The Bank of England is in a mess of its own making

Today looks as if it may be something of an epoch-making day for the UK as there is finally a decent chance that the 0.5% emergency Bank Rate will be consigned into history. Actually one way or another the decision has already been made as the Monetary Policy Committee voted last night. This was a rather unwise change made by Governor Carney as it raises the risk of leaks or what is called the early wire as the official announcement is not made until midday. As you can see from the chart below the BBC seems to think that the decision is a done deal or knows it is ( h/t @Old_Grumpy_Dave ).

This provides us scope for a little reflection as any move hardly fulfils this from back in June 2014.

This has implications for the timing, pace and degree of Bank Rate increases.
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.

This was taken at the time as a promise and markets responded accordingly as interest-rate futures surged and the UK Pound £ rallied. From time to time people challenge me on this and say it was not a promise. What that misses is that central bankers speak in a coded language and in that language  this was a clear “Tally Ho”. Of course the “sooner than markets currently expect” never happened and whilst you may or may not have sympathy for professional investors and traders it was also true that ordinary people and businesses switched to fixed-rate borrowing in response to this. The reality was that the Bank of England via its credit easing policies and then Bank Rate cut of August 2016 pushed mortgage and borrowing rates lower affecting them adversely. Such has been the record of Forward Guidance.

What about now?

There was something else in that speech which was revealing as a sentence or two later we were told this.

The ultimate decision will be data-driven

Okay so let us take the advice of Kylie and step back in time. If we do so we see that the UK economy was on a bit of a tear which of course was another reason for those who took Governor Carney at his word. In terms of GDP growth the UK economy had gone 0.6%,0.5%,0.9% and 0.5% in 2013 which was then followed by 0.9% in the first quarter of 2014. It did the same in the second quarter which he would not have known exactly but he should have known things were going well.

Let us do the same comparison for now and look at 2017 where GDP growth went 0.3%,0.2%,0.5% and 0.4% followed by 0.1% in the first quarter of this year. If you were “data driven” which sequence would have you pressing the interest-rate trigger? I think it would be a landslide victory. The MPC may not have known these exact numbers due to revisions but a 0.1% here or there changes little in the broad sweep of things.

Some might respond with the pint that he is supposed to achieve an inflation target of 2% per annum. That is true but that has not bothered the MPC much in the credit crunch era as we have just been through a phase of above target inflation which of course they not only cut Bank Rate into but promised a further cut before even they came to the realisation that their Forward Guidance had been very wrong. Also before Governor Carney took office the MPC turned a blind eye to inflation going above 5%. Whereas post the EU leave vote they rushed to ease policy in something of a panic in response to expectations of a weaker economy.

The Speed Limit

The Bank of England Ivory Tower has had a very poor credit crunch. It has clung to outdated theories rather than respected the evidence. Perhaps the most woeful effort has been around the output gap which if you recall led to it highlighting an unemployment rate of 7% which the economy blasted through ( which you might consider was yet another case for an interest-rate rise in 2014). It has clung to equilibrium unemployment rates of 6.5%,6% 5.5% and 4.5% which of course have all been by-passed by reality. Such outdated thinking has led it to all sorts of over optimism on wage growth. Yet is seems to have learned little as this illustrates.

We think our economy can only grow at a new, lower speed limit of around one-and-a-half per cent a year. We also currently think actual demand is growing close to this speed limit. This means demand can’t grow faster than at its current pace without causing prices to start rising too quickly.

This is the MPC rationale for a Bank Rate rise and the problem is that they simply do not know that. They keep trying to build theoretical scaffolding around the reality of the UK economy but seem to learn little from the way the scaffolding regularly collapses.After all we grew much faster in 2014.

The banks

As ever the precious will be at the forefront of the Bank of England’s mind. I cannot help thinking that having noted the apparent improvement shown below maybe the real reason for a change is that the banks can now take it. First Lloyds Banking Group.

Since taking over the reins in 2011, Horta-Osório has presided over a bank which has swung from an annual loss of £260mln to a profit of £3.5bn.  ( Hargreaves Landsdown).

Then Barclays.

Barclays reported pretax profit of 1.9 billion pounds ($2.49 billion) for the three months from April-June, up from 659 million pounds a year ago and higher than the 1.46 billion average of analysts’ estimates compiled by the bank. ( Reuters)

Comment

A Martian observing monetary policy in the UK might reasonably be rather confused by the course of events. He or she might wonder why now rather than in 2014? Furthermore they might wonder why a mere 0.25% change is being treated as such a big deal? After all it is only a small change and the impact of such a move on those with mortgages will be both lower and slower than in the past.

