The Bank of England faces a new era as even the Swiss raise interest-rates

Today we have woken up to something of a new reality as we review that rather panicky actions of central banks yesterday. It turned out that the ECB emergency meeting was something of what is called in modern language a nothing burger. They took their time to tell us they were planning something so pretty much what we knew anyway. Putting it another way the ten-year yield in Italy is 4% this morning so “trouble,trouble,trouble” as Taylor Swift would say.

But the main event was this which had several condequences.

At today’s meeting the Committee raised the target range
for the federal funds rate by 3/4 percentage point, resulting in a 1-1/2 percentage point increase
in the target range so far this year. The Committee reiterated that it anticipates that ongoing
increases in the target range will be appropriate ( Chair Powell)

In terms of a market response and expectations he also said this.

As shown in the SEP, the median projection for the appropriate level of the federal funds
rate is 3.4 percent at the end of this year, 1.5 percentage points higher than projected in March
and 0.9 percentage point above the median estimate of its longer-run value.

So we learnt that Nick Timiraos of the Wall Street Journal is the way that the Fed now leaks its intentions. That is the new intended reality to which the Bank of England needs to respond. Before we get to that let me just point out two issues here. Frstly aiming for the end of the year raises a smile when only last week they intended to raise interest-rates by 0.75%. Then their forecast of 1.7% economic growth looks too optimistic to me in an economy which is certainly slowing and may see a recession.

A Swiss Surprise

I was not necessarily surprised that the Swiss National Bank acted but the size of the move does provoke a wry smile.

The SNB is tightening its monetary policy and is raising the SNB policy rate and the interest rate on sight deposits at the SNB by half a percentage point to −0.25% to counter increased inflationary pressure.

This cocks something of a snook at the ECB which last week decided not to raise interest-rates as the Swiss. For them this level of inflation is too high.

Inflation reached 2.9% in May and is likely to remain at an elevated level for the time being.

Whereas Italy has updated us this morning with this.

In May 2022, according to preliminary estimates, the Italian harmonised index of consumer prices (HICP) increased by 0.9% on monthly basis and by 7.3% on annual basis (from +6.3% in April),

Next comes the issue of all the equity purchases to weaken the Swiss Franc.Perhaps not only are they no longer necessary but the SNB will sell some.In which case I can see why equity markets are falling today. This also leaves the Bank of Japan looking even more isolated in its role of The Tokyo Whale.In addition to its 2.2 trillion Yen purchases of government bonds on Tuesday, it bought some 70 billion Yen of equities on Monday.

The Bank of England

The issue now for the Bank of England is of international comparisons and the UK Pound £. We find that monetary policy has rather switched from trying to get your currency to fall to trying to get it to rise.Well apart from the United States which has the reserve currency and in something of an irony has been seeing a King Dollar phase. There is another way of putting this.

It’s hardly a coincidence that the Fed, ECB, SNB or RBA all came up with surprise moves in the past week. It started with the IMF meetings, and there’s been an implicit coordination since then. ( @fwred)

There is some spinning here on behalf of the ECB as the others have raised interest-rates whilst it has not. But there is an underlying drumbeat for everywhere but the Euro area.

The most important exchange rate is versus the US Dollar right now because that is what commodities are priced in. So a stronger currency is one way of helping to control inflation. Regular readers will know I have made that point many times but central bankers are much slower on the uptake as we saw from the Bank of England last time around.

The MPC sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. At its meeting ending on 4 May 2022, the MPC voted by a majority of 6-3 to increase Bank Rate by 0.25 percentage points, to 1%

Although three of them were more on the case.

Those members in the minority preferred to increase Bank Rate by 0.5 percentage points, to 1.25%.

The other six may have been deterred by the fact that the Monetary Policy Committee has never raised interest-rates by 0.5%. But in terms of a currency which has fallen versus the US Dollar and slipped a little versus the Euro whilst rising against the Yen we need to do this I think.

(Back it up baby) I found out love just ain’t enough
I need devotion to back it up (Back it up now) ( Nils Lofgren)

Interest on Reserves

The Financial Times is pushing this.

Rishi Sunak would save up to £57bn for taxpayers over the next three years if he stopped the Bank of England paying interest on money held by commercial banks at the central bank, according to a new report seen by the Financial Times.

Sounds superficially good albeit immediately unlikely so how?

The report by the New Economics Foundation, a left of centre think-tank, recommends the BoE reforms the way that its interest rate underpins the financial system — by no longer paying interest on most of the nearly £1tn reserves held by commercial banks overnight.

Oh hang on it is not actually £57 billion but might one day be.

The interest on the reserves cost taxpayers almost nothing when rates were at rock bottom after the global financial crisis, but would cost up to £57bn by 2025 if rates follow market expectations of a rise to 2.5 per cent.

Now there is a glaring flaw which is if interest-rates are 2,5% then how are you going to implement them as a monetary policy when you also have an interest-rate of 0%? So you would be cutting one interest-rate as you raise the others!

Maybe I have misunderstood and April 1st gas been moved.

Comment

The situation is now one where central banks are competing to raise interest-rates and after considering moves as small as 0.1% are now competing to move by the largest amount. Whilst they claim this is about inflation it is as much a foreign exchange move for most. Also we see that after the decade of competing for a lower exchange-rate they have now joined me in wanting a higher one. Whilst it is a compliment their timing is out because the time to do this was late last summer so it would be helping reduce inflation now.

When we look back on this week the epoch move may be from the Swiss who not only a pushing for a higher exchange-rate from a position of strength. But the possibility that they may sell some of their large equity portfolio has seen equity markets fall 2% this morning.

Shame on You

I can only say I am embarrassed on behalf of my alma mater.

ECB’s Lagarde all dressed up to receive an honorary doctorate from the London School of Economics! ( @david_milliken )

On the day of the emergency meeting that produced nothing too. So we can add Italians to the Greeks and Argentinians writing letters and emails of complaint.