The Bank of England is facing the consequences of its own mistakes

Yesterday brought us some new insights into the thinking of the Bank of England and indeed the UK establishment. This was because what you might consider the ultimate insider gave evidence to Parliament as Sir John Cunliffe joined the Department of the Environment as long ago as 1980. Intriguingly his degrees and lecturing experience in English Literature apparently qualified him to high level roles in HM Treasury. So he is also an example of how HM Treasury established the Bank of England as “independent” but then took back control. Actually I think all the Deputy Governors have been at the Treasury at some point in their careers. Also if we return to his degree we see another feature of modern life where those on the lower rungs have to be highly qualified in their sphere whereas it is no issue at all for those at the top. That is because they are considered to be – by themselves if nobody else – so highly intelligent that qualifications are unnecessary.

Sir John gave us a warning about the future.

One pocket of rapid growth that the FPC is monitoring closely is in leveraged lending which appears to have been driven by strong investor demand for holding the loans,
typically in non-bank structures such as CLOs (collateralised loan obligation funds). Gross issuance of leveraged loans by UK non-financial companies reached a record level of £38 billion in 2017 and a further £30 billion has already been issued in 2018. And lending terms have loosened with only around 20% of leveraged loans now having maintenance covenants, which used to be standard for all loans. The global leveraged loan market is larger than – and growing as quickly as – the US subprime mortgage market was in 2006.

The Bank of England Financial Policy Committee of which Sir John is a member ( he has nearly as many jobs as George Osborne) also posted a warning according to BusinessInsider.

Leveraged lending to corporates has ballooned in recent years, with the global market reaching a value of around $1.4 trillion, according to recent estimates.

Thus we see the establishment at play. Let us note that the ground is being prepared to blame “Johnny Foreigner” and also that as Nicola Duke points out below another deflection technique is at play.

This is how central bankers prepare for the next financial crisis. They take no action while ensuring they have their excuses in order. “We warned you in 2018”.

Let us take her point and see what is actually being done and the answer as usual appears to so far be nothing.

The FPC is planning to assess any implications for banks in the 2018 stress test and we will also review how the
increasing role of non-bank lenders and changes in the distribution of corporate debt could pose risks to financial stability.

As ever this is reactive and frankly a lagged reactive at that. These bodies never act in advance and are invariably asleep at the wheel whilst it is taking place. Of course if their real role is merely to describe what has happened then I may have been mistaken about Sir John’s qualifications for the job as suddenly English Literature becomes useful.

But there is an elephant in the room which is way that the Bank of England itself has fed this. It slashed interest-rates in response to the credit crunch and even now they are only 0.75% or around 4% below where they were previously. It has deployed some £435 billion of conventional QE and £10 billion of corporate bond QE. Then in 2012 it did this too.

The Funding for Lending Scheme is designed to encourage banks and building societies to lend more to households and businesses. It does this by providing funding to these firms for an extended period, with the quantity of funding we provide linked to their lending performance.

So the system has been flush with cash or to be more technically accurate, liquidity. Can anybody be surprised that like the ship of state the monetary system is a leaky vessel? Or to use a word from a couple of decades or so ago we are seeing another form of disintermediation. But wait there is more.

Since the referendum, the Bank of  England has augmented these capital and liquidity buffers by making available more than £250 billion of liquidity and by lowering banks’ Counter-Cyclical Capital Buffer to facilitate an extra £150 billion of lending.

This is from a speech given by Chief Economist Andy Haldane which was liked so much it was if you recall published twice just to make sure we got the message. Well perhaps the leveraged loans industry did! We’ve got your backs lads ( and lasses). But wait there was even more.

Put differently, I would rather run the risk of taking a sledgehammer to crack a nut than taking a miniature
rock hammer to tunnel my way out of prison – like another Andy, the one in the Shawshank Redemption………And this monetary response, if it is to buttress expectations and confidence, needs I think to be delivered promptly as well as muscularly.

The Bank of England has claimed some 250,000 jobs were saved/created ignoring that it would have been perhaps the fastest response to a monetary policy change in history. That leads it into conflict with the ECB that thinks the response time slowed. But if we return to what we might label in this instance as disintermediation there have been two clear examples.

  1. A surge in unsecured lending pushing into annual growth in the double digits that is still above 8%
  2. Corporate lending now increasingly leveraged with underwriting standards dropping like a stone.

