The Bank of England gets ready for another cut interest-rate cut

Yesterday saw Bank of England Governor Mark Carney in full flow at the Bank of England itself in a type of last hurrah. I am grateful to him for being kind enough to exhibit at least 4 of the themes of this blog in one go! That is quite an achievement even for him. I will start by looking at something of a swerve which was introduced by the then Chancellor George Osborne and it has never received the prominence I think it deserves.

A major improvement to the inflation targeting framework itself was to confirm explicitly beginning with the
2013 remit that the MPC is required to have regard to trade-offs between keeping inflation at the target and
avoiding undesirably volatility in output. In other words, the MPC can use the full flexibility of inflation
targeting in the face of exceptionally large shocks to return inflation to target in a manner that provides as
much support as possible to employment and growth or, if necessary, promotes financial stability.

I make the point because you could argue from that date the Bank of England was acknowledging that its priority was no longer inflation targeting. Some of this was accepting reality as back in 2010 it had “looked through” inflation over 5%. To be more specific it is now concerned about inflation under target but much less so if it is above it. This is confirmed in the speech in part of the section on the period after the EU Leave vote.

Inflation rose well above the 2% target, eventually peaking at 3.1% in late 2017, an overshoot entirely due to
the referendum-induced fall in sterling.
UK growth dropped from the fastest to the slowest in the G7.

He cut interest-rates in this period in spite of the fact that the lower UK Pound £ meant that inflation would go in his words well above the 2% target. Actually tucked away on the speech is something of a confession of this.

In the wake of the referendum, the MPC’s
aggressive monetary easing, despite a sharply depreciating currency and rising inflation,

The Unreliable Boyfriend

It seems he cannot escape behaving like this and this week he has given us a classic example. We only need to go back to Wednesday for this.

In a wide-ranging interview with the Financial Times, the outgoing governor warned that central banks were running out of the ammunition needed to combat a downturn.

Yet a mere 24 hours or so later things were really rather different.

Of course, the effectiveness of unconventional policies means that there is considerable total policy space.
In the UK, the MPC can increase its purchases of both gilts and corporate bonds, providing stimulus through
a number of channels including portfolio rebalancing……..All told, a
reasonable judgement is that the combined conventional and unconventional policy space is in the
neighbourhood of the 250 basis points cut to Bank Rate seen in pre-crisis easing cycles.

Glen Campbell must be a bit disappointed as he famously took 24 hours to get to Tulsa whereas Governor Carney has managed the road to Damascus in the same time. Perhaps the new Governor Andrew Bailey had been on the phone. Anyway however you spin it “running out of ammunition” morphed into “considerable total policy space”.

Cutting Interest-Rates

Regular readers will be aware that I have been suggesting for a while now that the next move from the Bank of England will be to return us to a 0.5% Bank Rate. This was regarded as an emergency official interest-rate at the time but as so often language has been twisted and manipulated as it turned out to be long-lasting. I will discuss Forward Guidance in detail in a moment but for the moment let us just remind ourselves that Mark Carney has regularly promised interest-rate rises during his Governorship. Whereas yesterday we were given a hint of another U-Turn.

This rebound is not, of course, assured. The economy has been sluggish, slack has been growing, and
inflation is below target. Much hinges on the speed with which domestic confidence returns. As is entirely
appropriate, there is a debate at the MPC over the relative merits of near term stimulus to reinforce the
expected recovery in UK growth and inflation.

For newer readers central bankers speak in their own language and in it this is a clear hint of what is on its way.

Forward Guidance

The Governor cannot avoid a move which backfired rather quickly in his term.

The message the Committee gave UK households and businesses was simple: the MPC would not even
think about tightening policy at least until the unemployment rate had fallen below 7%, consistent with the creation of around three quarter of a million jobs.

The simple sentence below must have stung as he wrote it and later spoke it.

In the event, the unemployment rate fell far faster than the MPC had expected, falling below 7% in February
2014.

