economies often follow the same cycles. This time around however the Bank of England has cut to 0.25% whilst the Federal Reserve has been raising interest-rates creating a gap of 0.75% to 1% now. In terms of the past maybe not a large gap but of course these days the gap is large in a world of zero and indeed negative interest-rates. Also we can expect the gap to grow in the future.
The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate;
There was also more as the Federal Reserve made another change which headed in the opposite direction to Bank of England policy.
The Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.
So the Federal Reserve is planning to start the long journey to what used to be regarded as normal for a central bank balance sheet. Of course only last August the Bank of England set out on expanding its balance sheet by another £70 billion if we include the Corporate Bond purchases in what its Chief Economist Andy Haldane called a “Sledgehammer”. So again the two central banks have been heading in opposite directions. Also on that subject Mr.Haldane was reappointed for another three years this week. Does anybody know on what grounds? After all the wages data from yesterday suggested yet another fail on the forecasting front in an ever-growing series.
Andrew Haldane, Executive Director, Monetary Analysis and Statistics, and Chief Economist at the
Bank of England, has been reappointed for a further three-year term as a member of the Monetary Policy
Committee with effect from 12 June 2017.
For those interested in what Andy would presumably call an anti-Sledgehammer here it is.
( For Treasury Bonds) the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month…… ( for Mortgage Securities) the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.
Whilst these really are baby steps compared to a balance sheet of US $4.46 trillion they do at least represent a welcome move in the right direction.
The Inflation Conundrum
This has several facets for the Bank of England. The most obvious is that it eased policy last August as inflation was expected to rise and this month we see that the inflation measure it is supposed to keep around 2% per annum ( CPI ) has risen to 2.9% with more rises expected. It of course badged the “Sledgehammer” move as being expansionary for the economy but I have argued all along that it is more complex than that and may even be contractionary.
Today’s Retail Sales numbers give an example of my thinking so let me use them to explain. Here they are.
In May 2017, the quantity bought in the retail industry was estimated to have increased by 0.9% compared with May 2016; the annual growth rate was last lower in April 2013…..Month-on-month, the quantity bought was estimated to have fallen by 1.2% following strong growth in April 2017.
So after a strong 2016 UK retail sales have weakened in 2017 but my argument is that the main driver here has been this.
Average store prices (excluding fuel) increased by 2.8% on the year; the largest growth since March 2012.
It has been the rise in prices or higher inflation which has been the main driver of the weakness in retail sales. A factor in this has been the lower value of the Pound which if you use the US inflation numbers as a control has so far raised UK inflation by around 1%. This weakness in the currency was added to by expectations of Bank of England monetary easing which of course were fulfilled. You may note I say expectations because as some of us have been discussing in the comments section the main impact of QE on a currency happens in the expectations/anticipation phase.
On the other side of the coin you have to believe that a 0.25% cut in interest-rates has a material impact after cuts of over 4% did not! Also that increasing the Bank of England’s balance sheet will do more than adding to house prices and easing the fiscal deficit. A ten-year Gilt yield of 0.96% does not go well with inflation at 2.9% ( CPI) and of course even worse with RPI ( 3.7%).
I spotted this earlier in the Financial Times which poses a serious question to Bank of England policy.
Since 1980, the compounded inflation-adjusted gain for a UK homeowner has been 212 per cent. Before 1980 house price gains were much tamer over the various cycles either side of the second world war. Indeed, in aggregate, prices were largely unchanged over the previous 100 years, once inflation is accounted for.
A change in policy? Of course much of that was before Mark Carney’s time but we know from his time in Canada and here that house price surges and bubbles do happen on his watch. The article then looks at debt availability.
The one factor that did change, though, and marked the start of that step change in 1980, is the supply of mortgage debt……….has resulted in a sevenfold increase in inflation-adjusted mortgage debt levels since then.
This leads to something that I would like Mark Carney to address in his Mansion House speech tonight.
Second an inflation-targeting central bank, which has delivered a more aggressive monetary response to each of the recent downturns, because of that high debt burden.
On that road we in the UK will see negative interest-rates in the next downturn which of course may be on the horizon.
There is much to consider for the Governor of the Bank of England tonight. If he continues on the current path of cutting interest-rates and adding to QE on any prospect of an economic slow down then neither he nor his 8 fellow policy setting colleagues are required. We could replace them with an AI ( Artificially Intelligent ) Robot although I guess the danger is that it becomes sentient Skynet style ( from The Terminator films ) and starts to question what it is doing?
However moving on from knee-jerk junkie culture monetary policy has plenty of problems. It first requires both acknowledgement and admittal that monetary policy can do some things but cannot do others. Also that international influences are often at play which includes foreign monetary policy. I have looked at the Federal Reserve today well via the Far East other monetary policy applies. Let me hand you over to some research from Neal Hudson of Residential Analysts on buyers of property in London from the Far East.
However, anecdotal evidence suggests that many of these buyers have been using local mortgages to fund their purchases. The limited evidence I have suggests that around half of Hong Kong and Singaporean buyers use a local mortgage while the majority of mainland Chinese buyers use one.
Okay on what terms?
The main difference is that the mortgage rate tends to be slightly higher (London Home Loan comparison) and local lenders allow borrowers to have far higher debt multiples.
These people are not as rich as might previously have been assumed and we need to throw in changes in the value of the UK Pound £ which are good for new buyers but bad for existing ones. Complicated now isn’t it?
On a personal level I was intrigued by this.
Last year I visited a development in Nine Elms and the lobby felt more like a hotel than a residential block. There were significant numbers of people appearing to pick up and drop off keys with suitcases in tow.
You see I live in another part of Battersea ( the other side of the park) and where i live feels like that as well.