Peter Gabriel may have done this but the Bank of England merely repeated the same old song.

I’ve kicked the habit
shed my skin
this is the new stuff

I go dancing in, we go dancing in


There are plenty of familiar themes at play today as we look again at how the establishment operates. There is a clear asymmetry between the way a move sees even fantasies proclaimed as triumphs but failures get ignored. It is the same way that “vigilant” means asleep and “we will also review” means a review will be necessary as by then it will probably have blown up. Fortunately we can then claim to be experts and specialists ( in failure to quote Jose Mourinho ) and sit on the various committees set up to discover what went wrong? That will of course make sure that those asleep at the wheel do not get the blame, as long as they can manage to stay awake during the meetings of the new committee.

Meanwhile the UK economy continues to bumble along. Whilst today’s headline may appear not so good it is in fact pretty strong.

In September 2018, the quantity bought declined by 0.8% when compared with August 2018, due mainly to a large fall of 1.5% in food stores; the largest decline in food store sales since October 2015.

That made the Office of National Statistics uncomfortable enough to delay it to the third paragraph of the release. But actually with a little perspective and somewhat amazingly the UK consumer continues to spend.

In the three months to September 2018, the quantity bought in retail sales increased by 1.2% when compared with the previous three months………When compared with September 2017, the quantity bought in September 2018 increased by 3.0%, with growth across all sectors except department stores.

Presently in economic terms ( as opposed to political) the main dangers to the UK economy have been created by the Bank of England.

Core Finance TV






31 thoughts on “The Bank of England is facing the consequences of its own mistakes

  1. Shaun, definately worth exploring. I wss the 1st commenter on this headline article in the FT yesterday. Companies have enjoyed leverage with the low cost of money. My pointed and sarcastic comment was quickly shot down by an established finance guru who explaind that increasing borrowing via share buy backs is just as valid as any other kind of leverage, asset secured lending, increased share issuance etc.

    Of course I dont agree, I think its a business strategy change, it risks manipulating share price, is necessarily short term and is and unfortunate side effect of ZIRP which the CBs have chosen.

    The thrust of the arguments seem to point at leveraged M&A, where companies are bought by new owners and the cost of purchase is loaded straight ontop of existing debt along with the new owners inflated benefits package.

    Will it blow up? who can say. Rising interest rates will test the behaviours but they do have to go up for the test case to undertaken.

    Paul C.

    • Good points. I was just reading about the demise of Sears in the USA. Over six years, it spent $6 billion on share buybacks etc while only having operating free cash of $1.8 billion.
      And now it’s almost bust blaming Amazon for its weak position.

  2. Shaun, may I politely explain econ 101 to you, food prices have fallen and wages have risen therefore of course food consumption goes u… Hang on I need to rethink this.

  3. It seems so obvious that I must be missing something – follow the FED and raise interest rates slowly and steadily. If investors know that credit conditions are tightening, they will restrain their enthusiasm but the slow pace of rate rises will give people time to reposition. It’ll also flush out poor credit risks because lenders will start to prefer strong borrowers. Plus no more ‘covenant lite’ securitised loans, which are just problems waiting to go wrong.

    Oh well, I’m off to find an English Lit professor who can explain why it’s not this simple!

    • Hi DoubtingDick

      The essential problem is that having acted on such a scale central bankers are afraid of what will happen when they start to withdraw that action. I feared this from the early days on here but did not know then the scale of the subsequent action. What I would have considered to be “all in” back then turned out to be much larger making the problem worse.

      So for all the rhetoric the reason why we have not seen the policy you suggest is, in my opinion, mostly fear of the consequences. What if things quickly turn south?

      • Thanks and I agree, which depresses me. I would gladly become Governor and receive north of half a million a year to do nothing for fear of what might happen. Just my luck that the job’s already filled.

  4. The BoE have seen credit, to most parts of the economy, rocket and have done absolutely nothing about it, apart from making a few limp warnings. You have to ask yourself, why, after the lessons of the 2008 crash, they have not reacted and brought in measures to head off the next crash?
    There can only be two reason;
    1. They are incompetent.
    2. The Government has told them not to.
    It is probably a combination of both, but the result is that you and I will pay for this mess. They, however, will retire on their RPI linked, no limit Lifetime Allowance Pension!

