What is going on at the Bank of England these days?

Yesterday saw the publication of Brexit forecasts from HM Treasury and the Bank of England. The former was always going to be politically driven but the Bank of England is supposed to be independent, although these days we have to ask independent of what? There is little sign of that to be seen. Let us take a look at the Bank of England scenarios.

The estimated paths for GDP, CPI inflation and unemployment in the Economic Partnership scenarios are
shown in Charts A, B and C. The range reflects the sensitivity to the key assumptions about the extent to
which trade barriers rise, and how rapidly uncertainty declines. GDP is between 1¼% and 3¾% lower than
the May 2016 trend by end-2023. Relative to the November 2018 Inflation Report projection, by end-2023 it is 1¾% higher in the Close scenario, and ¾% lower in the Less Close scenario.

After singing its own fingers last time around it is calling these scenarios rather than forecasts but pretty much everyone is ignoring that. The problem with this sort of thing is that you end up doing things the other way around. Frankly the answers are decided and then the assumptions are picked to get you there. We do know some things.

Productivity growth has slowed, sterling has depreciated and the increase in inflation has squeezed real incomes.

However really the most certainty we have is about the middle part of a lower UK Pound £ and even there the Bank of England seems to omit its own part ( Bank Rate cut and Sledgehammer QE ) in the fall. That caused the fall in real incomes as we see how policy affected the results.

If we move wider the Bank of England attracted fire from both sides as for example this is from the former Monetary Policy Committee member Andrew Sentance who is a remain supporter.

The reputation of economic forecasts has taken a bad blow today with both UK government and appearing to use forecasts to support political objectives. Let’s debate – which I strongly oppose – rationally without recourse to bogus forecasts.

Why would he think that?

Well take a look at this.

The estimated paths for GDP, CPI inflation and unemployment in the disruptive and disorderly scenarios
are shown in Charts A, B and C. GDP is between 7¾% and 10½% lower than the May 2016 trend by end 2023.
Relative to the November 2018 Inflation Report projection, GDP is between 4¾% and 7¾% lower by
end-2023. This is accompanied by a rise in unemployment to between 5¾% and 7½%. Inflation in these
scenarios then rises to between 4¼% and 6½%.

It is the latter point about inflation and a claimed implication of it I wish to subject to both analysis and number-crunching.

How would the Bank of England respond to higher inflation?

Here is the claimed response.

Monetary policy responds mechanically to balance deviations of inflation from target and output
relative to potential. Bank Rate rises to 5.5%.

Let us see how monetary policy last responded to an expected deviation of inflation above target to back this up.

This package comprises:  a 25 basis point cut in Bank Rate to 0.25%; a new Term Funding Scheme to reinforce the pass-through of the cut in Bank Rate; the purchase of up to £10 billion of UK corporate bonds; and an expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion.

As you can see the mechanical response seems to be missing! Unless of course you count the mechanical response of the mind of Mark Carney as he panicked thinking the UK was going into recession. The other 8 either panicked too or meekly fell in line. The point is further highlighted if we look at the scenario assumed for the exchange-rate of the UK Pound £.

And as the sterling risk premium increases, sterling falls by 25%, in addition to the 9% it has already fallen
since the May 2016 Inflation Report.

Let us examine the reaction function. Let us say that the £ had fallen by 10% when the Bank of England took action then if it ” responds mechanically” we would expect this time around to see a 0.625% reduction in Bank Rate and some £150 billion of extra QE as well as another Term Funding Scheme bank subsidy of over £300 billion.

Instead we are expected to believe that the Bank of England would raise and not cut interest-rates and would do so by 4.75%! There is also an issue with the timing as the forward guidance of the Bank of England has been for Bank Rate rises for over 4 years now and we have had precisely 0.25% in net terms. So at the current rate of progress the interest-rate increases would be complete somewhere around the turn of the century.

Actually there is more because other interest-rates would go even higher it would appear.

Uncertainty about institutional credibility leads to a pronounced increase in risk premia on sterling
assets, including a 100bps increase in the term premium on gilts.

