What is going on at the Bank of England these days?

Yesterday saw the publication of Brexit forecasts from HM Treasury and the Bank of England. The former was always going to be politically driven but the Bank of England is supposed to be independent, although these days we have to ask independent of what? There is little sign of that to be seen. Let us take a look at the Bank of England scenarios.

The estimated paths for GDP, CPI inflation and unemployment in the Economic Partnership scenarios are
shown in Charts A, B and C. The range reflects the sensitivity to the key assumptions about the extent to
which trade barriers rise, and how rapidly uncertainty declines. GDP is between 1¼% and 3¾% lower than
the May 2016 trend by end-2023. Relative to the November 2018 Inflation Report projection, by end-2023 it is 1¾% higher in the Close scenario, and ¾% lower in the Less Close scenario.

After singing its own fingers last time around it is calling these scenarios rather than forecasts but pretty much everyone is ignoring that. The problem with this sort of thing is that you end up doing things the other way around. Frankly the answers are decided and then the assumptions are picked to get you there. We do know some things.

Productivity growth has slowed, sterling has depreciated and the increase in inflation has squeezed real incomes.

However really the most certainty we have is about the middle part of a lower UK Pound £ and even there the Bank of England seems to omit its own part ( Bank Rate cut and Sledgehammer QE ) in the fall. That caused the fall in real incomes as we see how policy affected the results.

If we move wider the Bank of England attracted fire from both sides as for example this is from the former Monetary Policy Committee member Andrew Sentance who is a remain supporter.

The reputation of economic forecasts has taken a bad blow today with both UK government and appearing to use forecasts to support political objectives. Let’s debate – which I strongly oppose – rationally without recourse to bogus forecasts.

Why would he think that?

Well take a look at this.

The estimated paths for GDP, CPI inflation and unemployment in the disruptive and disorderly scenarios
are shown in Charts A, B and C. GDP is between 7¾% and 10½% lower than the May 2016 trend by end 2023.
Relative to the November 2018 Inflation Report projection, GDP is between 4¾% and 7¾% lower by
end-2023. This is accompanied by a rise in unemployment to between 5¾% and 7½%. Inflation in these
scenarios then rises to between 4¼% and 6½%.

It is the latter point about inflation and a claimed implication of it I wish to subject to both analysis and number-crunching.

How would the Bank of England respond to higher inflation?

Here is the claimed response.

Monetary policy responds mechanically to balance deviations of inflation from target and output
relative to potential. Bank Rate rises to 5.5%.

Let us see how monetary policy last responded to an expected deviation of inflation above target to back this up.

This package comprises:  a 25 basis point cut in Bank Rate to 0.25%; a new Term Funding Scheme to reinforce the pass-through of the cut in Bank Rate; the purchase of up to £10 billion of UK corporate bonds; and an expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion.

As you can see the mechanical response seems to be missing! Unless of course you count the mechanical response of the mind of Mark Carney as he panicked thinking the UK was going into recession. The other 8 either panicked too or meekly fell in line. The point is further highlighted if we look at the scenario assumed for the exchange-rate of the UK Pound £.

And as the sterling risk premium increases, sterling falls by 25%, in addition to the 9% it has already fallen
since the May 2016 Inflation Report.

Let us examine the reaction function. Let us say that the £ had fallen by 10% when the Bank of England took action then if it ” responds mechanically” we would expect this time around to see a 0.625% reduction in Bank Rate and some £150 billion of extra QE as well as another Term Funding Scheme bank subsidy of over £300 billion.

Instead we are expected to believe that the Bank of England would raise and not cut interest-rates and would do so by 4.75%! There is also an issue with the timing as the forward guidance of the Bank of England has been for Bank Rate rises for over 4 years now and we have had precisely 0.25% in net terms. So at the current rate of progress the interest-rate increases would be complete somewhere around the turn of the century.

Actually there is more because other interest-rates would go even higher it would appear.

Uncertainty about institutional credibility leads to a pronounced increase in risk premia on sterling
assets, including a 100bps increase in the term premium on gilts.

So an extra 1% on Gilt yields although this is only related to a particular piece of theory as we skip what they would be apart from an implication of maybe 6.5%. A particular catch in that is the current ten-year yield is a mere 1.33% and over the past 24 hours it has been falling adding to the previous falls I have been reporting for a while now. Markets do of course move in the wrong direction at times but Gilt investors seem to be placing their bets on the Gilt market and ignoring the Bank of England scenario.