Nationwide: The vast majority of new mortgages have been extended on fixed interest rates. The share of outstanding mortgages on variable interest rates has fallen to its lowest level on record, at c.35% from a peak of 70% in 2001. ( h/t @moved_average )

So if they do move the impact will be lower than in the past which makes you wonder why they have vacillated so much and been so unreliable?

The MPC have got themselves on a road where all the indecision means that the timing is likely to be off. What I mean by that is that whilst I expect economic growth to pick-up from the first quarter this year will merely be an okay year and currently the threats seem to the downside in terms of trade for example. We do not yet know where the Trump trade tariffs will lead but we do know that the Euro area has seen economic growth fall such that the first half of 2018 was required to reach what so recently was the quarterly growth rate. Also the ongoing rhetoric of the Bank of England about Brexit prospects hardly makes a case for a Bank Rate rise now either as it would be impacting as we leave ( assuming we do leave next March).

The next issue is money supply growth which in 2018 so far has been weak and now (hopefully) has stabilised. That does not make much of a case for raising now and would lead to the MPC operating in the reverse way to monetary trends as it cut into strength in August 2016 and now would be raising into relative weakness.

So there you have it on what is an odd day all round. I think UK interest-rates should be higher but also think that timing matters and that a boat or two has sailed already without us on it. Accordingly my view would be to wait for the next one. For the reasons explained above whilst the MPC has managed to verbally box itself into a corner I still  think that there is a chance ( 1/3rd) of an unchanged vote today. It is always the same when logic points in a different direction to hints of direction.

There is also the issue of QE which rarely gets a mention. If we skip the embarrassment all round of the Corporate Bond purchases we could also have taken the chance to trim the QE package when money supply growth was strong. I remember making that case nearly five years ago in City-AM.

Me on Core Finance TV

 

 

 

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25 thoughts on “The Bank of England is in a mess of its own making

  1. Top blog Shaun, and very polished presentation on CF.
    Difficult to explain, isn’t it?
    Let’s have a go.
    If 1/4 % = £35 a month on your mortgage, obviously more if you have a bigger mortgage, whom is Carney going to hurt?
    Top decile of mortgage holders, whose remuneration increase rates have been substantially above inflation, or the bottom decile, who are already spending every penny they can afford on housing, whose wages have probably lost ground, and for whom inflation is well above the headline rate?
    Pick ’em off from the bottom up; it’s UN Agenda 21: can you propose a logical alternative motive?

    • I think that you will very relieved to know that it won’t affect Mr Carney himself, as I believe that we taxpayers are funding his rather agreeable West London residence. I would hate to think of him suffering while shouldering his extraordinary tough job…

  2. Grat article always Shaun.

    Well done for making the BBC news feed.

    All the papers were leading this morning, that a rate rise was a given.It had to have been leaked?

    • Hi Jason and thank you

      I think when it came to today most people were expecting it. I guess that was shown by the currency markets where the £ rallied for a bit and then fell back. So there was some value in an “Early Wire” but not an enormous amount.The Gilt market did not do much either so if it was leaked there was not much to be gained. Even the FTSE 100 fall was less than the German Dax.

  3. Excellent stuff, Shaun, but I would be even more blunt. I think that the BoE no longer has any idea of what the levers are in the economy. The stuff about unemployment, the output gap etc are demonstrably nonsense. The growth is, as you say, less than it was when previous rate rises were in the offing. Without straying into politics, I think that Carney lost all credibility at the time of the Brexit referendum, with his dire predictions followed by an unnecessary rate cut.
    As to explaining the rise, I have a Machiavellian theory – Carney is so worried about Brexit next year that he wants to be able to cut interest rates next March. To make a big cut, he has to start at higher than 0.5%. Just a theory…

    • James,

      “Carney is so worried about Brexit next year that he wants to be able to cut interest rates next March. To make a big cut, he has to start at higher than 0.5%. Just a theory…”

      I think the same. The comments about high employment and things picking up a load of waffle, Joe Public are finding things difficult, there may be more people in work but not also on poor wages.

      So hike now and I think the next move is down.