    • Hi Foxy

      They convinced themselves that the next monetary easing effort would solve things. It is a type of institutional self-delusion. After all if you have had ~4% of interest-rate cuts why would you believe that another 0.25% as we saw on August 2016 would have a big impact? As I have replied above they are afraid that when the tide goes out they will be seen to be without swimwear to use the famous Buffet quote.

  5. I’m not sure independence has done much for the BOE. It’s thrust them into the limelight and given them responsibilities that they may not be comfortable with. Fifty years ago no one knew who the Governor of the BOE was and when they spoke they only said one word: “perhaps”! As to growth in dodgy loan all the Governor had to do was to raise his left eyebrow and the practice would cease! Nowadays they are just seen as one more vested interest with a reputation to defend. Do we have proper accountability or just good PR under independence?

    There are certainly good arguments for independence but there are also downsides. Would the austerity period of 2011-2012 have taken place if the BOE had been part of the Treasury? With interest rates at the ZLB austerity is a dumb policy; would it have been enacted if the BOE had been “in house”? Of course we’ll never know but it may have been less likely because monetary and fiscal policy are seen as complementary tools to be co-ordinated rather than pursued independently.

    I honestly think you’re pushing it a bit to say that: “Presently in economic terms ( as opposed to political) the main dangers to the UK economy have been created by the Bank of England.”. The main danger is surely the banking system which, although ostensibly in the purview of the BOE, must also be subject to heavy political interference in view of its size and importance. You can’t say that the BOE has a free hand here but I would agree that they do not appear to have pushed aggressively against the banks and must bear a fair share of responsibility for the survival of a system that is not structured appropriately.

    Whist they’ve kept interest rates far too low for far too long to my way of thinking the level of debt has been increasing which implies a lower “neutral” rate as time has gone on, not a higher one. To have raised interest rates would have achieved little and would have brought the whole house of cards crashing down which means they would get the blame for any recession that occurred. Would it therefore have been better for the politicians to be accountable (which is where I came in)?

    • One thing the BofE has proven is that it is anything but independant.Carney’s collusion to keep the UK in the EU is just one example.

      “To have raised rates would have achieved little”
      If they hadn’t allowed a property bubble to form in the first place there wouldn’t have been any blame to apportion would there?
      So what are you saying then, we can never let house prices go down ever again?

      If the Bank of England was/is independant, why would politicians then be culpable for the ensuing house price crash, as they had no part in its formation if the BofE was independant and therefore had total control over the interest rates and lending which caused it !!!

      • Kevin

        There are trade offs and just because a policy has some bad effects does not mean that, in aggregate it is wrong.. Keep rates low and you stimulate spending (GDP) but you also get asset bubbles. Which is better: low asset prices and low growth, even recession or higher asset prices and higher GDP? Most would say the latter which is what we’ve had; the policy has emphasised the flow (GDP) rather than the stock (asset prices).

        However, there’s no doubt in my mind that house prices are far too high and we should have had policies which brought them down. Given that IRs were structured towards safeguarding GDP the thing that is left is better regulation and here this has only been a partial success through such things as MMR which needed strengthening.

  6. I can’t speak for Sir John, but perhaps he is at the Bank of England as part of an exchange deal, now that economists run the universities?
    And following the financial crisis, there remains a big question mark next to the credibility of the Economics profession (present company excepted – infact, Shaun, it’s your skills with the written word along with your understanding of figures which make your blog such a rewarding resource).
    Perhaps Sir John should give the unreliable boyfriend and his merry band of economists a lecture on Epistemological Radical Scepticism, aka, it’s hard to make predictions, especially about the future.

    • Hi HDL and welcome to my corner of the web

      Thank you for the phrase Epistemological Radical Scepticism which is the opposite of the view from the Dune series of novels I sometimes refer to. There the future is known ( at least to Paul Atreides and his son Leto) but the past is much more doubtful.

      Also the Road to Nowhere has a similar view.

