The Bank of England sets out a road map for UK interest-rates to fall to 4%

On Friday evening we got quite a significant policy speech from the Bank of England. This is partly because of its structure as of the 9 members of the Monetary Policy Committee some 5 of them are “insiders” under the patronage of the Governor. So if the operate as a pack which they usually do they can overrule the 4 external members in theory. In practice we have a situation where Governor Bailey has suggested he may soon be considering interest-rate cuts and we already have one external member ( Swati Dhingra) voting for them.

So when the “markets and banking” Deputy Governor Dave ( Sir David to his friends) stood up to speak in Washington there was interest. Not least as to how he got there as the Bank of England is a committed climate change warrior?

Our climate objective is to play a leading role, through our policies and operations, in ensuring the financial system and the Bank of England itself are resilient to the risks from climate change and in understanding its macroeconomic implications. Where there is alignment with the Bank’s objectives and legal framework, it acts to support the transition to a net-zero emissions economy.

Of course they do not mean for themselves they mean for plebs like us.Although as the “markets man” Dave will this afternoon be again demonstrating how he bought the UK bond market at the top as the Bank of England charged into the market like a headless chicken and is now selling at the bottom. Another £800 million will be sold this afternoon and the price will be lower due to the rises in US bond yields.

Inflation 

Although he does not put it in such words the speech highlights another failure by Dave.

Throughout much of 2023 I was worried that the UK was an outlier among advanced economies, diverging in terms of inflation performance and the degree of persistence.

There is particular significance in this as the speech was given at the Peterson Institute headed by Adam Posen who was regularly quoted in the mainstream media saying this. Unfortunately neither Dave nor the MSM bothered to check that Mr,Posen left the Bank of England because his inflation forecasts went very wrong. Those who were aware of that would not be surprised by this.

But over the last few months I have become more confident in the evidence that risks to persistence in domestic inflation pressures are receding, helped by improved inflation
dynamics.

Actually I had been making the point all along with particular reference to weak and at times declining numbers for the money supply. But I can agree that Dave deserves a large slice of humble pie.

.But we should travel with a high degree of humility, given
the ongoing uncertainties and complexities we face in forecasting inflation.

What Next?

The crucial moment in the speech came here.

.For me the balance of domestic risks to the outlook for UK inflation, relative to the February MPR forecasts, is now tilted to the downside, with a scenario where inflation stays close to the 2% target over the whole forecast period at least as likely.

So with inflation forecasted to be close to 2% then an interest-rate of 5.25% is 3.25% over that. Putting it another way if you wish to bear down on inflation the rule of thumb is that you put interest-rates 2% above it. So we have an upper tier for future UK Bank Rate of 4% to 4.25% and remember that if you are on target you do not really need  to near down on inflation so minds will shift to an interest-rate beginning with a 3. There are consequences from such thinking but let us stay for the moment with the speech.

In case you are wondering why the thoughts of Adam Posen has disappeared from the MSM this is pretty devastating.

This leaves the UK as less of an outlier and more of a laggard in terms of recent inflation performance, and one that is now catching up quickly.

He gets to my points above here.

The MPC’s assessment of the risks emphasised three key indicators of persistence: labour market tightness, private sector wages and services inflation. Trends in these indicators have also played an important part in the MPC’s decision to hold Bank Rate at 5.25% since last August, alongside communications which have stressed the
need for monetary policy to remain restrictive for an extended period of time, in order to
slow the economy and bring inflation sustainably back to the 2% target.

The next bit is really rather basic and we have been on the case for around a year now but for devotees of the Adam Posen line it has come as a surprise.

 This divergence was broad based but also in part reflected the timing of UK energy interventions relative to those across Europe which prolonged the impact of high energy
prices on UK inflation.

Also he confesses that I was right all along and that the wages growth they were concentrating on was a lagging and not a leading indicator.

More recently, I’ve started to focus more on
shorter-term expectations given the closer correspondence to headline inflation and importantly their significance in our understanding of wage dynamics.

You might have thought that basic competence would mean a policymaker had spent quite a lot of time thinking about and looking at wage dynamics but apparently not Dave. He has been singing along with Diana Ross.

Upside down
Boy, you turn me
Inside out
And round and round

Now the real world has not changed simply Dave’s perception of it with wages now following rather than leading.

But there is also analytical evidence that services inflation has been determined to a
greater extent by the energy prices shock

Or if you prefer what has been my point all along. In terms of the detail we get it here.

For example, by estimating the effect using the
most recent data and exploiting the cross-country differences in energy prices my former
MPC colleague Jan Vlieghe finds energy prices to be more important in driving services.

Actually there is something worse for the Bank off England which has previously been ignoring its own research.

And the Bank’s neural network model for services inflation, one of the recently developed cross-check modelling approaches the MPC deploys, also finds a significant role for energy prices.

Comment

This speech sets out a road for UK Bank Rate to decline to 4% and in reality to have a big figure beginning with 3. The problem with that comes from the market response as the “markets” man put the skids under the UK Pound £ as it fell below US $1.24. Someone needs to tell Dave that foreign exchange markets do not observe civil service hours.

One area of concern is how the “markets” man has no market experience at all.

Before joining the Bank, Dave was Chief Economic Adviser to the Treasury and Head of the Government Economic Service from 2007 – 2017……….Previous to that he held a number of civil service roles including leading the Treasury work advising on whether the UK should join the Euro.

If I was intervening in markets on such a grand scale I would want someone experienced and battle-hardened.

This is part of two basic themes at the Bank of England where HM Treasury has in effect taken it back. Three of the four Deputy Governors are alumni of HM Treasury. Also how did we get to having four Deputy Governors as we have seen clear inflation in this area? This is also how they claim to have taken only small pay rises as they get promoted and this more pay instead.

Let me leave you with a final point. If they now believe inflation will be on target why are they still racking up large losses by selling UK bonds via QT? One for the markets man I think….

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The Bank of England should stop its QT bond sales

Today the focus is on the UK as we have a continuation of the time of the month where we get economic data plus some Bank of England news. We can start with what was a good Retail Sales release … Continue reading →

The Bank of England is facing the consequences of its own past actions

This week is one packed with central bank policy meetings. However the picture has changed considerably since the start of the year when markets were expecting March to start the interest-rate cutting cycle. Indeed if the rumours about the Bank of Japan ending its policy of negative interest-rates are true this month may be know for a rise after 17 years to 0%. Although I guess that relies on someone knowing where the interest-rate switch is as it has been 17 years since a rise there. But in spite of that there is quite a bit for the Bank of England to consider as it mulls the consequences of its past actions.

We can start with its favourite topic and the research student presenting the morning meeting mist have been delighted to see the news screens.

An increase in buyer demand and stronger house sales during March have combined to push the average UK home’s asking price up by a further £5,279 to almost £370,000, as the market picks up after a “muted 2023”.

