How the Bank of England eased monetary policy yesterday

Yesterday something happened which is rather rare a bit like finding a native red squirrel in the UK. What took place was that part of the Forward Guidance of the Bank of England came true.

At its meeting ending on 1 November 2017, the
MPC voted by a majority of 7-2 to increase Bank Rate by 0.25 percentage points, to 0.5%.

Not really the “sooner than markets expect” of June 2014 was it? Also of course it was only taking Bank Rate back to the 0.5% of them. Or as it was rather amusingly put in the comments section yesterday the Bank of England moved from a “panic” level of interest-rates to a mere “emergency” one!


It was not that two Monetary Policy Committee members voted against the rise that was a problem because as I pointed out on Wednesday they had signalled that. It was instead this.

All members agree that any future increases in Bank Rate would be expected to be at a gradual pace and to a limited extent.

In itself it is fairly standard central bank speak but what was missing was an additional bit saying something along the lines of “interest-rates may rise more than markets expect”. Actually it would have been an easy and cheap thing to say as expectations were so low. This immediately unsettled markets as everyone waited the 30 minutes until the Inflation Report press conference began. Then Governor Carney dropped this bombshell.

Current market yields, which are used to condition our forecasts, incorporate two further 25 basis point increases over the next three years. That gently rising path is consistent with inflation falling back over the next year and approaching the target by the end of the forecast

This was a disappointment to those who had expected a series of interest-rate rises along the lines of those from the US Federal Reserve. Some may have wondered how a man who plans to depart in June 2019 could be making promises out to 2021! Was this in reality “one and done”?

Added to this was the concentration on Brexit.

Brexit remains the biggest determinant of that outlook. The decision to leave the European Union is already having a noticeable impact.

The latter sentence is true with respect to inflation for example but like when he incorrectly predicted a possible recession should the UK vote leave the Governor seems unable to split his own personal views from his professional  role. This gets particularly uncomfortable here.

And Brexit-related constraints on investment and labour supply appear to be reinforcing the marked slowdown that has been evident in recent years in the rate at which the economy can grow without generating inflationary pressures.

The new “speed limit” for the UK economy of 1.5% per annum GDP growth comes from exactly the same Ivory Tower which told us a 7% unemployment rate was significant which speaks for itself! Or that wage increases are just around the corner every year. In a way the fact that the equilibrium unemployment rate is now 4.5% shows how wrong they have been.

The UK Pound

The exchange-rate of the UK Pound £ had been slipping before the announcement. As to whether this was an “early wire” from the long delay between the vote and the announcement or just profit-taking is hard to say. What we can say is that the Pound £ dropped like a stone immediately after the announcement to just over US $1.31 and towards 1.12 versus the Euro. Later after receiving further confirmation from the Inflation Report press conference it fell to below US $1.306 and to below Euro 1.12.

If we switch to the trade-weighted or effective index we see that it fell from the previous days fixing of 77.76 to 76.44. If we use the old Bank of England rule of thumb that is equivalent to a Bank Rate reduction of around 1/3 rd of a percent.

UK Gilt yields

You might think that these would rise in response to a Bank Rate change but this turned out not to be so. The cause was the same as the falling Pound £ which was that markets had begun to price in a series of increases and were now retreating from that. Let us start with the benchmark ten-year yield which fell from 1.36% to 1.26% and is now 1.24%. Next we need to look at the five-year yield because that is often a signal for fixed-rate mortgages, It fell from 0.83% to 0.71% on the news.

The latter development raised a smile as I wondered if someone might cut their fixed-rate mortgages?! This would be awkward for a media presenting mortgage holders as losers. This applies to those on variable rates but for newer mortgages the clear trend has been towards fixed-rates.

But again the conclusion is that post the decision the fall in UK Gilt yields eased monetary policy which is especially curious when you note how low they were in the first place.

This morning

Deputy Governor Broadbent was sent out on the Today programme on BBC Radio 4 to try to undo some of the damage.

BoE’s Broadbent: Anticipate We May Need A Couple More Rate Rises To Get Inflation Back On Track – BBC Radio 4 ( h/t @LiveSquawk )

The trouble is that if you send out someone who not only looks like but behaves like an absent-minded professor the message can get confused. From Reuters.

The Bank of England’s signal that it may need to raise interest rates two more times to get inflation back toward the central bank’s target is not a promise, Bank of England Deputy Governor Ben Broadbent said on Friday.

Then matters deteriorated further as “absent-minded” Ben claimed that Governor Carney had not said that a Brexit vote could lead to a recession before the vote and was corrected by the presenter Mishal Husain. I do not want to personalise on Ben but as there have been loads of issues to say the least about Deputy Governors in the recent era from misrepresentations to incompetence what can one reasonably expect for a remuneration package of around £360,000 per annum these days?