      “We know where we’re going / But we don’t know where we’ve been”

  7. Hi Shaun, great article thanks.
    I have a feeling the global stock market party is starting to end, and the cause is something of an outlier – the horrendous Saudi journalist murder. These things are impossible to predict, and people are focusing on the Brexit negotiations, but the bigger story is that UK representatives will not be attending Davos. Since the UK has traditionally been Saudi’s closest western contact, this is a major move which signifies the Saudis are no longer going to get a free pass.
    Since Saudi money has been keeping the US startup tech party from popping, via Softbank, the inevitable sanctions on Saudi investment will force the Unicorns to IPO in greater number than anticipated; then their paltry revenue figures will be exposed and investors will start fleeing the NASDAQ as it becomes clear tech has overheated once again.
    At the same time the Saudis will react politically by raising the oil price, injecting inflation into the US economy and accelerating interest rate hikes.
    Or something like that…

    • Hi Born in Carolina

      It would certainly be time if things were normal but of course they are not. One thing that is certain is that the Saudi explanations have managed to provide some nearly literal gallows humour.

  8. As I said at the time, “It is an idiot who takes a sledgehammer to crack a nut, as it just makes the kernel unusable, & is totally destructive.”
    With a little hammer, you may take longer, but you get where you want to be without laying everything waste.
    Having said that, the analogy may well prove appropriate.

    • Hi therrawbuzzin

      Those who lauded Andy Haldane back in the days when Time magazine lauded him as one of the 100 most influential people in the world seem to have gone quiet these days. But maybe the bar is low as some years ago I was watching the Barcelona olympics athletics and a group from Time magazine took their seats and one asked, how many times around the track is 400m?

  9. Great video as usual, Shaun. The inflation rate for the zombie RPI for all items excluding mortgage interest payments and council tax adjusted for the formula effect was unchanged at 2.5% in September from the previous month. It is arguably a better target inflation indicator for the Bank of England than either the CPI or the CPIH. It would be better to have an RPIJ special aggregate for this series but the ONS has never released any RPIJ component detail. A dezombified series that included a stamp duty component would probably show somewhat lower inflation: the inflation rate for stamp duty was 2.2% in 20182, down from 2.4% in 2018Q1 and 2.6% in 2017Q4. However, it is unlikely to fall below the 2.4% CPI inflation rate for September and it definitely won’t fall below the 2.1% CPIH inflation rate. The ONS should definitely dezombify the RPI and add a stamp duty component. There is now simply too much work involved in second-guessing the CPI inflation rate.

    • Hi Andrew and thank you

      Your view in your last sentence is similar to a thought I have but from a different route. Back in the day investment firms were usually pretty good at guessing what the RPI would be each month. There was a story that someone used to check many of the prices himself each month although it may have been a City myth.

      However these days the consensus is much more often wrong and has been particularly caught out over the past 2 months expecting a drop in August and getting a rise and then expecting September to be the same and getting a drop. Can you think of a reason why CPI/HICP might be more unpredictable than RPI?

    • Hi Peter

      Well it can rise until one day we hear a popping sound which will quickly be added to by cries of ” It could not have been predicted and is not the fault of anyone in authority”.

      As to the public finances the MSM seem to have forgotten they have been going relatively well.

  10. Shaun,

    Interesting video, I just need to grasp more about the inputted rents but was surprised about the difference it made to the data in percentage terms which I think amounted to something like 17%.

    I don’t think many people fully understand this aspect of the data or how the measures could be revised to put a more accurate slant on inflation data.

    There can never be an accurate set of data as inflation affects people differently I suppose the ONS have to use an average to give the public some indication of what the inflation is running at.

    I don’t know whether anyone remembers this but the press used to use Mars Bars as a measure of inflation, and it could still be used today to compare a Mars bar price today from a year earlier !The only difference the size has probably shrunk and people need to buy more to get the same amount of energy, but it could suit the ONS somewhat!

      • What is useful with using the Mars Bar inflation as a benchmark is the ONS is also on another planet, if you see what I mean.

        • Hi Peter

          Last time I checked the weighting for Imputed Rents has varied this year between 16.8% and 17.3% this year which is why I said around 17%. Actually it should not be that unstable but that is another story.

          Continuing with the 17% this is why you will find me when I have time criticising places that use CPIH as a deflator for real wages as a decent part of it is simply made up.

          As an example of how they manipulate the numbers there is an alternative measure called CPI(NA) that has house prices. But exactly the same owner occupied housing sector then only gets a 6.8% weighting.

          So there is one of the ways the numbers are manipulated.

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