So an extra 1% on Gilt yields although this is only related to a particular piece of theory as we skip what they would be apart from an implication of maybe 6.5%. A particular catch in that is the current ten-year yield is a mere 1.33% and over the past 24 hours it has been falling adding to the previous falls I have been reporting for a while now. Markets do of course move in the wrong direction at times but Gilt investors seem to be placing their bets on the Gilt market and ignoring the Bank of England scenario.

But wait there is more.

Overall, interest rates on loans to households and businesses rise by 250bps more than Bank Rate.

Can this sort of thing happen? Yes as we saw it in the build up to the credit crunch as UK interest-rates disconnected from Bank Rate by around 2%. Also yesterday we were noting such a thing via the fact that Unicredit of Italy has found itself paying 7.83% on a bond which was yielding only 1% as recently as yesterday. But there are two main problems of which the first occurred on Mark Carney’s watch as we note that they way he “responds mechanically” to such developments is to sing along with MARRS.

Pump up the volume
Pump up the volume
Pump up the volume
Get down

Actually such a response by the Bank of England was typical before the advent of Governor Carney. Recall this?

For instance, during the financial crisis the exchange rate
depreciated around 30% initially but settled to be around 25% below its pre-crisis peak in the following
couple of years.

So in a broad sweep in line with the new worst case scenario especially as we recall that inflation went above 5% on both main measures. So Bank Rate went to 5.5%? Er now it was slashed by over 4% to 0.5% and we saw the advent of QE that eventually rose in that phase to £375 billion.

Comment

The first comment was provided by financial markets as we have already noted the Gilt market rally which was accompanied by the UK Pound £ rallying above US $1.28. The UK FTSE 100 did fall but only by 13 points. If there is anything a Bank of England Governor would hate it is being ignored.

Actually the timing was bad too. For some reason the report was delayed from 7:30 am to 4:30 pm but due to yet another problem it was another ten minutes late. This means that very quickly eyes turned to this by Federal Reserve Chair Jerome Powell.

Stocks ripped higher on Wednesday after Federal Reserve Chairman Jerome Powell said interest rates are close to neutral, a change in tone from remarks the central bank chief made nearly two months ago. ( CNBC )

Roughly that seems to take 0.5% off the expected path of US interest-rates and has led to the US ten-year Treasury Note yield falling back to 3%. Also trying to convince people about higher inflation is not so easy when the oil price ( WTI) falls below US $50.

Me on Core Finance TV

 

 

 

 

 

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The Bank of England is facing the consequences of its own mistakes

Yesterday brought us some new insights into the thinking of the Bank of England and indeed the UK establishment. This was because what you might consider the ultimate insider gave evidence to Parliament as Sir John Cunliffe joined the Department of the Environment as long ago as 1980. Intriguingly his degrees and lecturing experience in English Literature apparently qualified him to high level roles in HM Treasury. So he is also an example of how HM Treasury established the Bank of England as “independent” but then took back control. Actually I think all the Deputy Governors have been at the Treasury at some point in their careers. Also if we return to his degree we see another feature of modern life where those on the lower rungs have to be highly qualified in their sphere whereas it is no issue at all for those at the top. That is because they are considered to be – by themselves if nobody else – so highly intelligent that qualifications are unnecessary.

Sir John gave us a warning about the future.

One pocket of rapid growth that the FPC is monitoring closely is in leveraged lending which appears to have been driven by strong investor demand for holding the loans,
typically in non-bank structures such as CLOs (collateralised loan obligation funds). Gross issuance of leveraged loans by UK non-financial companies reached a record level of £38 billion in 2017 and a further £30 billion has already been issued in 2018. And lending terms have loosened with only around 20% of leveraged loans now having maintenance covenants, which used to be standard for all loans. The global leveraged loan market is larger than – and growing as quickly as – the US subprime mortgage market was in 2006.

The Bank of England Financial Policy Committee of which Sir John is a member ( he has nearly as many jobs as George Osborne) also posted a warning according to BusinessInsider.

Leveraged lending to corporates has ballooned in recent years, with the global market reaching a value of around $1.4 trillion, according to recent estimates.