Here is a thought for the Bank of England to help it with its “woman overboard” problems. The questioning of Mishal Husain was intelligent and she seemed to be aware of economic developments which puts her ahead of many who have been appointed……


There is a lot to consider here as we see that the Bank Rate rise fitted oddly at best with the downbeat pessimism of Governor Carney and the Bank of England. Actually in many ways  the pessimism fitted oddly with the previous stated claim that a Bank Rate rise was justified because the economy had shown signs of improvement. On that road the monetary score is +0.25% for the Bank Rate rise then -0.33% for the currency impact and an extra minus bit for the lower Gilt yields leaving us on the day with easier monetary policy than when the day began.

Today saw another problem for the Bank of England as some good news for the UK economy emerged from the Markit ( PMI) business surveys.

The data point to the economy growing at a
quarterly rate of 0.5%, representing an
encouragingly solid start to the fourth quarter.

How about simply saying the economy has shown strengthening signs recently and inflation is above target so we raised interest-rates? Then you keep mostly quiet about your personal views on the EU leave vote on whichever side they take and avoid predictions about future interest-rates like the Bank of England used to do. Indeed if you have an Ivory Tower which has been incredibly error prone you would tell it to keep its latest view in what in modern terms would be called beta until it has some backing.

Oh and as to the claimed evidence that private-sector wages are picking up well the official August data at 2.4% does not say that and here is a song from Earth Wind and Fire which covers the Bank of England’s record in this area.

Take a ride in the sky
On our ship, fantasize
All your dreams will come true right away


The rally of the UK Pound from the lows matches a 1.25% Bank Rate rise

Yesterday was a day where we discovered a few things. For example we learned that  Prime Minister Theresa may was not going to be the new Dr. Who nor the new manager of Arsenal football club as we discovered that she was in fact trying to launch a General Election. I say trying because she needs to hurdle the requirements of the Fixed Term Parliament Act later today although if she does I presume it will fade into the recycle bin of history. Let us take a look at the economic situation.

The outlook

Rather intriguingly the International Monetary Fund or IMF published its latest economic outlook. There was good news for the world economy as a whole.

With buoyant financial markets and a long-awaited cyclical recovery in manufacturing and trade, world growth is projected to rise from 3.1 percent in 2016 to 3.5 percent in 2017 and 3.6 percent in 2018.

There was particular good news for the UK economy.

Growth in the United Kingdom is projected to be 2.0 percent in 2017, before declining to 1.5 percent in 2018. The 0.9 percentage point upward revision to the 2017 forecast and the 0.2 percentage point downward revision to the 2018 forecast reflect the stronger-than-expected performance of the U.K. economy since the June Brexit vote,

However this was problematic to say the least for Christine Lagarde who after the advent of Donald Trump is now the female orange one.

. Asset prices in the UK (and, to a lesser degree, the rest of the EU) would likely fall in the aftermath of a vote for exit…..In the limited scenario, GDP growth dips to 1.4 percent in 2017, and GDP is almost fully at its new long-run level of 1.5 percent below the baseline by 2019. GDP growth falls to -0.8 percent in 2017 in the adverse scenario,

There was more.

On this basis, the effects of uncertainty seem to be universally negative, and potentially quite strong and persistent, even if ultimately temporary.

In fact asset prices rose and the uncertainty had no effect at all. Of course the long-term remains uncertain and ironically the IMF after being too pessimistic has no become more optimistic just as the factor which is likely to affect us is around, that is of course higher inflation. Oh and the UK consumer spent more and not less.

If we stick with the higher inflation theme there is this from Ann Pettifor today.

UK govt promotes usury: interest on student debt rises later this year from 4.6% to 6.1% = RPI + 3%.

That is the same UK establishment which so regularly tells us that CPIH ( H= Housing Costs via Imputed Rents) is the most “comprehensive” measure of inflation so is it not used? Also if we look other UK interest-rates we see Bank Rate is 0.25% and the ten-year Gilt yield is 1.02% so why should student pay 5/6% more please? Even worse much of that debt will never be repaid so it is as Earth Wind & Fire put it.

Take a ride in the sky
On our ship, fantasize

So can anybody guess the first rule of IMF Fight Club?

UK Pound £

There was an immediate effect here and as so often it was completely the wrong one as the UK Pound £ dropped like a stone. Well done to anyone who bought down there as it then engaged some rocket engines and shot higher and at one point touched US $1.29. For those unfamiliar with financial market behaviour this was a classic case of stop losses being triggered as so many organisations had advised selling the UK Pound that the trade was very over crowded. My old employer Deutsche Bank was involved in this as it has been cheerleading for a lower Pound £ at US $1.21, Ooops.

So we only learn from yesterday’s move that the rumours a lot of organisations had sold the UK Pound £ were true. As they looked to cover their positions the momentum built and we saw a type of reverse flash crash.

