The Bank of England wants to control UK house prices?

Today has given us an opportunity to bring together several of our ongoing theme at once. Let me open with news that will be announced to smiles at the Bank of England morning meeting.

“Average houses prices rose again in December, stretching the current run of continuous gains to six months.
However, the monthly rise of 0.2% was the lowest seen during this period and significantly down on the 1.0% increase in November. The average house price was therefore little changed, but nonetheless still reached a fresh record of £253,374.” ( Halifax)

The smiles will have then turned to cheers and only Covid-19 social distancing will have stopped a round of high fives.

“All this left average prices sitting some 6.0% higher at the end of 2020 when compared to December 2019, a notably
strong performance given the anticipated impact of the pandemic earlier in the year. Whilst the annual rate of inflation did fall compared to November (+7.6%) to stand at its lowest level since August, it should be noted that this also
reflects a particularly strong period for house prices towards the end of 2019 as political uncertainty at that time began to ease”

With the rather parlous state of the economy this is really rather extraordinary but seen through the eyes of our central bankers this is quite a triumph. In their circle the numbers from Italy ( 1% annual house prices growth) we looked at yesterday will be seen as a disaster. Indeed PhD’s will be instructed to explain how the Bank of England monetary easing in March boosted the change in 2020 observed below.

“2020 was a tale of two distinct halves for the housing market. Following a strong start, the first half was dominated by the restrictions on movement due to COVID-19, and prices were subsequently down 0.5% at mid-year as the market effectively ground to a halt. However, when the market reopened, prices soared as a result of pent-up demand, a desire amongst buyers for greater space and the time-limited incentive of the stamp duty holiday.”

Indeed some started early back in June and if you want your research sponsored by the Bank of England this this the way to do it.

The average house in the UK is worth ten times what it was in 1980. Consumer prices are only three times higher. So house prices have more than trebled in real terms in just over a generation. In the 100 years leading up to 1980 they only doubled

So confident are they after displaying such a number that they are willing to countenance a central banking heresy.

Recent commentary on this blog and elsewhere argues that this unprecedented rise in house prices can be explained by one factor: lower interest rates. But this simple explanation might be too simple.

But just as the Governor’s temper is tested they save the day by pointing out the contribution of other monetary policy measures.

Mortgage debt expanded rapidly as house prices rose in the UK before the crisis, so this could be an important channel for the UK.

This fits neatly with the £128 billion of the Term Funding Scheme which has pumped up the quantity of mortgage debt banks can offer without any need to attract any of those pesky depositors and savers. There is an irony here as, of course,  the money supply numbers I looked at on Monday show there has been a surge in deposits as savings have soared post the Covid-19 pandemic.

Central Control

I now wish to switch to a rather revealing speech by Andrew Hauser of the Bank of England yesterday. He opens by describing a scene which for a modern central banker sends a chill down the spine.

Increasingly we look to financial markets, rather than banks, to care for our savings or provide credit.
Millions save via pension, investment or exchange traded instruments……… And firms, large and small, borrow from capital markets or non-bank lenders.
Taken together, fully half of all financial assets are now held outside the banking system.

I guess we are reminding ourselves that a central bank has bank in its name. Because when you look at the liquidity mismatches which banking relies on this is quite a cheek.

Some of that reflects vulnerabilities in business models and practices of specific market participants: including liquidity mismatch in funds; leveraged and trend-following investment strategies; or insufficiently forward-looking margining practices.

Does “trend-following investment strategies” apply when the banks all piled into ( and then left with singed fingers) estate agents? Or when they lacked capital when the credit crunch hit as that is another form of margin? Anyway I am sure you have got the idea.

The issue is highlighted as we note the reference to the standard for this sort of thing.

And the canonical description of how to
achieve that is given by Walter Bagehot’s description of the ‘Lender of Last Resort’ (LOLR), which
(in essence) recommends stemming financial panics by lending freely, to sound institutions, against good
collateral, and at rates materially higher than those prevailing in normal conditions

It opens well as the Bank of England did splash the cash but at a time when the US Federal Reserve was liberally applying US Dollar swaps then “sound institutions” had a hollow ring in some cases and what is “good collateral” these days? I could write a whole article on that alone! For now let’s put that under Hmmmmmmm. Then the operations involving a Bank Rate cut, a surge in QE and the TFS were designed to give us rates materially LOWER than in normal conditions. You do not need to take my word for it as we get a confession later in the speech.