Thus we see the establishment at play. Let us note that the ground is being prepared to blame “Johnny Foreigner” and also that as Nicola Duke points out below another deflection technique is at play.

This is how central bankers prepare for the next financial crisis. They take no action while ensuring they have their excuses in order. “We warned you in 2018”.

Let us take her point and see what is actually being done and the answer as usual appears to so far be nothing.

The FPC is planning to assess any implications for banks in the 2018 stress test and we will also review how the
increasing role of non-bank lenders and changes in the distribution of corporate debt could pose risks to financial stability.

As ever this is reactive and frankly a lagged reactive at that. These bodies never act in advance and are invariably asleep at the wheel whilst it is taking place. Of course if their real role is merely to describe what has happened then I may have been mistaken about Sir John’s qualifications for the job as suddenly English Literature becomes useful.

But there is an elephant in the room which is way that the Bank of England itself has fed this. It slashed interest-rates in response to the credit crunch and even now they are only 0.75% or around 4% below where they were previously. It has deployed some £435 billion of conventional QE and £10 billion of corporate bond QE. Then in 2012 it did this too.

The Funding for Lending Scheme is designed to encourage banks and building societies to lend more to households and businesses. It does this by providing funding to these firms for an extended period, with the quantity of funding we provide linked to their lending performance.

So the system has been flush with cash or to be more technically accurate, liquidity. Can anybody be surprised that like the ship of state the monetary system is a leaky vessel? Or to use a word from a couple of decades or so ago we are seeing another form of disintermediation. But wait there is more.

Since the referendum, the Bank of  England has augmented these capital and liquidity buffers by making available more than £250 billion of liquidity and by lowering banks’ Counter-Cyclical Capital Buffer to facilitate an extra £150 billion of lending.

This is from a speech given by Chief Economist Andy Haldane which was liked so much it was if you recall published twice just to make sure we got the message. Well perhaps the leveraged loans industry did! We’ve got your backs lads ( and lasses). But wait there was even more.

Put differently, I would rather run the risk of taking a sledgehammer to crack a nut than taking a miniature
rock hammer to tunnel my way out of prison – like another Andy, the one in the Shawshank Redemption………And this monetary response, if it is to buttress expectations and confidence, needs I think to be delivered promptly as well as muscularly.

The Bank of England has claimed some 250,000 jobs were saved/created ignoring that it would have been perhaps the fastest response to a monetary policy change in history. That leads it into conflict with the ECB that thinks the response time slowed. But if we return to what we might label in this instance as disintermediation there have been two clear examples.

  1. A surge in unsecured lending pushing into annual growth in the double digits that is still above 8%
  2. Corporate lending now increasingly leveraged with underwriting standards dropping like a stone.

Peter Gabriel may have done this but the Bank of England merely repeated the same old song.

I’ve kicked the habit
shed my skin
this is the new stuff

I go dancing in, we go dancing in

Comment

There are plenty of familiar themes at play today as we look again at how the establishment operates. There is a clear asymmetry between the way a move sees even fantasies proclaimed as triumphs but failures get ignored. It is the same way that “vigilant” means asleep and “we will also review” means a review will be necessary as by then it will probably have blown up. Fortunately we can then claim to be experts and specialists ( in failure to quote Jose Mourinho ) and sit on the various committees set up to discover what went wrong? That will of course make sure that those asleep at the wheel do not get the blame, as long as they can manage to stay awake during the meetings of the new committee.

Meanwhile the UK economy continues to bumble along. Whilst today’s headline may appear not so good it is in fact pretty strong.

In September 2018, the quantity bought declined by 0.8% when compared with August 2018, due mainly to a large fall of 1.5% in food stores; the largest decline in food store sales since October 2015.

That made the Office of National Statistics uncomfortable enough to delay it to the third paragraph of the release. But actually with a little perspective and somewhat amazingly the UK consumer continues to spend.

In the three months to September 2018, the quantity bought in retail sales increased by 1.2% when compared with the previous three months………When compared with September 2017, the quantity bought in September 2018 increased by 3.0%, with growth across all sectors except department stores.