If we take stock we see the following which is that the UK Pound £ is now some 10.1% lower than a year ago against the US Dollar at US $1.282. As it sits just below 1.20 versus the Euro it is now only down some 5% on where it was a year ago. If we move to the effective or trade-weighted exchange-rate we see that at 79.1 it is some 6.7% lower than the 84.8 it was at a year ago. What a difference a day makes? Of course what we never have is an idea of what the permanent exchange rate will be or frankly if there is any such thing outside the economic theories of the Ivory Towers but if we stay here the outlook will see some ch-ch-changes. For example a little of the prospective inflation and likely economic slow down will be offset.

If we stay with inflation then there are other influences which are chipping bits off the oncoming iceberg. I have previously discussed the lower price for cocoa which offers hope for chocoholics and maybe even a returning Toblerone triangle well there is also this from

The Northern China import price of 62% Fe content ore plunged 5% on Tuesday to a six-month low of $61.50 per dry metric tonne according to data supplied by The Steel Index. The price of the steelmaking raw material is now down by more than a third over just the last month.

Shares and bonds

The UK Gilt market is extraordinarily high as we mull the false market which the £435 billion of QE purchases by the Bank of England has helped create. As someone who has followed this market for 30 years it still makes an impact typing that the ten-year Gilt yield is as low as 1.04%. This benefits various groups such as the government and mortgage borrowers but hurts savers and as I noted earlier does nothing for student debt.

The UK FTSE 100 fell over 2% but that was from near record levels. I do not know if this is an attempt at humour but the Financial Times put it like this.

The surging pound has pushed Britain’s FTSE 100 negative for the year

So a lower Pound £ is bad as is a higher £? Anyway they used to be keen on the FTSE 250 because they told us it is a better guide to the UK domestic economy which has done this.

So more heat than light really here because if we take a broad sweep the changes yesterday were minor compared to the exchange-rate move

House prices

Perhaps the likeliest impact here is a continuation of low volumes in the market as people wait to see what happens next. It seems likely that foreign buyers may wait and see as after all it is not a lot more than a month, so we could see an impact on Central London in particular.

In a proper adult campaign issues such as money laundering and the related issue of unaffordable house prices would be discussed. But unless you want to go blue in the face I would not suggest holding your breath.


The real change yesterday was the movement in the UK Pound £ which will have been noted by the Bank of England. I wrote only recently that some of it members would not require much to vote for more monetary easing such as Bank Rate cuts and of course should the UK Pound £ move to a higher trajectory that gives them a potential excuse. I do not wish to put ideas in their heads but since the low the rise in the UK Pound £ is equivalent to five 0.25% Bank Rate rises according to the old rule of thumb.

By the time you read this most of you will know the British and Irish Lions touring squad and as a rugby fan I look forwards to today’s announcement of the squad and even more to the tour itself. However just like economic statistics there seems have been an early wire about the captain.

By contrast the General Election announcement came much more out of the blue.

The economic consequences of devaluing the Euro

One of the features of current world economic policy is the implicit effort of the European Central Bank to gain a competitive advantage by driving the value of the Euro lower on the foreign exchanges. Yesterday there was another effort via Reuters.

A consensus is forming at the European Central Bank to take the interest rate it charges banks to park money deeper into negative territory in December, four governing council members said, a move that could weaken the euro and push up inflation.

Some argue that a deposit rate cut should even be larger than the 0.1 percent reduction currently expected in financial markets, the policymakers said.

Actually after the recent speeches of Mario Draghi it was already clear that a deposit rate cut of more than 0.1% was being considered. Or perhaps more specifically they want us to think is being considered. Reuters did however touch on what I consider is the real game here.

The euro fell by as much as half a cent in response to the Reuters story

Draghi’s Currency Wars

Back at the last policy meeting for the ECB it had a problem. The Euro effective or trade weighted exchange rate was in the low 94s which is where it was when it implemented a major expansion of asset purchases back in January. To be specific the value of the Euro had fallen sharply initially and had continued lower until it dipped below 89 in mid-April. But from then onwards it had risen back to pretty much where it had begun. If you look at this in terms of bang for your buck then treading water does not seem especially good value in return for 60 billion Euros of QE a month.

Thus we saw Mario Draghi respond with a salvo of Open Mouth Operations which have involved hints and promises about taking the deposit rate which is already at -0.2% lower and either a fast rate of asset purchases or extending the term beyond the current end date of 2016. In response the Euro has fallen again and has done so most markedly against the US Dollar where it is now in the 1.07s but if we look wider we see that it is at 91.55 on the effective index. Accordingly Mario’s jawboning has been a success in financial markets terms as the Euro has dropped, however for the real economy we need to take care as if you think about it investment decisions are based on estimates of where they think an exchange-rate will be over a period of years not weekly or monthly fluctuations.

Mario has not always been a soft currency supporter

Back in July 2013 we were told a rather different story. From Reuters.