According to the UK’s biggest property website, Rightmove, this month’s 1.5% price growth is notably higher than the historical March average of 1%, and is the biggest monthly increase for 10 months. ( The Guardian)

He or she will be able to bask in the ability to make Governor Andrew Bailey smile. This will continue as he notes this.

Rightmove said estate agents were reporting a significant increase in buyer demand this month as more people were “seeing a window of opportunity to buy”………Tim Bannister, the director of property science innovation at Rightmove, said the number of sales agreed since the beginning of March was 13% higher than at the same time last year, and that demand for larger homes appeared to be driving most of the price jumps

For our purposes there is always the cautionary note that these are asking prices as opposed to sold ones.After all you can ask any price you like and some do. But there has been similar messages from the other measures of house prices. So we have our second unintended consequence today as we see that the era of higher mortgage rates has not turned out as one might have reasonably expected.

After several weeks of creeping mortgage-rate rises, the average five-year mortgage rate is now 4.84% compared with 4.64% five weeks ago, Rightmove said, a trend that continues to test buyer affordability. ( The Guardian)

Remember when we were looking at mortgage rates below 2%? But the crucial point is that the falls in house prices were more minor than I expected and may soon be over.

Money Markets

Last week saw a flurry of announcements from central banks about this and if we look at the UK it relates to this from Governor Andrew Bailey on February 12th

Before the financial crisis, the major UK banks held £10 billion of reserves at the Bank of England. Today, they hold £467 billion, a substantial part of the stock of high quality liquid assets.

These ch-ch-changes are if we continue a musical theme something The Sweet sung about back in the day.

Does anyone know the way?
Did we hear someone say
“We just haven’t got a clue what to do!”
Does anyone know the way?
There’s got to be a way
To Block Buster!

None of the central banks are sure as to what the new “normal” will be in this area and I would add there may not be one. We are returning to another feature of my point that they should not have intervened on this scale without better planning, or at least some planning. Or as Governor Bailey put it in the same speech.

 I will go a bit further and say that my best guess today is that the demand for reserves by the banks will settle at a level higher than we would even in the recent past have expected. That may be for more than one reason, of which one may well be the lessons of last year.

The Gilt Market

The UK bond market is what the Governor was referring to and on the 28th of last month I analysed this from Deputy Governor Sir Dave ( David to his friends) Ramsden.

To illustrate the separation, the MPC could unwind the APF fully, if it judged necessary for policy reasons, and the level of the PMRR should not affect this judgement.

According to Dave the amount of reserves (PMRR) do not matter. But you see Dave has a credibility problem and I spent some years pointing out the issue that the Bank of England “markets man” has not markets experience. Now we can look at what he has done which has been to but the Gilt market at the top and sell at the bottom creating large losses.Indeed there will be a sale of £750 million this afternoon as Dave and his colleagues create more losses and hope you will not notice.

There is another issue if we think back to the problems in the UK Gilt market back in the autumn of 2022. Because as the Bank of England owned so much of it how did it go wrong? Were the jitters caused by its plans to see some of its large holdings?

A New Plan

I am not sure this is the best of starts as this is about the man with the plan..

Andrew Hauser, the then Executive Director to Markets…..,  Since then, Andrew has gone on a 10,000 mile journey to take up a role as Deputy Governor at the Reserve Bank of Australia.

So on the 12th of this month we heard from Nick Butt.

Therefore, in the first phase of our work we are looking to develop a tool that will act as a backstop in stress by providing liquidity to this market by lending cash to non-bank financial institutions (NBFIs) against gilts.

From a central bankers point of view this is awful news as they are forced to look away from The Precious. Also it triggers a warning signal.

 But our focus remains on continuing the journey to develop tools to help ensure the resilience of core markets.

For newer readers the use of the word “resilience” has often been followed in the past by a collapse. If that troubles you then the use of innovative only adds to it ( for example the Irish banks were innovative all the way to bankruptcy.

Third, while this is an innovative facility it will draw on traditional central banking principles:

What do we get?

First, we are developing a tool that helps ensure financial stability in the gilt market by providing back stop liquidity in periods of market dysfunction to eligible insurance companies, pension funds and associated liability driven investment funds.

Second, and over time, we will consider how this tool might be broadened in scope and scale to include a broader range of NBFIs as counterparties. We will do this in a way that is aligned with, and helps support, improvements in resilience in those sectors.

Comment

As you can see whilst above the water I am expecting little from the Bank of England this week there is quite a bit going on behind the scenes. Indeed I am reminded of this from Alice in Wonderland.

“My dear, here we must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that.”

The Bank of England is intervening in markets to fix problems it has created and there is a particular irony in it doing so as a consequence of its response to the “market turmoil” of the autumn of 2022. Indeed the extraordinary central banking efforts of this decade have been accompanied by an even worse economic performance.

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The Bank of England is hoping you will not spot the mess it has made of QE and QT

Yesterday brought a very significant speech by the Bank of England Deputy Governor for Markets and Banking Sir Dave ( David to his friends) Ramsden. I have given him his full title because it might make one think he has experience in this area when in fact his official CV tells us this.

Before joining the Bank, Dave was Chief Economic Adviser to the Treasury and Head of the Government Economic Service from 2007 – 2017.

So he is part of the HM Treasury reverse takeover of the Bank of England where after claiming something is independent you pack it full of the “right” people to make sure it isn’t. But for today’s purpose the relevant bit is that he has no experience of markets at all.

Previous to that he held a number of civil service roles including leading the Treasury work advising on whether the UK should join the Euro.

If we now look at a major plank of Bank of England policy for monetary expansion ( QE) and more recently contraction (QT) we see that our markets innocent really piled in.

The amount of gilts held in the Bank’s Asset Purchase Facility (APF) on behalf of the MPC reached a peak of £875 billion in early 2022 and has since fallen back to £735 billion. As a share of outstanding government debt, the share has fallen from 35% to 31%.

Perhaps it is Sir Dave’s inexperience which makes  him claim the reverse below.

The Bank can track its connection to bond markets all the way back to its incorporation in 1694.

There is quite a confession here, because I do not know about you, but before I deployed over £1 trillion I would think about how I would get out of it.

Central banks globally are considering issues relating to their future balance sheet. The Bank’s balance sheet peaked at over £1 trillion in 2022,

Indeed this is a long-running point of mine as I wrote a piece in City-AM back in September 2013 suggesting that the Bank of England reduce its balance sheet by letting its QE holdings mature without refinancing. If it had done so both it and us the taxpayer would be in better shape than we are.

Quantitative Tightening

Dave starts with something revealing.

The MPC has judged that reducing the size of the APF has the important benefit of reducing the risk of a ratchet upwards in the size of the central bank balance sheet over time, if successive policy cycles encounter the effective lower bound on interest rates.