  4. BRC didn’t take much time to comment:

    12:20
    “Rate rise decision is ‘ill-judged’
    The decision to raise interest rates, while expected, looks ill-judged against a backdrop of a sluggish economy. While a quarter point rise may have a limited long-term financial impact on most businesses, it risks undermining confidence at a time of significant political and economic uncertainty. The increase reinforces a concerning aspect of the Bank of England’s recent approach to monetary policy, which appears to be overly focused on reinforcing an idealised direction for rates, rather than on economic reality – an approach that unnecessarily risks UK’s growth prospects. The central bank’s assumption that the economy’s speed limit has slowed is unduly pessimistic, as sustained action to fix the fundamentals at home, from closing the skills gap to greater infrastructure investment, would materially help lift the UK’s growth potential
    British Chambers of Commerce”

    • Hi Peter

      If we are undermined by a 0.25% Bank Rate rise then we were in quite a mess to start with. Even if we throw the lot in ( he mentioned 3 more in the next 3 years in the presser) we would only be at 1.5% in 2021/2. Again if we cannot take that…

      I agree with them about the R-Star rubbish and the speed limit. There could be lots of the former and the Bank of England simply does not know the latter

  5. I’m sure you’re right that the small rise is happening now as up until now the banks would not have been able to cope with it so even though other factors should be considered, the reality is this is the first time it’s been possible.

    Also the US has also raised rates and as James says there is now scope for a reduction when the Brexit panic begins!

    • Hi Jan

      Governor Carney kind of hinted at that in his press conference. It was really rather odd to hear him mention interest-rate cuts in a meeting to not only discuss a rise but prospective rises but he did. The journalists did not help much as more than a few asked Brexit based questions which seemed a waste as frankly we all should know by now what he thinks of it.

      I think it is rather bizarre to raise so you can cut later which in these times probably means it was in their thinking!

  6. In general I think this move is consistent with the record of the BOE; in other words it is a misstep, an error of timing; they are nearly always wrong and they are wrong here.

    The economy is soft; growth is lacklustre; the earnings numbers are ambivalent and inflation shows no sign of taking off. The sensible option would be to do what they are so good at doing: nothing. However, as with Brexit and despite what they say about being data driven, this is a “PR” adjustment, that is it has nothing to do with economics but everything to do with reputation. This rise has been so well flagged we would have to be in the midst of World War III for it to be postponed as the BOE would look even more ridiculous than it is.

    I suspect it will be a case of one and done in which case it will only be a case of ridicule postponed rather ridicule vanquished because one increase is pointless, especially one of 0.25%.

  7. ” I would be even more blunt. I think that the BoE no longer has any idea of what the levers are in the economy.” h/t James

    Indeed. The purpose of money is to be scarce. And that if you affect its supply, then all the real world resources will follow it on the accountants discounted cash flow spreadsheet. There is now, to all intents and purposes, unlimited supplies of money and credit.

    “But if you massively increase the money supply the economy will overheat and embedded inflation (aka ‘wage’ inflation, you know, the thing that makes us better off) will take to the moon due to a shortage of labour to fulfil all the work and projects”, I hear you say. Well, guess what, with globalisation and open borders, there now exists no shortage of labour.

    But we will see the price of assets go up, those biggest purchases of one’s life – home, pension, stocks and shares thereby impoverishing those without, notably the young whose wages also remain crushed. And leveraging assets to corner more assets allows the declining few to rack up the rents on the rest.

    In fact, I would go as far to say that “capitalism” itself requires a shortage of money, it requires an interest rate – its very definition. If you have no reason apparently to have a meaningful interest rate as there is no inflation in the economy, no shortage of labour and the like (particularly if you exclude assets from your measures) then we no longer know what is worth doing and what is not. Anything becomes seemingly feasible whilst these conditions exist. I call the new economic management “moneyism” whereby money creation flows to assets in some way and the wealth effect apparently creates activity in the economy. But where do the limits of this wealth effect hit the buffers?

    • I guess the buffers will something like the pirates to the 17th century Spanish economy – like dutch disease – so much gold came in unregulated that it wasn’t worth while training anyone in Spain – you just purchased abroad. also assets inflated – sound familiar ?

      Spain was fabulously wealthy and powerful – for a while – but trades / skills declined and so when the gold began to run out ( spent on useless wars – USA ? ) there was nothing else left to replace it .

      look what’s been splashed out on keeping the Banks afloat ………

      its getting late ………………. enjoy it while you can 🙂

      Forbin

  8. Interest rates should be about 2% already. This would have stifled the hugh rise in unsecured household debt, cooled the housing market and given room to move on interest rates when Brexit comes. All they can do in future is negative interest rates and more QE, meanwhile the value of the pound will go down the drain.

    • Hi Foxy

      I agree. We needed to start edging interest-rates higher in 2014 which would have helped with some ( unsecured credit for example) of the problems now. Also they have encouraged borrowing which now makes it harder to raise them.