Noting that the currency’s recent strengthening on foreign exchange markets was a sign of renewed confidence in the euro, Draghi told a news conference:

So the current weakening is a sign of a lack of confidence in the Euro which Mario is encouraging? Anyway a year later Mario had decided you could have too much of a good thing. From CNBC in July 2014.

The recent rise in the value of the euro could stifle the flickering signs of growth in the euro zone,

Such reminders raise a wry smile but to be fair they also indicate that too much pressure is on central banks these days in terms of economic policy. Thus they have morphed into political style behaviour.

Competitive Devaluation

Here is something that rarely gets a mention so perhaps it is another example of the military dictum that it is best to hide something in plain sight. In today’s complex world how do you define a competitive devaluation and indeed exporting deflation. Well I would suggest that acting to drive your currency lower via monetary expansion when you are in the process of announcing a quarterly current account surplus of 53.8 billion Euros is a clear example. Indeed fuel is added to the fire by the fact that the surplus was over 20 billion Euros larger than a year before.

Now we get to something even more awkward if we look at the trade colossus which is Germany. In the first quarter of 2015 it announced a trade surplus of 56.8 billion Euros which means that the lower Euro is benefiting one of the factors which those who look at balance sheet balances think got the world into its current malaise. Also I have argued on here in the past that claimed defeats for Germany on policy such as over Greece might be considered a price to pay for a Euro value much lower than where a Deutschemark would be now. There has been an enormous competitive devaluation here which is being added to.

Just for clarity the German numbers include intra- Euro area trade so are not a like for like comparison with the overall Euro area ones.

What about QE?

Fans of the Matrix series of films will recall the bit when the Frenchman tells us about “cause and effect”. Sadly for his eloquent description we see that in the QE era the effect becomes before the cause. In the UK the UK Pound had its 25% or so fall in 2007/08 before QE began in 2009 and the Euro fell in 2014 ahead of the QE announcement in January 2015. Expectations of monetary easing lead to a currency fall before the easing happens or if you like we see yet another example of markets front-running central banks.

Take your pick as to where you think this began but back in April 2014 we saw the Euro top out in the mid-104s in trade-weighted terms but the acceleration began from 100 on December 16th 2014. Either date presents a much bigger move that what has happened since and makes any regression analysis problematic.

The economic impact

Back in March 2014 Mario Draghi told us what the ECB thinks the impact is.

 Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points. So we can say that between 2012 and today about 0.4 or 0.5 percentage points of inflation was taken out of current inflation because of the exchange rate appreciation. Having said that, we have to be cautious, because there was a previous depreciation of the euro.

If we look at where we are and compare to the nice round number of 100 of mid-December 2014 then so far if we assume the Euro remains where it is now for long enough for Mario to consider the move “permanent” then the maximum impact on the inflation rate is 0.4%.

The ECB has been much more reticent about the impact on economic growth but if we used the Bank of England rule of thumb we have seen a move equivalent to to 2% fall in interest-rates. If we make a larger jump and look at the numbers established by the US Federal Reserve yesterday then the Euro area would get a 2.2% rise in exports and a 0.6% rise in economic output or Gross Domestic Product. Now I rush to say that America is not the Euro area and we are ignoring gains from falls in imports as the Euro is not the reserve currency but it does give an impression. Also you could choose different dates to compare.

Also we have to factor in that the Euro area has lost some of the gains from the falling oil price as it fell too. Over the past year it has taken away about a third of the gains that would have otherwise taken place.


I will leave that to the Swedish Riksbank which has rather intriguingly trolled the ECB in its monthly minutes which were published earlier today.

The markets have also interpreted the latest communication from the ECB as a clear signal that further stimulus measures are to be expected in December……. The ECB has indicated that it may make its monetary policy even more expansionary.

Indeed is the next bit trolling or a threat?

Expectations of a more expansionary monetary policy from the ECB have, together with an appreciation of the Swedish krona in September, contributed to the majority of analysts expecting further easing measures from the Riksbank before the end of the year,

So the Riksbank is trolling both the ECB and analysts now? Anyway the Financial Times reported it this way.

Riksbank head ‘would not hesitate’ to intervene in FX (Foreign Exchange).

This is obviously in itself a localised issue in the sense that Sweden is so near to the Euro area and is relatively small. But we are faced if we look at the countries looking to lower their currency as well (Japan springs to mind) with the issue of who is going to import the deflation they export? Meanwhile Paul Krugman searches for David Bowie on Spotify.

Is there life on Mars?

Or for Jeff Wayne.

At midnight on the twelfth of August, a huge mass of luminous gas erupted from Mars and sped towards Earth

Has Iceland shown Mark Carney and the Bank of England the way?