It was a bit more than a “ratchet upwards” when he and his colleagues rushed into the UK bond markets like headless chickens. But as ever the language used by central bankers is to distract more often than inform. In fact we have some unintended humour.

The Bank combines this with market intelligence gathered from a broad set of market participants on both the buy and sell sides, to monitor gilt market functioning and liquidity for any sign of disruption.

If I was the market which remember has sold to the Bank of England at the top and has been buying back at the bottom when I stopped counting my profits I would tell them things are fine too. Indeed at the prices offered of course the auctions are going well!

Our QT auctions are going well, attracting strong demand, as reflected in good cover and pricing for the Bank.

In fact the markets have persuaded him to lose even more money as they make profits from it.

 In practical terms, this means that our auction sizes for shorter maturity bonds are now larger than for medium and, in turn, long maturities. This purely operational change in our approach seems to have been received well by the market, as reflected in feedback from market participants, and good participation in the re-sized auctions.

What about the future of QE and QT?

You might think that with losses accumulating on the QE programme that Dave and hos colleagues would avoid other interventions, but apparently they do not think so.

This aggregate level of reserves demanded by banks for transactional and precautionary liquidity needs forms what we call the Preferred Minimum Range of Reserves (PMRR). At some point during the unwind, the stock of reserves will eventually approach the minimum level needed by banks.

A consequence of QE that was not thought through was that it would change money markets and whilst no-one can be exactly sure the PMRR looks to be around £500 billion. But  don’t worry as Sir Dave has another cunning plan.

So, in 2022 we announced the launch of the Short Term Repo (STR) to supply reserves on demand at Bank Rate against gilt collateral on a weekly basis, to ensure that market interest rates remain aligned with Bank Rate.

In fact Sir Dave has another cunning plan in the background.

Our approach to this issue differs from other central banks, notably the Federal Reserve, which aims to maintain its QE portfolio at a level that will back an ‘ample’ level of reserves.

Seeing as he US Federal Reserve is the only central bank with proper experience of a QT programme that is somewhere between brave and reckless. Plus it has led to this hint of future policy.

At the point that reserves reach the minimum desired level, banks will be able to meet their demand for reserves at Bank Rate using the Bank’s facilities, stabilising the quantity of reserves and allowing the MPC to decide to continue reducing the stock of assets held in the APF if it wanted to.

So Sir Dave drops a hint that we may see quite a bit more of QT. Then he again illustrates my point that they should have thought about an exit strategy before putting on their bond buying boots rather than now.

The decision on the future size and composition of the balance sheet is a separate issue, which we are thinking about carefully.

But then we get what Americans would call the “money shot” where the point I have emphasised below has already been noted by financial markets.

To illustrate the separation, the MPC could unwind the APF fully, if it judged necessary for policy reasons, and the level of the PMRR should not affect this judgement.

Comment

Regular readers will know that I criticised the original Bank of England QT plans as following the route “stupid, stupider and stupidest”. The latest public finances release showed how right I was and how wrong the Bank of England has been.

The borrowing of both of these sub-sectors is affected by payments totalling £44.4 billion made by central government to the BoE over the last ten months under the Asset Purchase Facility Fund (APF) indemnity agreement. This was £39.4 billion more than the £5.0 billion paid in the same period the previous year.

There were booked profits of about £120 billion so the problem is that the £80 billion left of that is disappearing fast. For those who want more detail on this area I looked at the Treasury Select Committee report into QT on the 8th of this month. But the nub of the issue is that after highlighting 0.5% and 1% as significant interest-rate levels they found themselves raising interest-rates to 5.25%. Why does that matter? They charge themselves this so using Sir Dave’s numbers they ( and really I mean we) are paying £38.6 billion a year.

Let me look at it another way.In most jobs such incompetence would have got you the sack long ago. But those in roles like at the Bank of England survive because sacking them would reveal the truth which is very embarrassing.

We can look at Sir Dave via another prism. If we look back to July 2021 he was facing the biggest decision of his career and how historians will view him and he dropped the ball.

The first potential scenario I foresee is broadly in line with the MPC’s “central expectation” set out in the June
minutes: that the economy will experience a temporary period of strong GDP growth and above-target CPI
inflation, after which growth eases and inflation fall back towards the 2% target

Now like his view on QT he cannot escape his past mistakes.

 In terms of my thinking about the future, I am looking for more evidence about how entrenched this persistence will be and therefore about how long the current level of Bank Rate will need to be maintained.

Back then he thought 4% inflation could be dealt with via a 0.1% interest-rate. Now with it 4% and falling he thinks 5.25% is correct. About sums him up really……

Another Bank of England policymaker tells us not to take pay rises (after getting a large one herself)

Early morning commuters to the City of London may have been surprise to see someone resisting the rain with a beaming smile.today. It was of course the research student at the Bank of England who will have skipped to work anticipating being able to tell Bank of England Governor Andrew Bailey this.

Data from the UK’s Royal Institution of Chartered Survey’s (RICS) on January house prices showed new buyer enquiries were at their strongest in almost two years:

Measure of house prices rose to -18%, its highest since October 2022. ( Forex Live)

The RICS continued here.

“The UK housing market has seen a continued improvement in buyer activity through the early part of the year, supported by the recent easing in mortgage interest rates

Although sales volumes through much of the year ahead are likely to remain relatively subdued compared to the longer-term average, the outlook has now turned modestly brighter on a consistent basis over the past few survey reports.”

Career prospects are always improved by being able to tell the Governor how masterfully he has dealt with the housing market. Plus it will allow our research student to remind him of yesterday;s news. something which they may have considered to be a missed opportunity.

“The average house price in January was £291,029, up +1.3% or, in cash terms, £3,924 compared to December
2023.
“This is the fourth consecutive month that house prices have risen and, as a result, the pace of annual growth is
now +2.5%, the highest rate since January last year.”

Those are the house price numbers from the Halifax and there is more should our research student link the falls in mortgage rates to all the Bank of England support for banks.

“The recent reduction of mortgage rates from lenders as competition picks up, alongside fading inflationary
pressures and a still-resilient labour market has contributed to increased confidence among buyers and sellers.
This has resulted in a positive start to 2024’s housing market.” ( Halifax)

The Pound

If they are especially sharp they will have spotted this.

PoundSterlingLIVE – “We may now be entering a period of euro weakness, like what we saw in 2013-2015.”

This has consequences as shown below.

We may now be entering a period of euro weakness, like what we saw in 2013-2015. Back then, a wave of pressure on the euro pushed EUR/GBP towards 0.7000,” says Alex Kuptsikevich, senior market analyst at FxPro.

The call comes as the Euro to Pound exchange rate retreats back to 0.8520, (in Pound to Euro terms this equates to a rise to 1.1740). ( Investing.com)

This presents another opportunity to tell the Governor how well he is handling things. The UK appears to be doing better than the Euro area.