I will spare you the re-writing of history that the Governor indulges in but he cannot avoid confirming another issue I have raised many times.

As part of these exercises, the MPC revised down its (hitherto private) estimate of equilibrium unemployment rate from 6½% in August 2013 to 5½% in August 2014,

Actually the “hitherto private” claim is not true either as we knew. Also the equilibrium unemployment rather according to the Bank of England continued to fall and is now 4.25%. Thus as a concept it is effectively meaningless not only because it became a laughing stock but it’s use as an anchor was undermined by all the changes.

Anyway as we approach the end of the week it is opportune to have some humour, at least I hope this is humour.

 People understood the conditionality of guidance, as they and the MPC had learnt that there was still considerable
spare capacity in the economy.

I do love the idea that the (wo)man on the Clapham Omnibus had any idea of this! For a start it would have left them better informed than the Governor himself.

Inflation Targeting

I have argued many times that it needs reform and a major part of this should be to realise the influence of asset prices both pre and post credit crunch. On that road house prices need to go into the consumer inflation measure.

But apparently things have gone rather well.

This performance underscores that the bar for changing the regime is high.

I am not sure where to start with this.

Inflation expectations have remained anchored to the target, even when CPI inflation has temporarily moved away from it.

After all the Bank of England’s own survey told us this only last month.

 Asked about expectations of inflation in the longer term, say in five years’ time, respondents gave a median answer of 3.6%, up from 3.1% in August.

Comment

We can continue the humour with some number crunching Mark Carney style.

At present, there is sufficient headroom to at least
double the August 2016 package of £60 billion asset purchases, a number that will increase with further gilt
issuance. That would deliver the equivalent of around a 100 basis point cut to Bank Rate on top of the near
75 basis points of conventional policy space. Forward guidance at the ELB adds to this armoury. All told, a
reasonable judgement is that the combined conventional and unconventional policy space is in the
neighbourhood of the 250 basis points cut to Bank Rate seen in pre-crisis easing cycles.

So if 1% is from QE and 0.65% from an interest-rate cut to his “lower bound” of 0.1% then that means he is claiming that Forward Guidance can deliver the equivalent of 0.85% of interest-rate cuts. That really is something from beyond even the outer limits of credibility. Oh and I have no idea why he says “near 75 basis points of conventional policy space” when it is 0.65%.

As I have been writing this article a fifth theme of mine has been in evidence which is that these days Monetary Policy Committee members only seem to exist to say ” I agree with Mark”.

“If uncertainty over the future trading arrangement or subdued global growth continued to weigh on UK demand then my inclination is towards voting for a cut in bank rate in the near term,” she says. ( The Guardian)

That is Silvano Tenreyro who has rushed to be in line and it is especially disappointing as she is an external member. It is the internal members that have historically been the Governor’s lapdogs.

28 thoughts on “The Bank of England gets ready for another cut interest-rate cut

  1. No surprise to me interest rates falling around the globe the BOE should have been in front of the trend.

    Its been a terrible Christmas for the majority of retailers and there will be over 3,000 retail jobs lost this month.

    The markets pricing a 60% chance of cut by December 2020 they need to be cut now not wait for further weakness that would be behind the trend. I happen to think they will hold on another month but who knows.

    A cut will boost house prices, many wont like that but the BOE running out of ideas at the moment.

    As for negative interest rates they may have to consider going that path as well to force people to spend to assist the economy.

    • Hello Peter

      I don’t think a cut now will make much difference to house prices – too late for that.

      Also so many are on fixed rates – so who or what will such a cut help ?

      you seemed to have upset some one – not me, I didn’t mark your post down 😉

      Forbin

      • forbin

        I have upset a few!

        I agree most the mortgages now on fixed rates but it will help some on variable rates. Also it will help highly indebted companies pegged to the bank rate.

          • Arthur

            Not quite a would have cut last month and gone along with the two who voted for a cut.