But wait there is more.

Overall, interest rates on loans to households and businesses rise by 250bps more than Bank Rate.

Can this sort of thing happen? Yes as we saw it in the build up to the credit crunch as UK interest-rates disconnected from Bank Rate by around 2%. Also yesterday we were noting such a thing via the fact that Unicredit of Italy has found itself paying 7.83% on a bond which was yielding only 1% as recently as yesterday. But there are two main problems of which the first occurred on Mark Carney’s watch as we note that they way he “responds mechanically” to such developments is to sing along with MARRS.

Pump up the volume
Pump up the volume
Pump up the volume
Get down

Actually such a response by the Bank of England was typical before the advent of Governor Carney. Recall this?

For instance, during the financial crisis the exchange rate
depreciated around 30% initially but settled to be around 25% below its pre-crisis peak in the following
couple of years.

So in a broad sweep in line with the new worst case scenario especially as we recall that inflation went above 5% on both main measures. So Bank Rate went to 5.5%? Er now it was slashed by over 4% to 0.5% and we saw the advent of QE that eventually rose in that phase to £375 billion.


The first comment was provided by financial markets as we have already noted the Gilt market rally which was accompanied by the UK Pound £ rallying above US $1.28. The UK FTSE 100 did fall but only by 13 points. If there is anything a Bank of England Governor would hate it is being ignored.

Actually the timing was bad too. For some reason the report was delayed from 7:30 am to 4:30 pm but due to yet another problem it was another ten minutes late. This means that very quickly eyes turned to this by Federal Reserve Chair Jerome Powell.

Stocks ripped higher on Wednesday after Federal Reserve Chairman Jerome Powell said interest rates are close to neutral, a change in tone from remarks the central bank chief made nearly two months ago. ( CNBC )

Roughly that seems to take 0.5% off the expected path of US interest-rates and has led to the US ten-year Treasury Note yield falling back to 3%. Also trying to convince people about higher inflation is not so easy when the oil price ( WTI) falls below US $50.

Me on Core Finance TV







21 thoughts on “What is going on at the Bank of England these days?

  1. Hi Shaun

    To be fair Carney’s projections have been panned pretty widely, not only on account of the BOE’s lamentable record but also on the almost fantastic assumptions made.

    The 8% hit to GDP is double that in 2009, which was the worse recession for around 100 years. Not only that there is apparently no recovery; it just stays there. Utterly absurd.

    The whole thing has been characterised by Paul Krugman as ” motivated reasoning” which basically means Carney wanted to produce apocalypse as a result and then fitted assumption around this.

    You have given other instances where the assumptions are really quite ridiculous. This is truly Alice in Wonderland stuff and when Carney leaves the bank he will leave behind a record which has diminished the bank’s reputation quite severely.

    The biggest risk to the UK economy right now is not a “no deal” Brexit; it is the EU itself with its mounting economic and political problems – the Euro in particular.

    • Bob,

      “The biggest risk to the UK economy right now is not a “no deal” Brexit; it is the EU itself with its mounting economic and political problems – the Euro in particular.”

      Fair point but one of the biggest risks to the UK at the moment is also the fear of the worst case scenario when its almost impossible to predict any outcome and fear increases more fear and investment comes to a halt. The public are already tightening up on the use of credit these things can become self fulfilling.

      The BOE got its forecasts wrong last time and the public are getting to the stage don’t believe what the BOE are saying now.

      However just because the general public don’t trust both the government and the BOE the uncertainty tends to lead people into making the wrong decisions in any event.

      Surprisingly the stock market not moved much either way today, after all the doom and gloom about the worst case scenario, with a threat of interest rates on the rise I would have expected investment to move out of shares and more volatility in the UK markets. Unless of course they simply don’t believe the worst case scenario will ever happen!

      Too many variables to make any accurate predictions at the moment imo.

  2. The trouble with these absurd predictions is that:
    1. They undermine the credibility of the BoE more broadly
    2. They make the independence of the BoE a joke.
    I have been sent a rather amusing calculation of how GDP will be reduced by 99.332% in 824 years if you extrapolate that far and it seems to sum it all up.

  3. As I have said before, let’s have a “scenario” from the B of E, of the EU and Euro falling apart, as surely it must, and the effect on the UK economy – hasn’t it gone quiet!