“With interest rate changes on the agenda, interest is being drawn to the more buoyant economies where the UK has an advantage due to domestic demand,” he says.”

Sarah Breeden

The appointment and indeed promotion of Sarah Breeden to Deputy Governor was one that intrigued me on two counts. Firstly she is a classic Bank insider and secondly I cannot recall her ever having any public views on monetary policy. A case of what in bureaucratic circles would be described as promoting the “right ” person. Correct me if I am wrong but this heads in completely the opposite direction to this.

David Roberts, Chair of Court, said: “It is crucial that the Bank continuously learns and adapts as an organisation. It is right that we take an independent and objective look at the processes which underpin the MPC’s policy decisions and I am delighted that Dr Bernanke has agreed to lead this work.”

The road above rather leads to this sort of view.

For services inflation to fall to levels consistent with target, some combination of a further moderation in labour cost growth and firms’ margins will be needed………

Labour costs make up a significant part of services firms’ costs. Some combination of a moderation in pay pressures and firms’ margins will be required for services inflation to return to more normal rates.

Yes her view is that the plebs need to take a pay cut. That is an interesting line of argument from someone who has just had a pay rise of more than £100,000 per year. According to the 2023 accounts she had a base salary of £192,259 whereas a Deputy Governor’s salary was £288,700. Plus she is a 1/50th member of a valuable pension scheme where she takes cash at what looks like it will now be £86.000 or so a year.

As to monetary policy Sarah in December told us this,

At that juncture, the question I was focused on was whether there was evidence of more persistent inflationary pressures which might mean we needed to tighten further.

Since then the main news ( PMI business survey) is that the UK economy is picking up and Sarah now tells us this.

As I have become more confident that persistence is likely to evolve as embodied within our forecast, I have become less concerned that rates might need to be tightened further. Instead my focus, and indeed the focus of many on the MPC, has shifted to thinking about how long rates need to remain at their current level.

As Darryl Hall and John Oates reminded us.

Take a look around
You’re out of touch
I’m out of time

Quantitative Tightening

There has been a rather welcome development here. Regular readers will be aware that this was a disaster waiting to happen. It is hard to believe now that the Bank of England signposted interest-rates of 0.5% and 1% as being significant and then raised them to 5.25%! So this from the Commons Treasury Committee shines a light on things.

 In September 2022, the MPC voted to begin selling the Bank’s stock of QE gilts in the secondary market, following a strategy published the previous month, referred to in this report as ‘active’ QT………In September 2023, the MPC decided to undertake an additional £100 billion of QT over October 2023 to September 2024 (with passive and active QT accounting for around £50 billion each), which will bring the purchases of gilts down to around £650 billion.

Those who follow my Twitter (X) feed will know that I report the weekly ( Monday) sales. These mean that the Bank of England approach is very different to that elsewhere.

The Bank was among the first central banks in the world to embark upon active QT, and international experience in passive QT is also limited.⁴ Indeed, other major advanced-economy central banks, including the US Federal Reserve, European Central Bank and the Bank of Canada, are only proceeding with passive QT.

Sadly they do not really press on with challenging the issue of buying bonds at the top and now selling them at the bottom with at times very large losses, But it is a start.

Comment

This is a mixed period for the Bank of England. The economic news looks to be heading in its favour as the UK looks set to outperform the Euro area. Plus the domestic energy price fall set for April will bring inflation much lower and maybe with a following wind on target. But its policymakers retain the habit of putting their feet in their mouths via in this instance receiving a large pay rise before telling others not too.

Plus the whole QE/QT experience has turned into a shambles. They rushed into the UK bond market like headless chickens and now are panicking about the consequent losses created by their own interest-rate rises. Only the establishment can get away with such stupidity as anyone else would have for their P45 ages ago.

 

The weak economic outlook for Italy suggests a year focusing on debt costs and fiscal policy

As 2024 has opened quite a few of the economic themes in play point at it. We can start with this morning’s speech by ECB Vice-President de Guindos.

By contrast, growth developments are more disappointing. Economic activity in the euro area slowed slightly in the third quarter of 2023. Soft indicators point to an economic contraction in December too, confirming the possibility of a technical recession in the second half of 2023 and weak prospects for the near term.

As you can see the economic outlook for the Euro area overall is poor. Also you may like to note how central bankers deal with it as many ECB speakers have previously informed us there will not be a recession and that things were expected to pick up in 2024. It is a form of public relations or PR rather than an actual forecast as they only admit reality when there is no other alternative. In fact Vice-President de Guindos has become rather downbeat.

The slowdown in activity appears to be broad-based, with construction and manufacturing being particularly affected. Services are also set to soften in the coming months as a result of weaker activity in the rest of the economy.

Indeed it seems that the ECB is for the first time willing to admit that trouble looks to be on the way for the labour market.

However, we are seeing the first signs of a correction taking place in the labour market. The latest data on total hours worked show a slight decline in the third quarter, the first since the end of 2020.

For our purposes today this provides a poor backdrop for the Italian economy.

National Debt

This again is an issue in the financial news as whilst the Financial Times tried to concentrate on the UK and US it is hard not to think of Italy when you read this.

In Europe, ten of the eurozone’s largest countries will issue around €1.2tn of debt this year, around the same level as last year, according to estimates from NatWest. But the bank expects net issuance — which includes the impact of quantitative tightening and excludes refinancing existing bonds — to rise by around 18 per cent this year to €640bn.

According to Eurostat the national debt to GDP ratio was 142.4% at the end of the second quarter of last year. That has its flaws as a measure as you are comparing a stock with a flow but it provides a signal. For Italy it has told us two main things over time of which the first is that we keep being told it will fall whereas it has risen. Secondly the Euro area must regret using 120% as a level in the Greece crisis because whilst Portugal improved we see that Italy went above it and kept rising. In terms of absolute debt level that is now 2.85 trillion Euros.

Fiscal Policy

Mostly this is not a cause of Italy’s debt problem but as I pointed out on the 28th of September last year this time looks different.

ROME, Sept 25 (Reuters) – Italy’s government plans to raise its 2024 budget deficit target to between 4.1% and 4.3% of gross domestic product (GDP), up from the 3.7% goal set in April, sources familiar with the matter told Reuters on Monday.

The numbers were slipping away and a weaker economic outlook will put them under more pressure. Also as Fitch pointed out on the 11th of October 2023 was slipping away in fiscal terms as well.

The government’s wider 2023 deficit target of 5.3% of GDP (from 4.5% in April’s Stability Programme) is driven by the cost of “Superbonus” tax breaks on residential investment exceeding expectations by 1.1% of GDP (taking the overall cost of the scheme since 2020 above 6% of GDP).

The “Superbonus” scheme was just so Italian as were to efforts to keep it out of the fiscal numbers.

