Why is the Bank of England preparing for a 0% interest-rate?

Sometimes events have their own motion as after enjoying watching England in the cricket yesterday which is far from something I can always I had time to note it was Mansion House speech time. My mind turned back to 2014 when Bank of England Governor Mark Carney promised an interest-rate rise.

There’s already great speculation about the exact timing of the first-rate hike and this decision is becoming
more balanced.
It could happen sooner than markets currently expect.

Of course four years later we are still waiting for the unreliable boyfriend to match his words with deeds. Indeed last night he was sailing in completely the opposite direction as shown by this.

The additional capital means the MPC could, if necessary, re-launch the TFS in future on the Bank’s balance sheet, cementing 0% as the lower bound.

We have learnt in the credit crunch era to watch such things closely as preparations for an easing on monetary policy have so regularly turned into action as opposed to tightening for which in the UK we have yet to see an outright one. All we have is a reversal of the last error ridden cut to a 0.25% Bank Rate as I note that the extra £60 billion of QE, Corporate Bond QE and Term Funding Scheme are still in existence.

There was another mention of a 0% interest-rate later in the piece.

Although the principles guiding the MPC’s choice of threshold still hold, with the lower bound on Bank Rate
now permanently close to 0%,

In the words of Talking Heads “is it?”

The Lower Bound

This has been an area which if we keep our language neutral has been problematic for Governor Carney to say the least! For example last night’s speech mentioned an area I have flagged for some time.

relative to the effective lower bound on Bank
Rate of 0.5% at that time

When the statement was originally made there were obvious issues when we had countries that had negative interest-rates well below the “lower bound”. As an example the Swiss National Bank announced this yesterday morning.

Interest on sight deposits at
the SNB remains at −0.75% and the target range for the three-month Libor is unchanged at
between −1.25% and −0.25%

As they are already equipped for a -1.25% interest-rate and have a -0.75% one it is hard not to smile at the “lower bound” of Mark Carney. The truth in my opinion is that it means something quite different and as ever the main player is the “precious” or the banks.

In August 2016, the MPC launched the Term Funding Scheme (TFS) in order to reinforce the pass-through
of the cut in Bank Rate to 0.25% to the borrowing rates faced by households and companies.

As you can see it is badged as a benefit to you and me which of course is a perfect way to slip cheap liquidity to the banks. After all competing for savings from us must be a frightful bore for them and it is much easier to get wholesale amounts and rates from the Bank of England.

Bank of England balance sheet

There are changes here as well.

With the Chancellor’s announcement tonight of a ground-breaking new financial arrangement and capital
injection for the Bank of England, we now have a balance sheet fit for purpose and the future.

What arrangement? There will be a capital injection of £1.2 billion this year raising it to £3.5 billion. That can go as high as £5.5 billion should the Bank of England make profits bur after that it has to be returned to HM Treasury.

The gearing for liquidity operations is quite something to behold.

The additional capital will significantly increase the amount of liquidity the Bank can provide through
collateralised, market-wide facilities without needing an indemnity from HM Treasury to more than half a
trillion pounds. This lending capacity would expand to over three quarters of a trillion pounds when, as
designed, additional capital above the target level is accrued through retained earnings.

On the first number the gearing would be of the order of 140 times.Care is needed with that though as the Bank of England does insist on collateral in return for the liquidity. Mind you that is not perfect as a guardian as those who recall the episode where the Special Liquidity Scheme was ended early due to “phantom securities”. If you do not know about that the phrase itself is rather eloquent as an explanation.

Reducing the National Debt

Yesterday was  good day for data on the UK public finances but that may be dwarfed by what was announced in the speech.

Today’s announcement increases the amount of risk the Bank can carry on its balance sheet. As a result,
the Bank plans to bring the £127 billion of lending extended through the TFS onto our balance sheet by the
end of 2018/19 the financial year.

That had me immediately wondering if the Office for National Statistics will now drop the requirement for this to be added to the UK National Debt. this would bring us into line with rules elsewhere as for example if you will forgive the alphabetti spaghetti the TLTROs and LTROs of the European Central Bank are not added to the respective national debts. Such a change would reduce our national debt from 85.4% of GDP to below 80%. I am sure I am not the only person thinking that would be plenty to help finance the suggested boost to the NHS should you choose.