The Bank of England provided extra liquidity to banks through a wide range of facilities, at
favourable rates, in the early stages of the March crisis.

Next we get to the crux of what we might call the Hauser matter.

‘Market Maker of Last Resort’ (MMLR). Buiter
and Sibert believed that central banks, acting as MMLR, should be ready to tackle dysfunction in securities
markets relevant to monetary or financial stability, by making two way prices to buy and sell those securities,
or lending against them.

You can figure where that is going,especially if you have followed the mission creep of central banks in the credit crunch era. It is hard not to laugh as the Bank of England purchases of corporate bonds is used as an example because they were an example of a dictum used in the early stages of the Desert War ( World War Two) “order, counter order, disorder”

In case you had not figured out where we are being led.

The review of the Bank’s liquidity framework carried out by Bill Winters in 2012 recommended formalising the
Bank’s approach to MMLR, setting out public principles under which future interventions might occur……
But in the event, the Bank –
in common with other central banks – chose to say relatively little in public.

Comment

I wish now to give an example of the muddled thinking going on here. Let me start with this from the speech.

Since March of last year, G10 central bank balance sheets have risen by over $8 trillion.

As even in these inflated times those are large numbers they have intervened on a grand scale. But apparently they do not influence the price at all.

Purchases typically took place at prevailing market prices

It gets worse.

While not charging an ‘insurance premium’ to market participants for an extended period may be understandable in a severe unexpected pandemic,

Actually they did exactly the reverse they actually paid an “insurance premium” to sellers of government bonds. What I mean by that is that they drove the price of them to record highs. For example they bought the UK’s 2068 bond in the 230s which is extraordinary for a relatively recent bond. This issue of the extraordinarily high prices paid gets ignored in the debate because these days the concentration is usually on yields. For those who prefer that the signal is that up to around the 6 year maturity the UK has negative bond yields and is paid to borrow.

Let me give you another example of what is at best muddled thinking.

driving term repo rates and government bond yields sharply higher.

Okay so the UK benchmark ten-year yield went to around 0.8% which in another perspective is historically extraordinarily low. Central banks intervened on a massive scale and it fell to 0.08% but apparently that is a “market price”

No the Bank of England set the price for UK bonds via the large scale of its purchases so could it set policy for house prices? Well this year I think we are about to find out.

 

The Bank of England intervenes in support of Tottenham Hotspur

We have been provided with some more insights into the thinking of the Bank of England via a speech from Executive Director Andrew Hauser. We open with a curious accident of timing.

I have always had a funny feeling about Friday the 13th – and 13 March 2020, Mark Carney’s last day in the
office as Governor of the Bank of England, was no exception.

Actually he had various leaving dates as one might expect from an unreliable boyfriend. Then the speech shows it is being given by a central banker because we are told this.

But this is no time for self-congratulation.

But then it apparently is.

Hailed globally as a shining example of how monetary, fiscal and regulatory policies
could work together to reinforce one another, the combination of interest rate cuts, government spending,
cheap funding and capital easing measures seemed sure to stabilise markets and restore some muchneeded confidence to households and businesses.

Can you applaud yourself whilst also slapping yourself on the back, but avoid self-congratulation?

Policies

We get a confirmation of one of my points.

The dollar swap lines may be the most important part of the international financial stability safety net that few
have ever heard of.

In essence the US Federal Reserve was effectively operating as the world’s central bank.

QE

The events are described thus.

This was by far the largest and fastest single programme ever launched: equivalent to around a tenth of UK GDP, or 50% of the MPC’s existing holdings, and more than twice as rapid as the opening salvo of purchases in 2009.

The impact is described in glowing terms.

The impact was immediate, and decisive. Gilt yields fell back sharply as confidence returned, and market
functioning measures began to normalise . Purchase operations have since taken place
smoothly, with good participation and tight pricing.

There are issues with this though as we find ourselves noting that “as confidence returned” actually means that the Bank of England buys vast numbers of Gilts ( bonds). In fact the present rate of purchases at £13.5 billion per week means that few others need “confidence” as the UK has sold around £13.3 billion of new Gilts this week. So this week nobody else needed any confidence at all! Next is the yield issue where the Bank of England buying has driven short-dated Gilts into negative territory. I looked at the detail of the purchases on Tuesday and Wednesday and over 90% of the short-dated auction so around £2.9 billion was driving prices into negative yields which is apparently “tight pricing”. Also if I was being offered profits and in some cases enormous profits like this I think you might see “good participation” from me too.