Bond Market

This is an area which on the surface has got better since the autumn as we have seen bond yields decline across much of the world. The benchmark ten-year which briefly went above 5% is now 3.8%. Whilst the decline is welcome when you have a much debt as Italy the issue keeps chipping away at you even at lower yield levels. From the 28th of September last year.

italy has to refinance 400 billion of public debt in the next 12 months, ( @spaghettilisbon )

Last week Bloomberg estimated that Italy would pay 3.8% of its GDP in debt costs in 2023 meaning it was paying more than Greece.

If we look ahead we see that there is a potential issue on the horizon. Looking back we see that the ECB offered enormous support to the Italian bond market via its QE bond purchases. Then as they ended it offered a more technical support by being willing to adjust its portfolio in favour of Italian bonds as opposed to German or Dutch ones. Whereas if we return to the speech by Vice-President de Guindos we see sales ahead rather than purchases.

Over the second half of 2024, the PEPP portfolio will decline by €7.5 billion per month on average. We discontinued asset purchase programme reinvestment of redemptions in July 2023 and we expect to discontinue the reinvestments under the PEPP from 2025.

The Italian Economy

This morning has seen the release of the retail sales figures which were mixed. There was some monthly growth.

In November 2023, an economic growth of 0.4% in value and 0.2% in volume is estimated for retail sales.

But the rolling three monthly figures were weaker and there was a fall compared to 2022.

n the September-November quarter of 2023, in economic terms, retail sales fell both in value (-0.1%) and in volume (-0.8%)………On a year-on-year basis, in November 2023, retail sales increased by 1.5% in value and recorded a decline in volume of 2.2%.

Yesterday brought some good news on the employment front because as well as a small monthly rise there was this.

The number of employed people in November 2023 exceeds that of November 2022 by 2.2% (+520 thousand units).

Although measuring what they actually did is apparently not much.

In the third quarter of 2023, the gross domestic product (GDP), expressed in chained values ​​with the reference year 2015, corrected for calendar effects and seasonally adjusted, grew by 0.1% both compared to the previous quarter and compared to the third quarter of 2022.

Comment

For newer readers the “Girlfriend in a Coma” theme is that whilst the economy of Italy takes part in downturns it very rarely grows at an annual rate of above 1%. That means that the promised convergence with Euro area performance has not only not happened but things have got worse.

If we look at recent times there were promises that the EU Next Generation funds would improve matters and they did help create some growth, But now they have reduced the economic growth has not lasted. In essence a lack of growth is the Italian problem but this time around fiscal policy is looser and we are seeing for the first time for around a decade more substantial bond yields.

Another topic for Italy is its banks with Monte Paschi being the wrong sort of standard bearer. This phase is not helping their domestic bond holdings so any real recovery for them looks to remain in the distance.

 

 

 

 

The UK government spends rather a lot for its austere claims

As we approach the end of the calendar year it is time to be a little more reflective. If one does that with this morning’s release on the UK Public Finances it is hard to avoid the view that the present government is somewhat spendthrift.

Borrowing in the financial year-to-November 2023 was £116.4 billion, £24.4 billion more than in the same eight-month period last year and the second highest financial year-to-November borrowing on record.

Another way of putting it is that it is fiscally expansionary which contrasts with the way that the word austerity is often bandied around as a description of it. One can argue that inflation is a factor here via its impact on cost of living payments and inflation linking. But that is a little awkward for the Prime Minister as the inflation fires were lit by perhaps the most expansionary UK fiscal policy ever via one Chancellor Sunak. Perhaps the Prime Minister could have a word with him.

November Borrowing

That general theme continues as I look at these numbers.

In November 2023, the public sector spent more than it received in taxes and other income, requiring it to borrow £14.3 billion. This was £0.9 billion less than was borrowed in November 2022 and is the fourth highest November borrowing since monthly records began in 1993, behind those of the 2020 coronavirus (COVID-19) pandemic period, the energy support schemes period of 2022, and in 2010 following the global financial crisis.

We are now supposed to be fully recovered from Covid in economic terms as we spent enough to achieve that. But we still seem to be borrowing a substantial sum. If we look back a year this was a government that was presented by the establishment as having what they considered to be sensible policies  as in getting borrowing back under control. Whereas we now know they in theory tightened policy but we are still borrowing large sums. This November might be considered to be a month where we would borrow less than last year due to the cost of the energy support schemes, but the reality is that we have borrowed very little less.

If you look at the total expenditure it does not look too bad and you might return to some sort of austerity theme.

In November 2023, central government’s total expenditure was £87.6 billion, £0.7 billion more than in November 2022 and the highest November total since monthly records began in 1993.

But the end of the energy support schemes changes that.

Subsidies paid by central government were £2.2 billion in November 2023, £3.1 billion less than in November 2022. This is largely because of the cost of the Energy Price Guarantee (for households) and Energy Bill Relief Scheme (for businesses) affecting this month last year.

There was another bit of that in the other category.

Payments recorded under central government “other current grants” were £1.7 billion in November 2023, £2.0 billion less than in November 2022, largely because of the cost of last year’s Energy Bills Support Scheme.

So a change of the order of £5 billion.

On the other side of the coin Receipts were higher.

Central government’s receipts were £77.6 billion, £3.6 billion more than in November 2022 and the highest November since monthly records began in 1993.

You may have spotted that these numbers should have led to a bigger fall in November borrowing. But there are other factors in there such as the Bank of England adding an extra £1.3 billion to the borrowing this year. That is another addition to the debit side on all its QE bond buying on which it so rarely gets challenged. I will return to that later as with the recent declines in bond yields its 2023 sales of bonds look awful. Or if you prefer it has added selling at the bottom to buying at the top.

Debt Interest

We can cover a lot of ground with this one and we can start with November.

In November 2023, the interest payable on central government debt was £7.7 billion, £0.1 billion more than in November 2022 and the highest November total since monthly records began in April 1997.

This became more of a factor as two influences came into play. First was the rise in inflation and specifically RPI inflation which pushed the expenditure on paying interest on them ( around a fifth of our debt higher). Then came the rises in bond yields which pushed the interest payments on the rest of our debt higher. As you can see above things stopped getting worse in November if you will indulge me for £100 million.

Part of the change has been this.

In November 2023, capital uplift was £3.0 billion and was largely determined by the 0.5% increase in the RPI between August and September 2023.

For those unaware most UK index-linkers have a three month lag to the inflation rate and thus changes are on their way. What I mean by that is that we already know the next two months and they were -0.2% and -0.1% so falls will happen soon and we may see more of that ahead. For example the latest energy price estimates for the April Energy Price Cap suggest a fall then.

Next up is the fact that issuing debt for the UK is now a lot cheaper than it was as recently as October. As I type this the benchmark ten-year yield is now 3.55% whereas it peaked at 4.7% in October. So the bond market rally you have been reading about means that going forwards it will be a fair bit cheaper to issue new debt and to refinance existing debt.