Tomorrow is what has become called “Super Thursday” for the Bank of England. This is where its latest policy decisions and meeting minutes are released with the Quarterly Inflation Report at 12 pm. According to Bank of England Governor Mark Carney this is more transparent which my financial lexicon now defines as swamping people with so much information that they cannot possibly digest it thoroughly. Although those invited to the Bank of England early will of course have a head start and let us hope that it has not been behaving like the European Central Bank. From the Financial Times.

ECB officials met bankers before key decisions, copies of their diaries reveal.

Also the policy decision will be made today as it is only the public announcement that is delayed until tomorrow so let us hope that nobody is more equal than others in the meantime. On the subject of transparency there are plans for another “improvement” which will reduce the number of meetings from 12 to 8 which as I have pointed out before is something of an irony when you consider it berates other organisations on the grounds of productivity.

What will they be discussing?

The first issue will be economic output where they will find themselves having to repeat what they did in September’s Minutes.

Bank staff had lowered their estimate of Q3 GDP growth to 0.6% from 0.7%.

As it turned out to be 0.5% then UK economic growth has underperformed their expectations as did growth in the United States ( they expected 2.4% annualised there). The UK annual rate of growth of 2.3% is solid but also as bit weaker than it was and below expectations. Accordingly they open with something of a downgrade.

There was also something to note in the breakdown of UK economic growth.

while output in manufacturing and construction is estimated to have fallen in the 3 months to September 2015.

Looking Forwards

This month’s purchasing managers reports have been very bullish for the UK economy. They opened with a very positive manufacturing report.

The start of the final quarter saw the UK manufacturing sector record its best month of output growth since June 2014,

This was followed by construction being strong at 58.8

the latest survey marked two-and-a-half years of sustained output growth across the UK construction sector

Then services too although perhaps the overall report was allowing for the fact that it can get over optimistic.

The survey data point to GDP rising at a quarterly rate of 0.6% at the start of the fourth quarter, up from 0.5% in the third quarter.

So the outlook is bright but there are issues here. For a start the manufacturing theme has supposedly completely changed from struggling due to currency strength to boom. We heard the British Chamber of Commerce on the struggling theme only yesterday Then of course there is construction where personally I have so little faith in the official numbers I am counting cranes! So better maybe. Let’s hope so.

On the subject of the British Chamber of Commerce you may like to note that I read the speech which said that exports were up over the past 6 years by 25% outside the EU and 6% within. Now here is how BBC Radio 4 Today reported it.

UK exports have fallen to their lowest level for six years. Joe Lynam presents.

Monetary Policy

Here we have had an unchanged Bank Rate for over 6 years and bond yields are maybe slightly higher than for the last Inflation Report. So any change comes from the exchange rate of the UK Pound £. Here the early thoughts will have been redacted as the UK Pound £ has regained ground. This is mostly due to the promises of Mario Draghi which have moved the Euro exchange rate from 1.36 to 1.41.

As a reminder the only actual tightening of monetary policy in the UK has come from the rise in the value of the UK Pound £ which under the old rule has been worth a 3.75% rise in Bank Rate since the nadir in March 2013.

Some Perspective

Yesterday’s Office for National Statistics Economic Review offered some food for thought for the Bank of England.

this extends a run of 11 consecutive quarters of positive quarterly growth during 2013, 2014 and 2015. GDP has risen by 13.3% compared to the trough of the economic downturn in Q2 2009 and is now 6.4% higher than the pre-downturn level of output in Q1 2008.

That is pleasing although of course some of that represents a population increase. As we move to look at wages it looks as if the ONS is trolling the Bank of England.

Growing evidence of tightening in the labour market has been accompanied by a sharp rise in the rate of earnings growth, driven in part by a sharp recovery in private sector earnings growth.

Such signals in the past  would have had the Bank of England reaching for the Bank Rate trigger. Although these days we wonder If they can still remember where it is! However again adding a bit of perspective changes things a bit.

Whole economy real earnings are now 5.1% below their 2008 level, while earnings in the financial, manufacturing and retail industries are now 2.5%, 3.0% and 2.1% below their 2008 levels respectively.

Just as a reminder the numbers would be worse with the various RPI alternatives and it is interesting that the ONS only gives us sectors doing better than the mean.

Also this bit gave me a wry smile. As I head towards my sixth anniversary online I recall the “rebalancing” promises of the then Bank of England Governor Mervin King.

While the output of the services industries is estimated to be 11.1% above its pre-downturn peak, the manufacturing industry remains 6.3% below this yardstick.

Perhaps one day Baron King of Lothbury will let us know how that went! Oh and I guess some of you are thinking of “march of the makers” at this point too. It seems the higher the volume of the rhetoric the worse prospects are.

There has been something of a rebalancing as the ONS in what it calls an “experimental nowcast” is beginning to catch up with something that has been a long-running theme on here.

These trends have helped to lift median real income for retired households from 66% of median non-retired household income to just over 75% between 2008/09 and 2014/15.