    • Hi Foxy

      The debate is somewhat one-sided I agree. Apparently all the risks are on one side with the Italian Banks and Deutsche Bank suddenly disappearing in a puff of smoke so that the Bank of England cannot see them,

      • I know that we don’t do politics here, but we also don’t really know what remain means in my opinion from a political point of view. If the populists take over the parliament in May, for example, we may see more loosening of the fiscal reins. If Macron gets his way, there will be a European army and, in my opinion, further integration of other, financial aspects of the EU.
        If popular sentiment swings in Germany against subsidising others, maybe the rules get tighter.
        In other words, not only do we not hear about the disastrous Italian banking scene (or much about Target 2, the German banks etc), but we don’t really know which direction the EU is going and, IMHO, this probably would make more difference to the “forecasting” going on at the BoE than the type of Brexit achieved.

  4. Many of us who voted leave do not share in any wealth generated by growth.
    As such, Mr Carney, we don’t give a flying toss if the economy crashes & burns, indeed it would promote schadenfreude amongst many of us.
    As such, get us out of the EU pronto, OR ELSE!!!.

  5. There has to be consequences for all the money that has been created out of thin air in this country over the last thirty years or so to finance the housing bubble and the budget deficits and also the QE and the trade deficits, and that will be a massive depreciation of sterling.

    Most people cannot understand why these policies continue for so long with no apparent effect on the exchange rate, and then suddenly there is a massive move, and everyone is thrashing around looking for reasons, the newspapers and TV news give the opinion of some talking head, but just like the reasons for stock market crashes, the reasons given are never the real cause – central bank policies and a desire to cause a change somewhere in the economic or political system is what causes huge movements in markets .

    Central banks nowadays continually blow bubbles to correct for the previous crash they caused which sets up the next crash, they cause housing bubbles like ours and then warn of a crash in house prices because a sectionof the electorate voted the “wrong way”, would they have crashed anyway or would they have kept going up? Who knows, but once central bankers decide a country’s currency should be taken down for whatever reason it will be(see Turkish Lira), if we had voted to remain this would never have been an issue, the Bank of England would have continued to support the housing market and sterling would have meandered on its way around $1.40-1.50 and 0.75-0.85 against the Euro.

    The countries of southern Europe and Ireland should never have had the luxury of a strong currency like the Euro and the low almost zero rates that go with it, and they never should have experienced housing bubbles like Spain and Ireland, but as long as they remain in the EU and play the game, they are OK, the minute they rock the boat, well everyone knows what follows -Italy take note.

    And so now the UK is the awkward customer who must be taught a lesson and boy have they got plenty of sticks to beat us with, a massively overinflated housing market, a massive structural trade deficit, a massive structural budget deficit, a totally corrupt government and Bank of England controlled by the very people who are determined to keep us in the EU and a population massively overextended on credit card debt, motor finance debt, personal loans and of course mortgage debt that is vulnerable to even the slightest increase in interest rates.

    I just checked out the number of deals available for credit card balance transfers at 0% and there are 6 offering periods between 12-26 months. The debt monkeys out there love these as they just keep moving from one to the other and never pay off the capital and in the process think they are being really smart.

    I wonder how long these deals will last if the UK keeps trying to leave the EU???
    How long will this country’s economy survive when those people have to pay the normal credit card interest rate of 25-30% on balances???? How long if fixed rate mortgage deals(loved by the “shrewd house buyers and BTLER’s who think you can never lose on property”) dry up and are replaced by new deals at much higher ates?

    Even a small increase in morgage rates and a suspension of 0% credit card interest deals would be enough to get the average BREXITEER on their knees begging for a return to the EU and the soothing policies of the Bank of England and the welfare state. Just how long will it take is the only question that needs answering.

  6. No I’m pointing out that if the UK persists in trying to leave the EU the consequences will be devastating, and the symptoms that will suddenly appear (that were suppressed while we played the game) will destroy the bubble/debt based economy we have assumed over decades to be “normal”.

    The fact we have a majority of corrupt, gullible and naieve politicians and civil servants, the Bank of England, economists and mainstrem media(BBC being the worst culprit) all lying, distorting the facts and trying to prevent BREXIT means the only way is to remain or rejoin later under even worse terms than we have now after the financial pressure or the political presssures force the hands of the puppet government.