Bank of England QE Problems

I said I would return to this and we can look at it via the UK long Gilt future. It bought a lot of bonds in the range 135-140 and it has sold some in the second half of this year in the mid 90s. Actually down to a low of 92. So there are strategic losses here from as I put it earlier buying at the top and selling at the bottom.

Also there is the tactical issue of selling bonds down to an equivalent of 92 and then seeing a ten point rally as we are above 102 as I type this. Yet this so rarely seems to get questioned.

Or if you want the change in the situation put another way.

The borrowing of both of these subsectors is affected by payments totalling £33.2 billion made by central government to the BoE over the last eight months under the Asset Purchase Facility Fund (APF) indemnity agreement. This was £32.4 billion more than the £0.8 billion paid in the same period last year.

Comment

The situation with the UK Public Finances is one which sees quite a few views bandied about. For instance in the over a decade I have been reporting on these numbers there has been a lot of talk of austerity but especially in the more recent period we have seen some extraordinary fiscal deficits. That drum beat seems to be continuing as we have a government which claims to be austere but is in fact fiscally expansionary.

Next up is the issue of the first rule of OBR Club which is that the OBR is always wrong.

In March 2023, the Office for Budget Responsibility (OBR) forecast that borrowing would settle at £152.4 billion in the financial year ending March 2023. In its Economic and fiscal outlook – November 2023, the OBR reduced this estimate by £24.1 billion to £128.3 billion.

As you can see their skill set not only involves getting the present and future wrong as they add the past to it. But on a more fundamental level they predicted a severe recession for this year leading to reports of a “Black Hole” for the Public Finances. Government policy was changed in response to this and it was changed in the wrong direction. In a way we see it from this.

Public sector net debt excluding the Bank of England (BoE) was £2,418.6 billion at the end of November 2023, or around 88.3% of GDP, £252.8 billion (or 9.2 percentage points of GDP) less than the wider measure. This difference is largely a result of the BoE’s quantitative easing activities, including the gilt-purchasing activities of the Asset Purchase Facility (APF) Fund.

Actually in a theme of the times deciding on the national debt is not as clear cut as you might reasonably think but I think the headline of 97.5% is misleading. Probably it is more like 91-92%.

 

The Euro area economy is facing the consequences of the ECB dithering over interest-rate rises

This has been a week heavy with central bank action. But with apologies to the Norges Bank who do not seem to have got the memo with their 0.25% interest-rate increase yesterday the major news was from the ECB. Let me start with the words of President Lagarde.

But let me remind you of one thing. We are data dependent. We are not time dependent. We are data dependent.

Now let me present this morning’s data from the HCOB PMI.

Business activity in the euro area fell at a steeper rate in December, according to provisional PMI® survey data, closing off a fourth quarter which has seen output fall at its fastest rate for 11 years barring only the early-2020 pandemic months. Downturns were again recorded across both manufacturing and services, with both sectors reporting further steep falls in inflows of new business, which led to a further depletion of backlogs of work. Jobs were cut for a second month running as firms scaled back operating capacity in line with the worsening order book situation and persistent gloomy prospects for the year
ahead, with future sentiment remaining well below its long-run average despite lifting slightly higher. Factories also cut inventories of inputs at a rate not seen since 2009.

I have presented the full picture there because it shows how downbeat the PMI is overall and at 47 it shows a further decline in December. In fact it is relying on better news from some of the smaller Euro area economies because at this stage we only get detail for Germany and France and their readings were worse at 46.7 and 43.7. According to the PMI reports France is seeing quite a crunch. We know from past mentions that President Lagarde and the ECB follow these numbers and we can assume they were given a heads-up.

If we stay with this theme then there is another issue because according to President Lagarde the economic brake is being pressed harder.

Our restrictive monetary policy continues to transmit strongly into broader financing conditions. Lending rates rose again in October, to 5.3 per cent for business loans and 3.9 per cent for mortgages.

Borrowing for economic activity is very weak.

Loans to firms declined at an annual rate of 0.3 per cent in October and loans to households also remained subdued, growing at an annual rate of 0.6 per cent.

So if we use her words we can expect a further slowing. I do not think it is a coincidence that we did not get a mention of the PMIs yesterday as it would have posed difficult questions. What fool raised interest-rates as recently as September for example? Also people may remind her of what she said in late February.

ECB’S PRESIDENT LAGARDE: IN 2023, THERE WILL BE NO EUROZONE COUNTRIES IN RECESSION.

As we stand the Netherlands and Austria are and if the PMI reports are anything like accurate several others are in danger of being in one right now, as is the Euro area overall. Also only a minor downwards revision to Germany would mean it has been in one all year. Yet here is President Lagarde from yesterday.

First of all, let me say that we do not have a recession in our baseline. Of course I’m not looking at specific countries, we are looking collectively at the euro area at large. Our mandate is not to cause a recession.

Interest-Rate Cuts?

If we looked at past ECB reaction functions we would be in the zone of interest-rate cuts so let us look further at that issue.

 On the first one, it is very easy. We did not discuss rate cuts at all. No discussion, no debate on this issue.

That is an awkward thing to claim even for her. After all the “dot plot” from the US Federal Reserve had suggested around three interest-rate cuts next year and the US economy is much stronger than the Euro area one. Then we got a type of riffing which was not a little bizarre.

And I think everybody in the room takes the view that between hike and cut, there’s a whole plateau, a whole beach of hold. It’s like solid, liquid and gas: you don’t go from solid to gas without going through the liquid phase.

She seems unaware of the concept of the Triple Point where you can go from solid to gas. But if we stop the chemistry/physics and return to economics there is a clear issue here and let me highlight it by looking at the ten-year yield of Germany. It got quite close to 2% yesterday in the post Federal Reserve euphoria and after bouncing it is 2.04% this morning. So the forecast ahead for interest-rates is for them to head towards 2% or if you prefer halve from here. Or you can take the ECB view that rates will be 4% for a while…..

The head of the Bank of France Francois Villeroy has been on the wires repeating this theme.

“We are standing on a plateau where one should take the time to enjoy the view, which means to appreciate the effects of monetary policy,” he added, referring to a potentially prolonged phase of high interest rates. ( Reuters)

I am not sure the PMI of 43.7 in France will mean that they will be enjoying the monetary view.

ECB’S VILLEROY: EUROPE WILL BE SPARED FROM RECESSION, SAME APPLIES TO FRANCE – Reuters News

Wages

This is how they get to the thoughts above and again this is if we are polite rather curious after the falls in real wages we have seen in the Euro area.

Point number two: when we look at all the measurements of underlying inflation, there is one particular measurement which is hardly budging. It’s declining a little bit, but not much, and that is domestic inflation. And domestic inflation is largely predicated by wages.

That was President Lagarde from yesterday’s press conference and according to her the labour market is strong.

The labour market continues to support the economy. The unemployment rate stood at 6.5 per cent in October and employment grew by 0.2 per cent over the third quarter.