Of course officially there isn’t any as 2015 has seen the official reading be pretty much 0%. Starbucks have joined the fray as Twitter has been full of complaints of a price rise of the order of 15 pence for a cup of coffee. You see this illustrates how the UK remains a nation with institutionalised inflation as pressure from rents and wages overruns the commodity disinflation of a 25% fall in coffee prices on the exchanges over the past year. Optimists amongst you may be hoping that Starbucks is raising some money to pay its corporate taxes…..


We have had plenty of hot air from Bank of England Governor Mark Carney on the subject of Bank Rate rises since he started his Open Mouth Operations at the  Mansion House speech of June 2014. This has qualified him as an interest-rate hawk for Bloomberg which is curious for a man who is yet to actually vote for one! As he has decided to pontificate on climate change there is something of an irony in all the hot air produced. These are promises Eric Clapton style.

La la, la la la la la.
La la, la la la la la.

Meanwhile if the Governor looks north to Iceland he will see that yet again they have decided to be different.

The Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to raise the Bank’s interest rates by 0.25 percentage points. The Bank’s key interest rate – the rate on seven-day term deposits – will therefore be 5.75%.

Their economy is indeed running hot – domestic demand growth is running at around 7% – so by no means an exact comparison. But of course some will be thinking of Greece at this point which has followed the opposite path and look where it is.

In terms of numbers let me offer a thought which is that it is symptomatic of where we find ourselves that in both the UK and US a 0.25% rise in interest-rates is considered such a big deal. Back when we were ejected from the ERM in 1992 the UK announced Base Rate increases as it was then of 5% in one day although only 2% ever happened.

Number Crunching

You might like to file this section under up is the new down.

Pete Comley who you may recall I helped with some advice on his book on Inflation a couple of years ago has successfully challenged the ONS on rather a basic point.

On September 1st, ONS published the results of a trial to scape food prices daily from the internet . These resulted in headlines such as: “costs rocketing;”cost of basic items has risen by 8% in last year”; and  “spaghetti up 20% in a year”. Yesterday, ONS put out a correction saying that they had got the scale inverted and that food prices had actually fallen by 3% a year – a figure now almost the same as the -2% decline in prices seen in CPI.

Or as Paloma Faith put it.

I tell you what (I tell you what)
What I have found (What I have found)
That I’m no fool (That I’m no fool)
I’m just upside down (Just upside down)

How much has Germany gained from its membership of the Euro?

It is an irony that in what is supposed to be a currency union of partners we spend so much time looking for winners and losers! The list changes as there was a time when the current largest loser Greece appeared to be a winner. The onset of the credit crunch reshuffled the pack and led the Euro area into quite a different place. Also the crisis has seen the media often push the view that Germany has been a loser and there have been regular reports of it being defeated at the European Central Bank. Putting it another way we have seen the policies of Mario Draghi pursued rather than the more hardline suggestions of Jens Weidmann who heads the German Bundesbank. Indeed the “whatever it takes (to save the Euro)” speech given by Mario Draghi in the summer of 2012 was seen as a clear victory over Germanic influences. On that road we have seen two trillion Euro projects with the LTROs and now QE as well as the mythical Jedi Mind Tricks of the Outright Monetary Transactions or OMTs.

However life is rarely that simple so let us examine an alternative agenda which is that Germany is in fact a beneficiary out of all this.

The hundred billion Euros issue

Step forwards the Leibniz Institute in Halle who have looked at this subject but as shown below only one aspect of it.

This note shows that the German public sector balance benefited significantly from the European/Greek debt crisis, because of lower interest payments on public sector debt.

They have an explicit and an implicit effect which I shall present in that order.

while the European Central Bank (ECB) monetary policy stance was quite close to an “optimal” monetary policy stance for Germany from 1999 to 2007, during the crisis monetary policy was too accommodating from a German perspective, due to the emerging disparities across the Euro area

in crisis times investors disproportionately seek out safe investments (“flight to safety”), bidding down the returns on safe-haven assets.

So the cost of issuing debt has been much cheaper than would otherwise have been the case for Germany over the Euro area crisis period. Regular readers will know that we have seen more than a few situations where Germany has been paid to issue debt and as I type this stretches almost to the five-year maturity. Who would have thought that not so long ago?

The Leibniz Institute have crunched some numbers as to the benefit from this.

As a result of these two effects, our calculations suggest that the German sovereign saved more than 100 billion Euros in interest expenses between 2010 and mid-2015.

This is an issue that politicians in many countries have avoided because many bond yields have dropped with my own country the UK having a ten-year bond yield of 1.85% which still seems extraordinary. So governments in many places have been given a windfall which of course gets ignored as they rush to take the credit.

Also they point out that this is more than Germany’s explicit exposure to Greece.

That is, Germany benefited from the Greek crisis even in case that Greece defaults on all its debt (a total of 90 billions) owed to the German government via diverse channels (European Stability Mechanism [ESM], International Monetary Fund [IMF], or directly).