  9. Back in 1979, I gave a short talk about Ludwig Erhard and the German Wirtschaftswunder. I started with his famous quote about what consumers benefit from – competition and the gains of productivity. Naturally, I went on to advocate skills training.

    I don’t think Carey et al have thrown away the textbooks – they have either deliberately ignored them or are too stupid to understand them. They went on a rate cutting fest in a bid to prop up demand as the world became cautious, but they had no grasp of two things – first that many people had borrowings at fixed rates, so rate changes did not affect demand, but second, they ignored the liquidity trap. Well, I say ignore – I suspect they knew exactly what would happen below that level: an inflation they did not measure in assets held by the more affluent in society. They knew that low rates would not prompt consumption borrowing, but a rush for assets, which could then be sold on with a profit, so there was no need to borrow anything – you just need that profit at the end.

    We see that playing out now -stupid house prices sucking the life out of current consumption, because wages have not kept up, due to a failure to improve (see Erhard) productivity. Why as others have noted, worry about productivity if the cost of things is easy to borrow cheaply for? Why increase your skills and pay tax on your better pay, if you can make more out of turning assets over. So, we have now reached the point where pay and all those wheezes by the govt have failed to push house and asset prices higher. The result – we will soon see it here will be demands for more govt spending (Keynes) alongside tax cuts, but the debt can go to Hell in a handcart. This has already started in the US and of course, the Donald is bemoaning rate rises. But the US has to raise rates to curb any overheating and attract debt buyers. Thus, the pressure comes on to the UK to raise rates to support the GBP. Carnegie may well be trying to give himself room to cut rates in a downturn, but these changes are well below trap levels and so, have no effect. Rate rises will come after he leaves and the zGBP is under pressure.

    What did I say about productivity in 1979?

  10. Mortgage Current monthly repayment New repayment 1.5% Increase
    £400,000 £1,795 £1,844(+49) £2,110(+315)
    £300,000 £1,346 £1,383(+37) £1,583(+237)
    £200,000 £897 £922(+25) £1,055(+158)
    £150,000 £673 £692(+19) £791(+118)

    Above are the new repayment figures for “typical” modern tracker mortgages, it can be seen that this much awaited increase by Carney is going to have absolutely no affect on the finances of even the most rabid lunatic buy to letter or house flipper.

    If like some of the people I work with and who regularly try to humiliate those like me who refuse to go along with this insanity and have £200-300,000 mortgages and brag about how much their house or portfolio of houses is going to be worth in years to come,it will mean at most less than a tenner a week extra – three pints of beer – and so all the media speculation about whether it would happen or not over the last few years has been about the price of a few pints of beer.

    Even if Carney raised rates 1.5% -todays increase six times(imagine how many decades that would take) , it would only mean £30 a week for someone with a £150,000 mortgage.

    Those people are still laughing at us, and we are still paying their mortages for them every month.

    • The Bbc managed to find someone who said that this rate rise is a disaster as she would now be cutting down food (meat had already gone). I felt very sad for her individually but what on earth are we doing letting people borrow when a 0.75% interest rate is crippling?

  11. Thanks Shaun for the update and commentary. If only you had been heeded in 2014 – if not earlier.
    I’m not a big fan of the unreliable boyfriend either, who was clearly appointed by George Osborne in order to stimulate house price inflation.
    But I wonder to what extent the B of E’s problems were initiated by the late “Steady” Eddie George? It was he who first dropped rates after the dot-com crash, saying that the next Governor would have to “sort it out”, starting a game of monetary pass the parcel in which no-one wanted the music to stop on their watch.
    Of course the background to this whole sorry state-of-affairs is the rise of the banks since Big Bang, and those stats on their profits are hard to read given the chaos they’ve caused since Mrs T fell for their spell all those years ago.
    I have a feeling this can’t go on, but that baring a Corbyn government (which I’m not ruling out) the end result will be a collapse of the currency.

    • Hi Signor and thank you

      I wrote to the Governor in February to point out that house price inflation had been 30% on his watch but that the official inflation measure had only risen by around 7%. I was discussing the RPI versus the CPI but the point applies here and yes you have to ask if the willingness to drive house price inflation was why Governor Carney was appointed?

      As to keeping going somehow it seems to keep doing that as that poor battered can receives ever more kicks

  12. Carney’s open mouth operations the day after have had more effect on Sterling than the rate rise,

    Keep going Shaun, From the long distance viewpoint at the other side of the world your insights are very much appreciated. I notice a piece on the Yahoo site implied Carney was now more of an Agony Aunt than an unreliable boyfriend

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