QE

There was a change here and this reflects the 0.5% change in the “lower bound”

Although the principles guiding the MPC’s choice of threshold still hold, with the lower bound on Bank Rate
now permanently close to 0%, the MPC views that the level from which Bank Rate can be cut materially is
now around 1.5%.
Reflecting this, the MPC now intends not to reduce the stock of purchased assets until Bank Rate reaches
around 1.5%.

Let me offer you two thoughts on this. Firstly as the Bank of England has yet to raise interest-rates from the emergency 0.5% level then discussing 1.5% or 2% is a moot point. Secondly this is a way of locking in losses as you will be driving the price of the Gilts owned lower by raising Bank Rate. Even holding the Gilts to maturity has issues because you get 100 back and in the days of the panic driven Sledgehammer QE buying where market participants saw free money coming and moved prices away the Bank of England paid way over 100.

Comment

It is hard not to have a wry smile at Governor Carney planning for a 0% Bank Rate as one of his colleagues joins those voting for a rise to 0.75%. Of course Governor Carney wants a rise to 0.75% eventually, say after his term has ended for example. The irony was that the person who has put so much effort into trying to be the next Governor voted for a rise. As to how Andy Haldane’s campaign has gone let me offer you this from Duncan Weldon.

Next month: 6 votes to hold 2 votes to hike And one vote for something involving a dog and a frisbee.

There was a time when people used to disagree with my views about Andy Haldane whereas now the silence is deafening in two respects. One is that I do not get challenged on social media about it anymore and the other is that if you look for the chorus line of support that used to exist it appears to have disappeared and in some cases been redacted.

Moving to more positive news there has been rather a good piece written by the England footballer Raheem Sterling and whilst no doubt there has been some ghostwriting the final message is very welcome I think.

England is still a place where a naughty boy who comes from nothing can live his dream.

 

 

 

 

 

 

30 thoughts on “Why is the Bank of England preparing for a 0% interest-rate?

  1. Well Shaun, this is my favourite subject at the moment this is why,

    About 10 years ago I mortgaged and took out a BOE tracker at 0.45% over base rate and invested the money. I am paying about £110.00 per month to service the interest charges, a little over £27 per week!

    Before the last rise went even lower and was only costing me a little over £20 per week!

    I gambled at the time I could make more money investing than the interest I was being charged.

    Better still I took out a “life time tracker” on a 7 year plan. However when it came up for redemption 2 years ago I had read the Bank which is now Barclays could be enforced to carry on with the “life time tracker which I did for another 5 years. At the end of the 5 years I will argue my again, the “life time tracker” must still go on, as lifetime is that was what was said.

    It will suit me down to the ground if interest rates go to 0% but what do you think will happen if they go negative?

    Will Barclays give me money back?

    • Couple of errors with my post, I meant to say I re-mortgaged with the Woolwich it may have been slight longer than 10 years ago, as in the initial year or two I was paying something like £700 per month, but interest rates then started to fall away quickly.

      What I had read what the financial Ombudsman had made a ruling that a “life time tracker” must be just that!

      I argued my case with Barclays the last time round and will do so again. Barclays accepted my argument, but agreed another 5 years due to my age, but I don’t think that will make much difference when it comes up for redemption again, otherwise I will argue age discrimination!

      • Danny Blanchflower sees interest rates going nowhere fast this is what he said 24 hours ago:-

        Danny Blanchflower Retweeted Tony Yates
        “vote for a rise is based upon zero data Q1 0.1% looks like q2 will be 0.2% or so ind prodn falling constructn weak; wage growth slowed since wrote minutes – they guess data is much stronger and wage growth is about to go off pop for the (313th time) and they just cant wait – joke”

  2. The cynic in me says this is simply a new wheeze to be able to bail out banks whilst not showing it in public accounts and as you correctly point out, an accounting mirage to “lower” public debt. For all the talk of “record employment” and “rising real wages” the BoE is still not convinced our economy can sustain even a quarter point rise, something does not compute.

    This is not a drill.

    • Hi bill

      That sounded familiar and then I got it. From Fleetwood Mac.