I have two thoughts on this. Firstly these are estimates and it is best to consider them as broadly similar. Next we need to take care as this is Germany’s sovereign exposure and does not count what might happen to the banks or the wider economy if Greece defaulted.

What about monetary policy?

The Leibniz Institute hinted at this issue here.

the European Central Bank (ECB) monetary policy stance was quite close to an “optimal” monetary policy stance for Germany from 1999 to 2007.

Another way of putting that was that Germany managed to run monetary policy such as interest-rates up to the credit crunch. So if it had not happened maybe it still would? We know that it certainly did not suit places like Ireland and Spain which saw a housing boom and bust result from it.

Also Germany has seen quite a considerable amount of monetary easing as it’s economy also benefits from the expansionary policies of the ECB. So it has an official interest-rate of -0.2% and has seen all sorts of extraordinary measures including now some 58.3 billion Euros of German government bonds as part of the QE operation. That poses a real question as we consider the ECB buying German bonds at negative yields. To what end?

However we are seeing an extraordinary level of stimulus being applied to the German economy particularly when you consider it has been one of the better performers in the credit crunch era. We await tomorrow’s update on what happened to GDP in the first half of 2015 but Germany’s Council of Economic Experts is fairly sanguine.

The GCEE expects real GDP to grow by 1.8 % this year,

The Exchange Rate

There have been plenty of swings in the value of the Euro currency in its existence but at 93.3 compared to 100 when it started you can see that it is actually not far from it right now and that it is lower. Indeed there has been a larger fall if we compare the peak which was as the Euro was perceived as attractive when the credit crunch first hit and rose to 114.4 in late 2014.

Now imagine when a German Deutschmark would be! I guess those of us who are old enough are singing along to the old Nimble bread advert.

Up, up and away
Up, up and away
Up, up and away

If we do a comparison with how the Swiss Franc has behaved in the credit crunch era then we have a rough ballpark estimate of 1.50 for what a new German Deutschmark would be worth in Euro terms as opposed to the current 1.11 versus the US Dollar. I am sure that some of you are thinking that the “safe haven” craze might have pushed it even higher.

Whilst it did not cause the situation below we can be sure that it has helped Germany maintain it at a time where exporting had to face the credit crunch.


There have been considerable gains for Germany from Euro membership. Contrary to the regular reports of it being defeated it has gained on most fronts. Before the credit crunch monetary policy was set for its benefit but there has been a much larger gain. Over the past few days I am others have accused China of currency manipulation and devaluation. Well what about Germany?! By joining the Euro it sent its currency on a lower path which post credit crunch has turned out to be a much lower path. On that road it has been able to continue its export success and hence boost economic output. If we look back did Germany fire the first salvo in the Currency Wars? Maybe that is going a little far but there is also a grain of truth in it.

If we look wider we see difficulties emerge as if Germany has a lower exchange rate other Euro area countries have a higher one. I think you can easily figure out who they are! Also if we are talking about China exporting deflation well what about Germany with its 214 billion Euro trade surplus in 2014? Whilst for example nobody is forced to buy a German car it is true that even they would find it harder to sell them at a much higher exchange -rate.

Hidden in the HSBC retrenchment announcement is another problem for the UK trade deficit

Today is that time in the month when we get to see how bad the UK’s balance of payments position is! Also some perspective was provided yesterday by the turmoil and indeed currency depreciation in Turkey. If we examine the problems in the current account of the balance of payments that Turkey has combined with a deterioration in its net international investment position who does that remind you of? As I pointed out such developments there have come with a currency heading downwards on a substantial scale and by the standards of these times high inflation.

UK exports

There was a time when the UK financial services industry was seen as a way of us improving our exports and thereby reducing our persistent balance of payments problem. Back then our banks bestrode the world whereas only this morning we have already been told that these are very different times. From HSBC.

Reduce Group RWAs by at least circa 25% and redeploy towards higher performing businesses; restore GB&M profitability.

The use of acronyms is a sure sign of trouble but RWAs are Risk Weighted Assets and therefore HSBC is retrenching on a considerable scale. This poses a problem as of course this is exactly what regulators and politicians want banks to do until they actually do it as they mull the lost jobs and economic output. Damned if the do and damned if they don’t! According to Siobhan Kennedy of Channel 4 News this has just been announced at the press conference.

HSBC CEO confirms 25k jobs to go globally, 7/8k jobs in the UK

Also this factor makes one wonder how long the HSBC head office will remain in the UK.

Contribution from Asia gone from 33% in 2004 to 64 % in 2014. Said massive growth opps in pearl river delta and ASEAN. Bigger than uk/EU.

This poses questions for UK output and employment which of course is something of an irony just after we have been told this by Chancellor George Osborne. From the Financial Times.