The latter claim has hit trouble this morning as Eurostat have released this.

In the EU, the employment rate of people aged 20-64 stood at 75.3% in the third quarter of 2023, a decrease of 0.1 percentage points (pp) compared with the second quarter of 2023.

The HCOB PMI reinforced the Eurostat message.

Employment fell for a second consecutive month as companies scaled back capacity in line with the weakened demand environment. Although only modest, the recent falls in employment are the first recorded since early 2021.

Comment

The ECB and the Euro area are today’s subject because frankly they are in the biggest economic mess. Prospects look the worst and according to the PMI reports a recession is likely.

EZ PMIs suggest the Eurozone bloc is on track to contract -0.2% or -0.3% this quarter @WilliamsonChris tells me After -0.1% in Q3: that’s a recession ( @CNBCJou)

President Lagarde and her colleagues decided inflation was a “hump” they could ignore and then found themselves in a panic to raise interest-rates. As I have pointed out many times the issue here is timing because the late awareness of the issue means that much of the impact of the rises is yet to come. That is how they find themselves pointing at wage growth in an effort to distract from the reality of what they have done. On that subject let me congratulate those of you in the comments section who argued back in the day that interest-rates would rise in response to wage growth rather than inflation as the ECB has proven you to be correct.

Let me finish on a piece of better news for the Euro area which is the recent fall in natural gas prices which hopefully will ameliorate the problems above and help with economic growth in the early part of next year. The problem for the ECB is that it reduces the inflation trajectory as well and thus returns us to the issue of its interest-rate.

As a final point adding QT to the mix looks even more bizarre although in the scheme of things it is relatively minor.

Over the second half of the year, it intends to reduce the PEPP portfolio by €7.5 billion per month on average. The Governing Council intends to discontinue reinvestments under the PEPP at the end of 2024.

France now looks as though it has entered an economic recession

We have been noting an apparent turn lower for the French economy for some months now. Those who recall how it manipulated inflation lower last year via dictating energy prices to EDF will recall I pointed out that there would be a catch-up once that fell out of the numbers. But before we get to that we can open with a significant revision from the French statistics office.

The evolution of GDP in the third quarter of 2023 is revised downward by 0.2 points, to -0.1%, compared to +0.1% in the first estimate. GFCF has been revised significantly downwards and consumption slightly downwards, so that the contribution of final domestic demand to growth is revised downwards by 0.2 points, to +0.5 points (compared to + 0.7 points in the first estimate).

The ch-ch-changes do affect the narrative here as France is now declining in GDP terms and is thus now vulnerable to being in a recession at the end of 2023. A 0.2% change is significant and someone more cynical than myself might fear that announcing a decline in a revision gets less publicity than in the first estimate. Also as I am often critical of PMI reports it is even-handed to point out they have correctly been suggesting weakness in the French economy. There is a detail in today’s report that suggests more troubles are ahead.

Since the previous publication, new information has been integrated, notably the September turnover indices, significantly lower than the extrapolations they replaced.

So if the end of the quarter is weaker it is logical to expect that to roll into the current one, further flashing a recession warning. For those wondering about the detail GFCF is investment and they got it very wrong in the original release at 1% as opposed to 0.2% now. There is logic to some extent in weaker investment growth in response to higher ECB interest-rates and if so more is likely on the way as the later rises are yet to fully impact. The further breakdown is again logical as one would expect construction to be particularly affected.

Gross fixed capital formation (GFCF) slowed down (+0.2% in the third quarter after +0.5% in the second), due in particular to the further decline in GFCF in construction (-0.8% after -0.2%)

Of course this does beg a question as the narrative is now very different with investment falling rather than seeing an unexpected surge.

Government Spending

Whilst looking at the German Debt Brake yesterday we got a reminder that French government spending sings along with Shirley Bassey.

The minute you walked in the joint
I could see you were a man of distinction
A real big spender

That came with the national debt figure being over 3 trillion Euros and that theme continued in today’s GDP release.

In the third quarter of 2023, the general government deficit widened by 0.4 points of GDP. It stood at 4.8% of GDP, after 4.4% in the second quarter of 2023. Public spending rebounded (+0.5% after -0.1%), while public revenue fell again (-0.1% after -0.4%).

As you can see the economy would have shrunk further but for a boost from public spending and presumably as well as an explicit influence it implicitly supported the household consumption numbers. Also those who look at an economy via the taxes it can collect will be noting this hint for future prospects.

The fall in revenue was due to lower income tax, particularly corporation tax.

Inflation

Let me now address the inflation issue I raised earlier. In isolation the news was better.

Year on year, the Harmonised Index of Consumer Prices should rise by 3.8% in November 2023, after +4.5% in October. Over one month, it should fall back (‑0.3% after +0.2% in the previous month).

The annual rate has declined and we have seen monthly disinflation via a 0.3% drop this month. So far so good. There was however something troubling in the detail because food inflation barely fell in annual terms and we were told this.

Those of food should increase over a month, due to fresh food, while the prices of other food products should remain steady.

We get little detail from the flash estimate but in the national CPI breakdown I note that the annual rate for fresh food went from 1.1% to 6.6% so something saw a chunky price rise.

But my central point comes from a comparison with the overall Euro area figures just released by Eurostat.

Euro area annual inflation is expected to be 2.4% in November 2023, down from 2.9% in October according to a
flash estimate from Eurostat, the statistical office of the European Union.

Having gained last year by suppressing energy prices there is a sort of payback this year as France experiences higher inflation than the Euro area average. That then feeds into my previous work suggesting this will affect consumption particularly via Retail Sales. As ever we never get an entirely clear picture because we see the French state increasing expenditure in perhaps something of a masking effort. But if we return to my theme it is no surprise to it that the economy of France should be turning relatively lower now.

French National Debt

The above does rather beg a question because we enter this phase with the French national debt at 111.9% of GDP. The total debt rose by around 128 billion Euros in the year to the end of the second quarter. So a period of economic weakness would start to put the numbers under pressure. There is existing pressure from higher bond yields and higher inflation for index-linked debt. This morning the ten-year yield is a nice round 3% which whilst a fair bit cheaper than the UK or US is much more expensive than when the ECB was sending French bond yields into negative territory. There may also be another factor in play as I note this.

A new ECB exclusive just out from @EconoStream

. The gist of the story is:

Exclusive: ECB Insider: We’ll Discuss QT in December; Lagarde Won’t Try to Delay It Indefinitely –

ECB insider: Some preference for reaching QT decision next year, since it means less once in 2024 –

ECB insider: Won’t take many meetings to come to PEPP decision, given broad agreement already ( @PIQSuite )

Actually that is a really stupid idea at the moment But the central point is that QT is likely to put upwards pressure on bond yields. You do not need to take my word for this because the information came with an official denial.