Presently in economic terms ( as opposed to political) the main dangers to the UK economy have been created by the Bank of England.

Core Finance TV

 

 

 

 

 

Has the Bank of England fed yet more subprime lending troubles?

One of the main drivers of the UK public finance data which arrives later is the state of the UK economy. There we find that the solid GDP ( Gross Domestic Product) growth of recent years has been replaced by slower more marginal growth in 2017 so far. Also the attempts of the Bank of England to boost the economy via its extra monetary easing of last August are hitting the problems described by former HM Treasury Permanent Secretary Nick Macpherson like this yesterday.

QE like heroin: need ever increasing fixes to create a high. Meanwhile, negative side effects increase. Time to move on.

It raises a wry smile to see a latter-day Sir Humphrey agree with me although Nick did in fact move higher in establishment terms as he is now a Lord. Also it is easy to say  it now after the damage has been done it would have been much braver to say it against the establishment consensus at the time.

Car Loans

One of the areas where stresses in the UK economy are being seen are in the car and car loan markets. As I wrote only on Friday these were fed by the way that the finance subsidiaries of the car manufacturers have been able to step into the market via what are rental deals dressed up as purchases. This will have been oiled by the Bank of England £435 billion of QE and £80.3 billion of its Term Funding Scheme. Whilst the latter specifically helped banks and building societies the aim was ” to support additional lending to the real economy,” Was it a further push for the car market?

The problem after the boom for the car market is that you pump it up so much that you then get a bust. On Friday I pointed out that incentive schemes and subsidies being provided by the manufacturers are a sign of trouble ahead and today the BBC is reporting this. From the BBC.

Ford is the latest car company to launch an incentive for UK consumers to trade in cars over seven years old, by offering £2,000 off some new models.

Unlike schemes by BMW and Mercedes, which are only for diesels, Ford will also accept petrol cars.

All of the part-exchanged vehicles will be scrapped, Ford said, which would have an “immediate positive effect on air quality”.

Old cars, from any manufacturer, can be exchanged until the end of December.

There is of course an addition for my financial lexicon for these times as we discover a price cut is in fact a “positive effect on air quality”.

Provident Financial

I have regularly pointed out the dangers of the surge in unsecured lending in the UK that was also fed by the Bank of England “Sledgehammer” QE and Bank Rate cut of last August. One of the places you would look for trouble is in the area of subprime lending where Provident Financial has released quite a tale of woe this morning. Let us go back only a month.

The group has continued to exercise strong discipline around credit and not observed changes in customer behaviour in relation to either demand for credit or credit performance.

And this morning.

Collections performance is currently running at 57% versus 90% in 2016 and sales at some £9m per week lower than the comparative weeks in 2016. ………….The pre-exceptional loss of the business is now likely to be in a range of between £80m and £120m.

That is a bit different to a pre exceptional profit of £60 million. How much can you lose in a month? This is the sort of Forward Guidance we associate with central banks. Yet again we see a banking organisation which chooses to be “economical with the truth” to coin a phrase and try to drip feed or manage bad news. It has not gone well today with the Chief Executive gone, the dividend scrapped, and a FSA investigation into one of the subsidiaries. The share price is not for the faint hearted because as I type this it is £6.78 or down some £10.67 on the day.

I do hope that someone will ask Bank of England Chief Economist Andy Haldane about this as he undertakes his UK tour which if the FT coverage is any guide seems to be part of an effort to make him the next Governor. After all it was entirely predictable ( please look at my past updates on here) that unsecured lending would boom and lead to trouble just like it has in the past. Andy’s “Sledgehammer” QE lit the blue touch-paper.

A Fiscal Stimulus?

I ask this on several fronts. Let me open with this from former Chancellor George Osborne on BBC Radio 4 Today earlier. From the BBC.

Former Chancellor George Osborne has urged the government to build high-speed rail lines across the north of England, from Liverpool to Hull.