      “When the night is cold and still
      When you thought you’d had your fill
      Take all the time you will
      This is not a test, it’s not a drill
      Take no prisoners, only kill”

      It always seems to be about “the precious” doesn’t it?

  3. Either 1) Steve Priest really has already taken over or 2) Carney has data showing the housing market is starting to tank, while consumption has stalled, despite the football and sunshine.

    There was a report in the Torygraph yesterday that the U.K. housing market has lost £1bn in value recently, so as Steve is getting ready to tour, it must be 2.

    • Hi David

      Surely for Steve it is an easy choice. Play in front of adoring fans or hide away in Threadneedle Street? Fly over the world living a stars lifestyle or going to Davos and lecturing people on climate change?

      I think if you gave 100 people those choices you would get 200 votes all exactly the same….

  4. Hi Shaun

    I’ve no doubt that Carney would much rather reduce rates than increase them and I would bet that the economic weakness will assert itself and that a cut is more likely than a raise in the next twelve months; after all we are still on emergency rates anyway.

    But folk are getting much more sceptical of this as you hint in your piece and are now seeing all this talk as nothing more than hot air signifying nothing.

    One of the major problems with all these schemes which subsidise rates (effectively the housing market) is that not only do they discourage saving of any sort but they ignore the huge elephant in the room: pension provision. These years of ZIRP have made pensions hugely more expensive and the bill for this may be down the road but it will be huge. I would place this issue on at least a par with the housing market but one that is much less visible.

    • Hi Bob J

      Yes it has been the last straw for final salary pension provision outside the private-sector. Those who had to do scheme projections when the Sledgehammer QE of late summer 2016 put the Gilt market through the rough must have got a dreadful shock. Even now index-linked Gilts ( to hedge the inflation risk) are very expensive.

      Also if you look at contributory schemes many have lifestyling to put investors in safer investments as they approach retirement age. The fact that Gilts are very expensive is ignored. What could go wrong?

  5. I wonder if he is planting a flag in the sand for future action, should should any Brexit shocks cause problems to the economy. And/or It might signal that lending banks have confirmed their computers have been updated and could now cope with a negative base rate as I remember this was one of the possible reasons for not going negative before.

  6. Slightly O/T , I notice that Croatia are ranked 20 in the world by FIFA with England at No.12.
    After seeing them annihilate Argentina last night, I can’t help wondering if FIFA need to update their tables???.
    As for England’s rating and their performance, there does seem to be somewhat of a disconnect, given they make hard work of beating very weak teams and their inability to score a goal, often grinding out 0-0 draws?.

  7. Trade wars on cars, will hit Europe, Europe manufacturing weakening, too many red flags around for an interest rate rise in the UK and my view is the BOE as likely to cut interest rates as increase them despite Haldane voting for a cut.

    Talk of an interest rate rise strengthens the £ and helps to reduce inflation, as inflation falls they will be able to say in August, “hold for now but we will have to think about a rise coming soon but need more information on the economy with a caveat there is always a possibility of a cut with Brexit and all that; However if the economy bounces from here, we see a rise coming sooner than later”!

    Then the £ rises again which helps to reduce inflation, so everything starts of all over again dependant on how bad the economy fares and if it keeps declining they make an emergency cut.

    With a 0.45% tracker above base rate, I am on the right side for now on my re-mortgage of £150,000. I did an inflation check over 10 years and my £150,000 debt has lost about 30% of its value from 10 years ago. I have no reason for redeeming my mortgage for now I am quite happy with any rate under BOE 1% and inflation at over 2%.

    I don’t think one can get those lifetime trackers anymore at a fraction of a percent above BOE rate someone evidently got it all wrong!

    • Hi Peter

      Yes it would appear that the Donald is on the case.

      “Based on the Tariffs and Trade Barriers long placed on the U.S. and it great companies and workers by the European Union, if these Tariffs and Barriers are not soon broken down and removed, we will be placing a 20% Tariff on all of their cars coming into the U.S. Build them here!”

      As to those low margin Bank Rate trackers they were for a time when the banks thought interest-rates would be in a 3-5% range, Nothing like what we have now. Any lifetime tracker is a bit of mortgage gold.