– ECB insider: Unworried how markets to take PEPP change; it’s expected anyway, plus liquidity still high

Comment

The economic tides have turned against France. If the PMI indices are any guide then it is now under performing even Germany

Demand for French goods and services
also worsened at the fastest pace in three years in November, while backlogs of work were depleted further……..Overall, the headline measure signalled
another steep reduction in business activity across the euro area’s second-largest economy midway through the fourth quarter ( HCOB)

As I have pointed out earlier there was always going to be a price to pay once the inflation suppression strategy ended.

But if I now switch to monetary policy it is even more extraordinary that the French led ECB is now talking about tightening monetary policy further when all the signals are hinting that they have already tightened too much. If they continue on this road then they will apply a further brake on the French economy potentially leaving it vulnerable to an old Euro area issue. Back in the days of the Greek debt crisis a national dent to GDP ratio of 120% was presented as being significant. There would be a particular irony if the policies of Christine Lagarde now trip a level she was part of warning about when she was French Finance Minister.

 

 

The performance of the Bank of England comes under fire from the House of Lords

The week has opened with the Bank of England in the news with Governor Bailey giving an interview but more importantly the Economic Affairs Committee has issued a report into its performance and accountability. As events are known Governor Bailey will have been humming along to Lyndsey Buckingham as he waited for the report to drop.

I should run on the double
I think I’m in trouble,
I think I’m in trouble.

The problem is clear to pretty much everyone except for central bankers.

The framework for operational independence has been tested by the rise in inflation and the resulting loss of public confidence in the Bank. All central banks, including the Bank of England, made errors in the conduct of monetary policy in recent years. In 2021 high rates of inflation were incorrectly forecast to be “transitory”.

The next part of the report was both damning and important.

Possible reasons for this include a perceived lack of intellectual diversity in the Bank of England and other central banks, which contributed to insufficient challenge as regards modelling and forecasts.

The issue is that such organisations have a tendency to appoint people they consider to be “One of Us”. That turned out to be a catastrophic failure as they all considered inflation to be “transitory”. This is a long-running issue for bureaucracies as those who watched the episode on “Equal Opportunities” from Yes Minister a week or two ago. Back in the 1980s the promotion of women was an issue in the civil service and we are shown a meeting of permanent under secretaries when one exclaims “You could not get a more diverse group than us”, when in fact they look alike and behave the same. The issue of women at the Bank of England came back to haunt the Governorship of Mark Carney. Now whilst there are more unfortunately they are cut from the same cloth as the men suffering from clear group think.

The Economic Affairs Committee thinks that change is badly needed.

The Bank must do more to foster a diversity of views and strengthen a culture that encourages challenge. Areas that need attention include governance, hiring practices and appointments, especially to the Monetary Policy Committee.

One simple start would be to check how many are alumni of HM Treasury and Goldman Sachs. Next up would be to appoint people who use something which was a useful guide.

The views of witnesses also focused on the Bank’s apparent disregard for accelerating money supply growth. Throughout 2020—when the annual growth in the M4 money supply reached double digits—until August 2022, there was no discussion of money supply measures in the Bank’s Monetary Policy Reports.

Remit

Next up is something that will send a chill down the spine of the bureaucracy of the Bank of England.

The Treasury should prune the Bank’s much-expanded remit, with a focus on the number of matters it is expected to “have regard to” or “consider”, to ensure that the Bank is focused on its primary objectives of tackling inflation and ensuring financial stability.

It is the next bit that they will hate.

The Bank’s management structure, which has grown along with the Bank’s remit, should be reviewed with a focus on whether it could be streamlined.

This was something I pointed out during the Governorship of Mark Carney where there was clear inflation in the number of Deputy Governors. At the moment we have four of them when in my opinion two would be plenty. Also in my opinion the absent-minded professor Ben Broadbent should not have been made one. Apart from his failures on policy he was an “external” member and thus supposedly had some independence. But now there is a clear patronage path for those who toe the line.

Problems for Democracy

As the power of the Bank of England has grown it has become less accountable so I welcome this bit too.

Parliament should conduct an overarching review of the Bank’s remit and operations every five years, enhancing Parliament’s ability to hold the Bank to account and express its view on the Bank’s performance and leadership.

The main issue I have is every five years enough? At the moment there is an annual remit from the Chancellor of the Exchequer, but it is not really for this purpose and there is a clear issue here.

Quantitative easing (QE) was a powerful tool used to combat a monetary contraction in the aftermath of the 2008 financial crisis, but its continued deployment has blurred the lines between monetary and fiscal policy.

Such blurred lines usually suit the Chancellor of the day.

QE and QT

Next up is an area that could do with more attention and publicity.

The Committee repeats the call, which it initially made in its report on QE in July 2021, that the Government should publish the Deed of Indemnity.

A crucial error was made by the Bank of England.

Professor Goodhart told us that in view of historically low interest rates in the decade or so after the 2008 financial crisis, “shortening the duration of debt was … exactly the wrong thing to do. If interest rates are historically as low as they can ever get, you ought to lengthen the duration of debt.”

Firstly good to see he is still around as he wrote some of the text books I read as a student at the LSE. Next up is that the Bank of England did the opposite of my recommendation for the UK to issue some century ( one hundred year) bonds. Instead it switched from a fixed-rate liability ( the coupon on a bond) to a variable-rate one which is its own Bank Rate. It then raised it to 5.25% meaning that is what it is presently paying on its still bloated balance sheet.

That is why it has been keen to sell off some of its bond holdings and it will sell-off another £670 million this afternoon. The trouble is that even sales of such size are minor compared to the £747 billion or so left. The Lords have a suggestion here.

Decisions on debt duration have consequences for debt management, so the Bank and the Debt Management Office (which is an agency of the Treasury) should draw up and publish a memorandum of understanding which clarifies how the interaction between monetary policy and debt management should operate.

Comment

In general this is a very welcome intervention by the Economic Affairs Committee. It has shown a light into frankly what has been a disaster of policy. It starts with recruiting from a shallow pool of talent who in spite of having no previous experience decided they were experts in bond markets and have now left us with their egg on our faces. They bought at the top and are now selling at the bottom.

I believe that something worse happened which is that their fears over what would happen to their bloated balance sheet was a major factor in the Bank of England delaying necessary interest-rate rises. They did not want to admit they had been fools and complete ones at that. Regular readers will know I warned about a likely QT disaster and let me give you an idea of how out of touch they were. The Bank of England QT plans signaled interest-rates of 0.5% and 1% as significant. Whereas they have raised them to 5.25% or ten times one and give times the other!

If we now look at the Newcastle Chronicle interview the Governor has sent this message.

Bank of England Governor Andrew Bailey suggested that interest-rate cuts are unlikely for the “foreseeable future” as he warned that the second half of the inflation battle will be “hard work.” ( Bloomberg)

If you look at his previous interest-rate forecasts you know what to do.

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