The Bank of England is trying to rewrite history

Yesterday added to the complicated situation faced by the Bank of England as we had something of a revolving door situation involving Chancellors of the Exchequer. Plus we had the view of the body that pretty much no-one has ever heard of as the Financial Policy Committee published its Financial Stability Report. Tucked away in it was one particular gem.

Amid high volatility, liquidity conditions deteriorated even in usually highly liquid markets such as US Treasuries, gilts and interest rate futures. Core UK financial markets have remained functional, with participants able to execute trades, albeit at a higher cost. However conditions could continue to deteriorate, especially if market volatility increases further……..Over recent months there has been evidence of reduced liquidity, even in typically highly liquid markets.

Perhaps if someone had not bought some £875 billion of the UK bond market thereby rigging the prices it would have been more liquid! Four members of the FPC actively voted for this policy in their roles on the Monetary Policy Committee. So in terms of blame it is a case of here’s looking at you.

Switching to the economy they pointed out the present problem which is this.

Inflation is expected to reach slightly over 11% towards the end of the year, weighing on real household income.

Combined with this.

 In May, the MPC projected aggregate UK real disposable household income would experience its second largest annual contraction since records began in 1964, largely reflecting increases in the costs of energy and, to a lesser degree, food.

This has caught them on the hop because they failed to act against inflation last year in the hope of protecting economic growth and now find that it is that inflation that has put the skids under economic growth.

A Bitter Pill

The problem has been highlighted again this morning by the Chief Economist Hugh Pill who has been reported saying this.

BOE’S PILL: I AM WILLING TO ACT FASTER ON TIGHTENING IF NEEDED. ( @financialjuice)

The problem is that he has been saying that since November so we are in a boy who cried wolf situation. That has meant that in terms of his own words and claimed objective he has been a failure.

But first I want to re-iterate the commitment I gave in my first interview on joining the MPC last autumn. I see my role as an MPC member as being ‘in the price stability business’. That means returning inflation to the 2% target in sustainable way. If there is one message that a wider public audience takes away from my remarks this morning, I hope it is that.

He is obviously bothered by claims ( from me for a start) that the Bank of England has done too little too late so he has had a go at rewriting history.

Returning inflation to its 2% target is at the heart of the MPC’s actions over the past 10 months. Ceasing asset purchases; starting to raise Bank Rate; beginning to shrink the asset portfolio; considering starting to sell gilts acquired via QE: all these actions serve to tighten monetary conditions and weigh against inflationary pressures.

He is also not very good at maths because if you look at the Bank’s website you see this.

We announced our last round of purchases in November 2020 and that ended in December 2021.

That isn’t ten months ago and even if it was claiming that you stopped trying to increase inflation via QE is hardly monetary tightening, He must be truly desperate.

Next comes another denial of reality as he points out this.

In May, inflation reached 9.1%.^footnote[4] The MPC forecasts a further rise to around 11% later in the year, once rises in international commodity prices stemming from Russia’s invasion of Ukraine pass through to UK utility and food prices.

That is on the measure he targets as the RPI is around 2% higher so even worse. But when you look at that the claim below is veering on Comical Ali territory.

But now that the initial stage of that transition have been successfully navigated

So successful in fact that it is unsatisfactory.

For an MPC member charged with achieving the inflation target of 2% – someone in ‘the price stability business’, if you like – this is obviously a very unsatisfactory situation.

More Dissembling

This is really poor as whilst the war in Ukraine is an additional factor the issue of Covid is now over 2 years ago so well within the time span for monetary policy.

In large part, recent price developments have been driven by a succession of unanticipated external disturbances to the UK economy – among others, the Covid-19 pandemic and its aftermath, and the Russian invasion of Ukraine.

Also in his list of excuses there is the issue that for years and indeed decades central bankers have dismissed energy ( and food) as non-core in inflation terms.

The direct implications of these external shocks for UK price developments transmits within a matter of months. Even with the added complications implied by the OfGEM price cap, higher European wholesale gas prices entered UK utility prices – and thus UK CPI inflation – within six months.

He tries to deflect away with the prices he quotes.

Looking at the daily data, from its trough in May 2020 at 8 pence per therm, spot UK natural gas prices rose to above 500 pence per therm in the immediate aftermath of the invasion of Ukraine.

But looking at the chart of the present main future ( August 2022) we see that it surged over 100 at the end of September. Another way of looking at it is that Ofgem announced it was going to raise the domestic energy price cap by 12/13% in early August 2021 and backed it up with hints of more to come.

This increase is driven by a rise of over 50% in energy costs over the last six months with gas prices hitting a record high as the world emerges from lockdown.

So the Bank of England could have responded but as regular readers will recall it preferred to claim that the inflation would be “transitory” when in fact it has been anything but.

Even more extraordinary is this claim after a period where they acted in lockstep on Covid and inflation being “transitory”

One of the strengths of the MPC set-up is individual accountability and the diversity of view that it encourages….. For all the commentary about ‘group think’ on the Committee, I see little evidence of that in our discussions or published votes.

Perhaps they could put out a joint statement denying any evidence of “group think”.

After the “group think” denial footnote 18 is somewhat delicious.

 I have also received helpful comments from Andrew Bailey, Tom Belsham,Ben Broadbent, Fabrizio Cadamagnani, Alan Castle, Andrew Hauser, Neil Kisserli, Catherine L Mann,
Nick McLaren, Dave Ramsden, Michael Saunders, Fergal Shortall and Silvana Tenreyro, for which I am most grateful.

Comment

As you can see the Bank of England had existing policy problems as it struggles to come to terms with economic reality as well as its own policy errors. This morning something new has been added to the mix.

The official added: “For the next stage, we need a plan for growth and not just balancing the books. He represents the government’s values and commitment.”
Another ally of Johnson said the prime minister and new chancellor were united on the economy. “Nadhim was very quick to recognise what the PM has grown increasingly frustrated at, which is a credible, easy, convincing plan for driving the economy and making Britain the best place in the northern hemisphere to start a business.” ( Financial Times)

Much can change but it feels like tax cuts are back on the agenda as opposed to the National Insurance rise of Rishi Sunak.