            I just happen to think they are behind the trend.

          • The trend?

            If the trend is more money for assets then we’re well ahead of trend.

            If the trend is socialism for the over leveraged id say we’re 20 years ahead of that trend.

            We need a new trend, one that is a return to capitalism and inflation based on the basics of life. ie food and energy. (not property as that is at epic bubble levels)

    • Is that you Mr Carney?

      Clearly ZIRP isnt enough to get people spending we need NIRP, that’ll fix things and make everything just right.

  2. With the chancellor setting the scene for a big boost in capital expenditure on 11/3 and potentially further tax cuts isn’t the economy going to get a boost out of that before they go cutting interest rates?

  3. This should not be surprising, there is no exit from this dark alley. The US tried to tighten but their stock and bond ponzi completely depends on CB accomodation, as does UK house prices. Its a one way street, Carney is having more “fun” now he is leaving to Tyrie. Carney escaped the consequences of his route map and hands over to another to own the mess.

    Given that Fiat currency is now cornered it does not make sense to hold it any more, I think they know that if they push to -ve rates for retail then the game is up. The next 3-5 year span will be one of avoiding this truth.

    More popcorn?

    • re ” Carney is having more “fun” now he is leaving to Tyrie.”

      wow! , I didn’t know they ran a ” Care In The Community ” program….;-)

      Forbin

    • all currencies moving with each other at the behest of the CB means not much will change.

      When a major player breaks ranks ….. uh oh ….

      Forbin

      PS: what isn’t a fiat currency ? Gold certainly is despite what the gold bugs say , also if you have gold and HMG wants it then they’ll just send round those nice boys in uniform to collect it – they;ll give you a receipt of course a paper promise 😉

      • Forbin, yes that is an interesting challenge. However what if you “lost” the Gold in card game? Or forgot where you buried it?

        • ah you see , if you don’t keep a record of it , then you’re a terrorist – no seriously

          loose it ? a couple of coins maybe but £20000 ? was it insured ? why not ?
          why do we have a receipt that you brought 100 sovereigns from the dealer – then you’re seen trying to buy a loaf of bread with one?

          lots of advertising that there are “hoarders” around and its your civic duty to report them

          not that easy you see , to spend gold you are not supposed to have

          Forbin

  4. Cutting or increasing interest rates 1/4% or 1/2%,in this economic environment, is not going to make any meaningful difference whatsoever. Even going ” negative” does not seem to have any desired effect of hitting inflation targets or reducing currency values.
    Everyone has tried with little or no real effect, so if the B of E tinker with the rate, next month, next year, it ain’t going to bring about any changes – so leave it where it is?
    But then they would be accused of not doing anything, there would be no headlines for the MSM and no opportunity for business correspondent to pontificate.
    So bet on 1/4% next, which will really have the desired result and be the solution to all our problems!

    • Hi Foxy

      I agree completely that more interest-rate cuts are not going to work. If we look at the Euro area at -0.6% they are in a similar situation to us at the moment. Ironically Governor Carney was for once in the right track on Wednesday when he talked about a liquidity trap. His mistake is not realising that it is already here.

  5. Problem with putting house prices into the consumer inflation measure. Is that they are now at what must be peak bubble insanity prices, so the only way for them is down, hence falling house prices could be responsible for the BoE keeping interest rates lower if they were added.

    Should have been done 25 years ago.

    Here is a reminder from 2003 when they property bubble blowers cut interest rates despite a 25% increase in prices. So to be fair to Carney they were even more incompetent back then … he’s just a terrible liar along with being incompetent.
    http://news.bbc.co.uk/1/hi/business/2732645.stm

    • re: “he’s just a terrible liar along with being incompetent.”

      yes but the bigger issue is why MSM doesn’t notice this ……. too busy fawning over his every utterance..

      Forbin

      • As long as their asset prices and that of their bosses are rising who cares, not as if its their job to hold the powers that be to account.