Covid Corporate Credit Facility (CCFF)

Let me thank Andrew Hauser for reminding me of this issue and it led me down an unusual road. So in the style of children’s TV let me say to Arsenal fans are you sitting comfortably? First the details of the scheme and it is another bad day for those claiming the Bank of England is independent.

Given the credit risks involved, financial exposures and
eligibility decisions would be owned by the Treasury, but the scheme – to be known as the Covid Corporate
Credit Facility (CCFF) – would be designed and run by the Bank, and funded through the issuance of
reserves, with the MPC’s agreement.

What has it amounted to?

So far, over 140 firms have signed up for the scheme, and have borrowed over £20bn in total,
some of which has already matured. Firms’ borrowing capacity in the scheme is more than three times that
level , helping to underpin confidence – and complementing the Government-run schemes, including the Coronavirus Business Interruption and Bounce Back Loan (BBL) Schemes, which together have lent a further £31bn.

This is a tidy sum indeed and the independence crew take another punch to the solar plexus as we note that he is linking Bank of England work with HM Treasury.

Whilst the help is no doubt welcome yet again we see a central banker unable to see the wood for the trees.

First, CP issuance under the scheme has been at least three times
larger than the size of the pre-Covid-19 sterling CP market – and nearly three quarters of CCFF firms have
set up a CP programme since applying. So the CCFF has helped to deepen the CP market, with potentially
lasting benefits.

The Threadneedle Street Whale is in the market buying it all up! Who would not want to offer debt cheaply? Small and medium-sized businesses must be looking on with envy. It also gives us an addition to my financial lexicon for these times.

“the normalisation of conditions in core markets, ” means the Bank of England is buying.

Meanwhile

 

 

Term Funding Scheme

This is reviewed in dare I say it? Self-congratulatory terms.

In addition to the CCFF, the Bank also opened the borrowing window for the new Term Funding Scheme
with additional incentives for Small and Medium Sized Enterprises (TFSME) on 15 April………There has already been £12bn of lending from the scheme – a far more rapid pace than the previous TFS.

Actually I would have expected more but of course the mortgage market is not yet properly open.

It does this by providing banks with cheap funding over
a four-year term (rising to six years for loans guaranteed under the BBL scheme).

So another one in 4 years as we note there is still £107 billion under the previous scheme?

Ways and Means

I looked at this on April 9th and concluded it was a minor factor which you might recall was very different to the mainstream media view.

The Ways and Means account has not been used since the financial crisis, and is normally worth £400m. But outside experts say that this will increase by billions, perhaps tens of billions to help the government manage a sharp increase in immediate spending,

I would suggest that Faisal Islam of the BBC needs some new “outside experts” as it has remained at £370 million and has therefore not been used.

Comment

We get some perspective from the scale of the interventions by the Bank of England which is described thus.

a balance sheet that has expanded by almost a third in three months, and will reach nearly 40% of annual UK GDP by
mid-year. To deliver that, we are doing more than ten times the number of weekly operations than in the
pre-Covid19 period.

He calculates it as £769 billion and as the pace continues I think it is more like £789 billion now.

Next is something that he rues but I am more hopeful about as the lack of groups may reduce the group-think.

Face-to face meetings – the lifeblood of central banking, sadly – have been seamlessly replaced with audio and
video calls.

Andrew Hauser clearly thinks about the situation but there is an elephant missing in his room which is how do we reverse all the central banking intervention and also deal with the side-effects? Have you noticed hoe the issue of the impact on longer-term saving ( pensions and insurance companies) has seen a type of radio blackout? Here are his suggestions.

First, do we understand why intermediaries struggled to make effective markets in core government
bond, money and foreign exchange instruments at crucial moments during the crisis?

Second, are we comfortable with the central role played by highly-leveraged but thinly-capitalised
non-banks in arbitraging between key financial markets, if the unwinding of those trades can amplify
instability so starkly?

Third, how do we deal with the risks posed to financial stability by the structural tendency for Money
Market and some other open-ended funds to be prone to runs, without having to commit scarce
public money to costly support facilities?

And, fourth, how can we ensure timely transition away from LIBOR, whose weaknesses were
highlighted so starkly by the crisis?

Still according to the Halifax Building Society house prices are (somehow) 2.6% higher than last May.