  8. I think it was Larry Elliott in The Guardian who said Carney is “all gong and no dinner”.

    So true – and he never stops.

  9. Great blog as usual, Shaun.
    Re Carney, in a June 15 comment on your blog I tried to figure out what Carney meant when he said to Lord Burns when asked about switching away from indexing gilts based on the RPI: “I have seen this in the past; I saw it in Canada—in the end you have to pick a date, and it tends to be seven, eight or 10 years down the road, at which point you will have transitioned off and then work back.” This was when he was testifying before the House of Lords Economic Affairs Committee in January. I surmised that he was talking about switching from indexing the RRBs based on one core inflation measure (CPIXFET) rather than another. It seems this was wrong although a BOC pub from the 1990s certainly seemed to indicate that indexing used to be based on the CPIXFET.
    It seems that indexing has always been based on the CPI All-items. the only break in the series occurred in June 2017: “Index ratios after and including 19 June 2007 are based on the 2002 official time base” rather than the preceding 1992 time base. As CPI documentation notes:”The official time base was changed from 1992=100 to 2002=100 starting with the CPI for May 2007. The change is strictly an arithmetic conversion which alters the index levels but leaves the percentage changes between any two periods intact, except for differences in rounding.” June 19, 2007 was the publication date for the May 2007 update when the time base changed.
    Carney’s remark to Lord Burns seems hard to justify. He was ADM at the Department of Finance then, and doubtless would have been informed of the switch. But it all happened in a day. There was no transition period. And the date was chosen by Statistics Canada, although Carney seems to suggest that the DOF was responsible. The DOF had nothing to do with it, except to decide that the switch to the new time base for the RRBs would be synchronous with the switch by StatCan. If the 2005 basket had been updated with the same timeliness as has been achieved before and since the break in the RRB series would have occurred in February rather than in June.
    If this is what Carney had in mind, and I suspect it is, comparing what was done to RRBs to what might be done with the gilts is an apples-and-oranges comparison. The change in the index base was a simple housekeeping measure with no impact, beyond rounding error, on inflation compensation. There is no comparison with the challenges involved in transitioning from indexing gilts based on the RPI to the CPI, an HCI or whatever.

  10. It’s all about protecting the assets of banks by avoiding a Lehman’s style credit crunch. They know Italy is going to go pop and are preparing for it. When we hear the pop, they now have enough funny money to grease the system and stop it grinding to an halt. Credit will still flow. The problem with this approach to ‘protecting’ financial stability is that it encourages moral hazard and so makes the financial system ultimately less stable. Some bankers can do things they shouldn’t be allowed to do because they know they will be bailed out, in aid of financial stability. It’s like putting a large barrel of apples in perfect storage conditions but forgetting to notice there are some rotten ones mixed in, that will rot the lot.

  11. The BOE warned about a China slowdown on Friday according to the FT ands it seems the risk to the UK is much bigger than previously thought!

    A 0% interest rate wouldn’t be just on the agenda, in a correction, the probability is the BOE would go negative.

    I am surprised no one had thought about this before, a lot of the London property prices been driven up by Chinese money,

    The BOE warns of a potential asset fall it would appear the UK banks are uniquely exposed to China and far more than the US. No on seems to believe the exact China GDP a more pronounced slowdown would have a dramatic shock to the UK economy almost eliminating all our GDP.

    FT
    https://www.theguardian.com/business/2018/jun/22/uk-china-bank-of-england-hong-kong

    Guardian
    https://www.theguardian.com/business/2018/jun/22/uk-china-bank-of-england-hong-kong

  12. A full blown trade war will increase inflation then interest rates will rise possibly followed by a recession. What then?

    “they are closing down the textile mills in my home town” Bruce Springtown:

  13. Why all the criticism of the BOE? As far as I can see inflation has been averaging about their target (taking the long run) and the markets believe it will continue to do so. I personally think we would benefit from a bit more inflation, but most people want low inflation so should be happy. Also, to beat the drum once again, if you want higher interest rates then the road to that is higher inflation. Higher inflation is caused by expansion of the money supply. So all you people arguing for higher interest rates, join me in arguing for a higher money supply – i.e. more QE.

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