George Osborne will signal an end to “banker bashing” next week, amid a clamour from the City for him to ease off on regulation and cut the controversial bank levy.

This sort of thing can really mess with your mind when you try to figure out which is the chicken and what is the egg! Especially as we note all the signs committed by bankers since the credit crunch (Libor and foreign exchange fixing for example) and note that Iceland which abandoned the too big to fail banking safety net is on its way to abandoning capital controls.The Mansion House speech is tomorrow night by the way.

If we return to concentrating on trade here according to a House of Commons report from February is the impact of UK financial services on it.

The trade surplus has been growing as a proportion of GDP over the last two decades, and although it dropped in 2008 it has since recovered. In 2013, the surplus on insurance and pensions was £20.9 billion and £38.3 billion on financial services. These two sectors therefore account for a large proportion of the services trade balance of £78.9 billion.

As you can see financial services do provide a considerable surplus for the UK. As the banking sector is plainly still retrenching that poses a question for the UK’s already troubled trade position going forwards. Also I note the surplus of the insurance industry and wonder how much that will be affected should the ultra-low long-term interest-rate and bond yield situation persist?

As to banker bashing another element of perspective is provided by the shortage of them in jail. If we had taken a different route maybe the banks would not still be retrenching some 7 years into the credit crunch. Oh and just a suggestion to HSBC as it looks for a new name in the UK, how about the Midland Bank?

Today’s numbers

The April numbers do provide a brief flicker of summer sunshine.

The UK’s deficit on trade in goods and services was estimated to have been £1.2 billion in April 2015, compared with £3.1 billion in March 2015………Exports of goods increased by £0.7 billion, of which £0.6 billion was attributed to countries outside of the EU.

So we have exported a little more and reduced the deficit. However you may note that falls in imports were much larger which provides another worrying hint that the UK economy may have slowed. Also there is a hint for the EU Referendum issue that we can indeed trade with the rest of the world! As it happens it was mostly chemicals (organic compounds to the USA).

However monthly figures are erratic to say the least and the clouds start to obscure the brief burst of sunshine when we look for some perspective.

In the 3-months to April 2015, the UK’s deficit on trade in goods and services was estimated to have been £7.2 billion; widening by £1.6 billion from the 3-months to January 2015.

In many ways here is our problem in a nutshell as we produce deficit after deficit in what is beginning to feel like an endless series. Rather oddly considering the economic improvement there we seem to be both importing less from and exporting less to the European Union area although we remain from their perspective very good Europeans.

In the 3-months to April 2015, the deficit on trade in goods with EU countries widened by £0.2 billion to £21.3 billion.

You might also have thought that the decline in oil prices would benefit the UK as we ae a net oil importer these days but this effect seems to have been swamped by the decline in North Sea output.

Longer-term trends

So for a long-term perspective there is this from the 2014 UK Pink Book.

The UK has recorded a current account deficit in every year since 1984

The last trade in good surplus was in 1982 and sadly the excellent effort below keeps being swamped by larger deficits elsewhere.

The trade in services account has shown a surplus for every year since 1966.

Unfortunately last year started to flash something of a red alert.

However looking over a broader time period shows a general deterioration in the current account; the deficit over the 2014 calendar year as a whole was £97.9 billion (5.5% of GDP), which was the largest figure since comparable records began.

Where this was awkward was that in addition to our existing issue we saw this development.

the deterioration in the current account has instead been driven by a large deficit in the primary income balance (mainly income earned by UK residents from investments overseas, less income earned by non-residents on their UK investments). ….. the 2014 calendar year figure of £38.8 billion also represented the largest deficit on record.

As these numbers are dreadfully inaccurate even by the poor standards of trade figures we are left both troubled and uncertain. But when I pointed out earlier that the UK has some similarities with Turkey well you can see now that we do.


Let me open with a basic point of economic theory which text books tell us is that a sustained balance of payments deficit leads to a currency fall with an open economy and flexible exchange-rates. Now consider that the UK Pound £ bottomed in trade-weighted terms in March 2013 at 77.98 and has been rising ever since and was 90.64 yesterday. Just as the UK current account deficit surged! Whilst foreign exchange traders do miss some things believing that there has been over 2 years of myopia is a bit much. So another chapter of our text books needs modification. This has had all sorts of casualties after all didn’t Max Keiser relocate to the UK some 2/3 years ago for a UK Pound £ collapse?

Meanwhile we do genuinely have a problem as our propensity to import sucks life from our economic growth efforts. The latest UK GDP (Gross Domestic Product) figures reminded us of that.

Net trade made a negative contribution to GDP of 0.9 percentage points.

Now we face ever more retrenchment in what is one of our strongest trade areas which is banking. The HSBC announcement is just one in a very long list. It of course will have quite a lot of symbolism should it move to the Far East but it does pose future issues for the UK’s already troubled balance of payments.