  6. Great blog as usual, Shaun.
    The title of Carney’s paper: “A Framework for All Seasons?” is clearly a homage to an earlier paper of his, “A Monetary Policy Framework for All Seasons”, delivered in New York City in February 2012, when Carney was just starting the fourth year of what was supposed to be seven years as governor of the Bank of Canada. In 2012, he affirmed that inflation targeting was a framework of all seasons. After seven years have passed he is questioning it, which is a little disquieting. I reference the speech in my 2018 paper “Governor Carney’s Governor Carney’s Evidence on Consumer Price Indices before the Lords’ Economic Affairs Committee:” “Carney noted that : ‘under NGDP-level targeting, the central bank would seek to stabilize the GDP deflator in order to achieve price stability. But the GDP deflator measures the price level of domestically produced goods and services, which may not match up well with the cost of living that the CPI measures and that matters most for welfare, particularly in small, open economies where imports make up a substantial share of the consumption basket.’ In other words, he rejected NGDP targeting because the GDP deflator is defined on a national basis, while an appropriate cost-of-living index should be based on a national basis. In this regard, the problem with a domestic approach is not only that the index excludes imports, as the CPI and CPIH exclude tourist expenditures abroad, but that it includes exports, as the CPI and CPIH include expenditures of foreign tourists in the UK and tuition fees of foreign students. These should not be in scope for a cost-of-living index for UK residents.” Obviously, an index based on a national approach like the RPI would be more appropriate. Nevertheless, when Carney gave written testimony to the House of Commons Treasury Select Committee not even a year later, he favoured the UK CPI as an inflation measure, and completely ignored the RPI. If you don’t like his principles, he has other principles.
    I have never got the idea that Carney had any clue about the difference between a household-oriented consumer price measure, or to use his term, a cost-of-living measure, and a macroeconomic measure, like the Eurostat HICPs, of which the CPI is one. The rationale for taking a domestic approach for such an index is the central bank’s inflation measure should only be based on prices over which it has some control. It was pretentious for him to give the paper the title it has, as if it were a careful analysis of the inflation targeting framework under which he worked as compared to alternatives, when it is obviously just another justification for the decisions the MPC made on his watch.

  7. Hi Shaun, i think Gene Pitney was the first man to be only 24 hours from Tulsa. Nevertheless more than 10 years on near-ZIRP monetary policy has proved to be a trap that, so far, is inescapable, 0.75% bank rate seems to be the upper bound.

  8. The evidence has always seemd to suggest to me that the ONLY inflation measure that the BoE has ever concerned itself with is “wage inflation”. The economist idea being that all other inflation can be “looked through”, but that it only gets serious when it becomes “embedded” with persistent wage inflation. In fact, one of their most keenly watched reports is the general public’s “inflation expectations” as some sort of early indicator for the phenomenon of wage inflaiton.

    Of course, when you stand back and think through what that actually asymmetry means, is that the Central Bank is seemingly charged with impoverishing ordinary people.

  9. Central Banks falling in line: “The new QE will take place near the end of a credit cycle, as overcapacity starts to bite and in a relatively steady interest rate environment. Corporate America is already choked with too much debt. As the economy sours, so too will the appetite for more debt. This coming QE, therefore, will go mostly toward government transfer payments to be used for consumption. This is the “QE for the people” for which leftwing economists and politicians have been clamouring. It is “Milton Friedman’s famous ‘helicopter drop’ of money.” The Fed wants inflation and now it’s going to get it, good and hard. The Federal Reserve will then face the same Hobson’s choice that confronted the Reichsbank in the 1920s: fund the Treasury market and drive continually rising consumer inflation or don’t fund it and let interest rates rise, which would crush financial markets and the economy. QE-for-the-people is the end game of the inflationary economic cycle. Gold will anticipate it first.” How many £billion is Boris going to pump in from his reserve war chest of £500B?

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