Mr Osborne, who launched the “Northern Powerhouse” initiative when in government,

The so-called HS3 railway project seems a much better idea than HS2 but then almost anything is. A weak minority government is always likely to succumb to such ideas and I was thinking of that as I noted this in this morning’s public finance release.

Over the same period, central government spent £245.9 billion; around 5% more than in the same period in the previous financial year.

Actually some £4.1 billion of this is extra debt interest. An awkward number when you consider we have such low yields as we mull a fiscal stimulus to holders of UK Gilts! What is happening here is the consequence of the rise in inflation as index-linked Gilts use the Retail Price Index which rose in July at an annual rate of 3.6%.

Revenue is not bad

Whilst it was eclipsed by the spending growth revenues did beat the official inflation data comfortably.

In the current financial year-to-date, central government received £226.6 billion in income; including £168.1 billion in taxes. This was around 4% more than in the same period in the previous financial year.

Indeed if we look at July specifically there was some hopeful news from the self-assessment numbers.

This month, receipts from self-assessed Income Tax increased by £0.8 billion to £8.0 billion, compared with July 2016. This is the highest level of July self-assessed Income Tax receipts on record (records began in 1999).

This meant we had a small surplus in July but that the fiscal year so far saw an extra £1.9 billion of borrowing compared to last year.

Comment

There are two ironies today. The first is that on a day when I was thinking about public sector debt we get a reminder of the troubles in private debt via the unsecured sector and subprime in particular. Next is a timing irony as this from Ann Pettifor hints at.

Former chairman of Northern Rock given a platform by to opine about “principles” shows how corrupt is the British establishment.

So a former chairman of a past subprime lender gets a media soapbox on a day new subprime fears see signs of a coming to fruition? The phrase credit crunch has many meanings but a flicker of it seems likely to be added to by the fact that official restrictions on outward investment from China seem to be biting. From City-AM.

Chinese conglomerate Dalian Wanda has ditched plans to buy London’s Nine Elms Square, it was announced this morning.

Meanwhile the Bank of England and its Governor Mark Carney are “Vigilant.”

 

 

The Bank of England has driven a surge in UK unsecured credit

Today sees the latest UK consumer credit figures and shows us that a week can be a long time in central banking. After all at Mansion House we were told by Bank of England Governor Mark Carney that its surge was in fact a triumph for his policies.

This stimulus is working. Credit is widely available, the cost of borrowing is near record lows, the economy has outperformed expectations, and unemployment has reached a 40 year low.

Happy days indeed although of course his expectations were so low it was almost impossible not to outperform them. But of course it was not long before we saw some ch-ch-changes.

Consumer credit has increased rapidly……….Consumer credit grew by 10.3% in the twelve months to
April 2017 (Chart B) — markedly faster than nominal
household income growth. Credit card debt, personal loans
and motor finance all grew rapidly.

But this is a triumph surely for the last August easing of monetary policy and Sledgehammer QE? Apparently no longer as we note that a week is as long in central banking as it is in politics.

The FPC is increasing the UK countercyclical capital buffer
(CCyB) rate to 0.5%, from 0% (see Box 1). Absent a
material change in the outlook, and consistent with its
stated policy for a standard risk environment and of moving
gradually, the FPC expects to increase the rate to 1% at its
November meeting.

There is something of a (space) oddity here as monetary policy is supposed to be a secret – although if we go back to last July Governor Carney forgot that – whereas we see that the same institution is happy to pre announce financial policy moves. Also we need a explanation as to why financial policy was eased in a boom and now tightened in a slow down

But that was not the end of it as yesterday Governor Carney went into full “unreliable boyfriend” mode.

Some removal of monetary stimulus is likely to become necessary if the trade-off facing the MPC continues
to lessen and the policy decision accordingly becomes more conventional.

This saw the UK Pound £ as the algo traders spotted this and created a sort of reverse “flash crash” meaning that it is at US $1.298 as I type this. Maybe they did not read the full piece as there was some can kicking involved.

These are some of the issues that the MPC will debate in the coming months.

So not August then? Also the Governor loaded the dice if you expect consumption to struggle and wage growth to be negative in real terms.