    Personally, I would like to think we could survive long enough after leaving under WTO rules until the EU collapses first following an Italy induced crisis or something similar, but considering the people behind the EU and the central bank money it’s not likely is it?

    They will just keep turning the screw until the politicians in Westminster sell us out again when the financial pain gets too much.

    • Hi Kevin

      One area where you are way ahead of the Bank of England is that you have identified risks on both sides. Whereas they have left the impression that one side is entirely risk-free.

      Cheers for the data on 0% credit card offers as I like to be kept informed of what is going on there. I would have covered the UK credit numbers today but there was so much going on.

    • Probably, if we stay then it helps the EU dowuble down on their own Ponzi. Its a win win, the Uk establishment get to carry on and the EU doesn’t lose a funder.

      I don’t doubt the possibility that our own bubble might burst, but hey if the larger Eu27 keep the ponzi alive for themselves (as a robust pact) and we are left broken… who is the winner?

  7. Hi Shaun,
    Years ago when we craved direction from the Board about business strategy and so on, my boss used to say – “If you want to know where Sir Tom is going watch his feet not his lips….”

    It’s what Carney does that matters not what he says.

  8. Great blog as usual, Shaun. I watched the video of Chairman Powell’s speech before the Economic Club of New York. The woman who introduced him, Marie-Josée Kravitz (née Drouin), has an MA in Economics from the University of Ottawa, like myself, and for a long time she had a regular economics column that was published in both English- and French-language papers here.
    If imitation is the sincerest form of flattery, I suppose the people at the Bank of England should be flattered that the US Fed is now publishing its own “Financial Stability Report”. It seems strange that the US Fed wants to keep the word “bubble” out of the reports though. One would think that preventing housing price or other price bubbles from developing would be a big part of any regulator’s job.
    It was surprising that the GM plant closures in Ohio, Michigan and Maryland, along with the closing of the Oshawa plant in Ontario, which was announced on Monday, didn’t get a mention in Powell’s speech, nor did anyone ask a question about them. Relative to size, the shutdown in Oshawa, Governor Poloz’s home town, will hurt the Canadian economy more than the American shutdowns will hurt the US economy, but they will still hurt enough that Trump was threatening GM about them. Besides making a rate hike by the US Fed in December or the Bank of Canada in January the layoffs do call for a reassessment of the USMCA agreed to on September 30. Then it seemed like the US negotiators had put in wage provisions to protect American workers, but would also benefit Canadian workers. Since then Mexican negotiators have argued, quite plausibly, that the USMCA won’t be so damaging to the Mexican industry and may even benefit it. However, the corollary to this is that auto plants north of the Rio Grande are still under threat.

    • Hi Andrew and thank you

      I note you mention the attempt to avoid the word “bubble” by the US Fed which is just another part of their strategy to distort language, After all price stability would be inflation at 0% rather than the 2% per annum they claim it is.

      As to the car industry the issue is getting more widespread. The UK media were keen on reporting the shutdown for a while at Jaguar Land Rover but have been much less keen on reporting similar issues around Europe. There was this ear;ier today.

      “Mercedes Vitoria – 4 days production stoppage in December” ( @WEAYL )

      So whilst I feel empathy for the Canadian car workers it is hard to know what else can be done about it. After all the measures to boost demand there was always going to be something of a hangover.

  9. Before the midterm elections, Larry Kudlow also spoke at the Economic Club of New York and Becky Quick asked him if Trump’s tariffs on other countries’ imports might not push up inflation which would lead the Fed to push up interest rates. Kudlow said that he didn’t want to discuss monetary policy because of central bank independence, which is something Trump should be a little more aware of. One would think that ideally the US Fed would want to look through at least the first round impacts of those tariff changes, but none of the core measures the Fed currently looks at do this.
    The most recent inflation data makes a case for not raising interest rates in December. The annual PCEPI inflation rate dipped below the 2% target in September and remained below it in October. The favoured core PCEPI measure, PCEPILFE, had its annual inflation rate fall from 1.94% in September to 1.78% in October. Housing prices are unfortunately not part of any of the many US consumer price measures, but they seem to be flagging as well. The annual inflation rate of the Case Shiller national home price index went from 5.7% in August to 5.5% in September and Zillow Real Estate Research has backcasted a further drop to 5.4% in October.

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