The extent to which the trade-off
moves in that direction will depend on the extent to which weaker consumption growth is offset by other
components of demand including business investment, whether wages and unit labour costs begin to firm,
and more generally, how the economy reacts to both tighter financial conditions and the reality of Brexit
negotiations.

Indeed as this week has been one for talk of central banks withdrawing stimulus let us return to reality a little. From @DeltaOne.

BOJ HARADA: NOT PLANNING TO REDUCE ETF PURCHASES UNTIL 2% INFLATION TARGET ACHIEVED – DJN

So it would appear that you might need to “live forever” Oasis style to see the Bank of Japan reverse course although they will run out of ETFs to buy much sooner.

Pinocchio

I spotted that Governor Carney told us this as he relaxed in the Portuguese resort of Sintra.

Net lending to private companies is been growing
following six years of contraction. Corporate bond spreads are well below their long-run averages.. And credit conditions among SMEs have been steadily improving.

Regular readers of my work will be aware that I have for several years now criticised policy on the ground that it has boosted consumer credit and mortgage lending but done nothing for smaller businesses. I will let today’s figures do they talking for me especially as they follow a long series.

Loans to small and medium-sized enterprises were broadly
unchanged

Also I have spotted that of the total of £164.3 billion to SMEs some £64.5 billion is to the “real estate” sector. Is that the property market again via the corporate buy to let sector we wondered about a couple of years ago?

Buy To Lets

Sometimes it feels like we are living in one of those opposite universes where everything is reversed like in Star Trek when Spock becomes emotional and spiteful. This happened to the max this week when former Bank of England policymaker David “I can see for” Miles spoke at New City Agenda this week about the house price boom. Yep the same one he created, anyway as you look at the chart below please remember that the “boost to business lending” or Funding for Lending Scheme started in the summer of 2013.

Today’s data

There is little sign of a slow down in this.

Annual growth in consumer credit remained strong at 10.3% in May, although below its peak in November 2016

I have been asked on Twitter how QE has driven this as the interest-rates are so high? Let me answer by agreeing with the questioner and noting that low interest-rates are for the banks not the borrowers as we note this from today’s data.

Effective rates on Individual’s and Individual trusts new ‘other loans’ fixed 1-5 years increased by 3bps to 7.68%,
whilst on outstanding business, effective rates decreased by 4bps to 7.38%.

I had to look a lot deeper for the credit card rate but it is 17.9% so in spite of all the interest-rate cuts it is broadly unchanged over our lost decade. My argument is that we need to look at the supply of credit which has been singing along to “Pump It Up” by Elvis Costello as we note £445 billion of QE, the FLS and now the £68.7 billion of the Term Funding Scheme. My fear would be why people have been so willing to borrow at such apparently high interest-rates?

The picture is not simple as some are no doubt using balance transfers which as people have pointed out in the comments section can be at 0%. But they do run out as we reach where the can is kicked too and a section of our community will then be facing frankly what looks like usury. The only thing which makes it look good is the official overdraft rate which is 19.7% according to the Bank of England.

Comment

The Bank of England is lost in its own land of confusion at the moment and this has been highlighted by its chief comedian excuse me economist Andy Haldane this morning.

Bank of England chief economist Andy Haldane said on Thursday that the central bank needs to “look seriously” at raising interest rates to keep a lid on inflation, even though he was happy with their current level.

Did anybody ask whether would also “look seriously” at cutting them too? Meanwhile for those of you who have read my warnings about consumer credit let me give you the alternative view from the Bank of England house journal called the Financial Times. Here is its chief economics editor Chris Giles from January 2016.

Britain is gripped by unsustainable debt-fuelled consumption. So fashionable has this charge become that Mark Carney was forced this week to deny that the Bank of England was responsible. The governor is right.

Indeed he took a swipe at well people like me.

Even armed with these inconvenient facts,ill-informed commentary accuses George Osborne of seeking to ramp up household debt.

As we make another addition to my financial lexicon for these times there was this which I will leave to you to consider.

Official figures show that after deducting debt, net household assets stood at 7.67 times income in 2014, a stronger financial position than at any point in almost 100 years.