Yesterday saw the publication of the minutes from the latest meeting of the Monetary Policy Committee of the Bank of England. This body sets UK interest-rates and monetary policy. Tucked away in these minutes was something of a bombshell and I repeat it below.
the Committee could not rule out the publication of official data showing GDP falling for three successive quarters.
This statement poses a lot of questions for a body which has undertaken an enormous and indeed unprecedented amount of monetary easing to try to stop such outcomes. If we look at the minutes and look forwards we see that they fear this.
In the second quarter, some activity was likely to be lost because of the extra bank holiday associated with the Queen’s Diamond Jubilee celebrations.
The problem with this is of course that we were told last year that the Royal Wedding and the associated bank holiday would boost the economy! It would seem that extra bank holidays are like the weather which is always too hot or too cold and never the right temperature,unlike Goldilocks porridge.
What is worrying them?
If we look at what has happened then they are concerned about this.
The ONS had also revised down the path for household consumption during 2011 such that the level at the end of the year was 0.5% lower than previously estimated.
Indeed considering the Bank of England’s view on saving they were probably also troubled by this.
this implied a sizable revision upwards to the estimated household saving rate. This now appeared to have fallen back only modestly since its peak in 2009.
How dare households consider it prudent to save when Charlie Bean in particular of the MPC wants them to emulate the famous statement of an early winner of the Pools.
Why this should not have been a surprise to them
Here is their view on wage rises.
Whole-economy average weekly earnings had risen by only 1.4% in the three months to January
And here is their view on inflation
seasonally adjusted annualised monthly inflation rates were somewhat higher than the inflation target.
Let me help them out. At that point their official inflation measure was at 3.4% so real wages were falling at 2% per annum. Those who have followed this weeks events will know that real wage growth has moved even more negative and that this is something which troubles me greatly. Let me repeat this from yesterday’s update.
Total pay (including bonuses) rose by 1.1 per cent on a year earlier, down 0.2 on the three months to January 2012.
So if we factor in the latest official inflation numbers we see that our estimate of the rate of fall of real wages has risen to 2.4%. I already thought that this would be a brake on our economy but if we add in the increased savings rates discussed above we see that it is not a surprise that our economy is weak and even worse this does not look likely to change.
For the MPC though there is the problem of this being a surprise due to their persistent underforecasting of the likely rate of inflation. If we had inflation at the level of their forecasts this would be a much smaller problem. In a roundabout way they do address this issue in their minutes.
But, as with all forecasts, there was a large margin of error around them.
I find it hard to read that sentence without placing the word our between all and forecasts,although some suspect that the mistakes have not been errors at all!
Readers of this blog will be aware of the rises planned in some UK mortgage rates with those on standard variable rates (SVRs) particularly affected. For those unaware of the situation in the UK SVR’s are often the default mortgage rate and as credit criteria have tightened more borrowers have been moved onto them. These rises start in May and are spread through the summer/autumn.
The Bank of England has spotted this
The impact of past increases in costs for UK banks of raising retail and wholesale deposits had been continuing to feed through into higher borrowing costs for some households and businesses.
I am not entirely convinced by the first part of that sentence as I consider it to be spin by the banking industry but the latter part is true. Also we see this.
Some further rise in spreads on loans to businesses had also been expected.
Let us step back for a moment and consider what Quantitative Easing was supposed to achieve
From the Bank of England website.
That lowers longer-term borrowing costs
So it has spent approximately £315 billion on UK Gilts (government bonds) to achieve this aim except as in its own words above it is not currently working.
Even worse if we move on from the price of credit as expressed by interest-rates and move onto the quantity of it we see that there are problems there too.
Respondents to the Bank’s latest Credit Conditions Survey had expected some further tightening in credit standards for secured borrowing by households, although less so for unsecured borrowing.
What about inflation?
This has become a perennial problem area for the MPC as it finds inflation always doing this.
If anything, the decline in February had been marginally less than the Committee had expected
As the latest inflation report had been in February we see that not only is the MPC unable to forecast inflation it does not know what it is at any period of time. Perhaps they are catching on a little though.
There was a risk that inflation would fall less rapidly in the near term than the Committee had anticipated
Although “fall less rapidly” metamorphosed into a rise in reality.
A Theoretical Problem
For three years now the Bank of England has persisted with an “output gap” theory of inflation and it still seems to believe in it as shown below and the emphasis is mine.
how rapidly domestically generated inflation would fall in response to weaker cost and price pressures from a recovery in productivity growth and the margin of spare capacity.
If this were true we would have undershooting inflation but reality has been different. If it has any effect it has been weak and the MPC should treat it like that not keep repeating it like a mantra. And there is no great sign of a productivity surge either.
unit labour costs were likely to have grown faster than in the previous quarter
In these minutes was an unintended critique of the MPC’s policy of slashing interest-rates to 0.5% and spending £315 billion on Quantitative Easing.
downside news on the near-term path of GDP likely to be published by the ONS and by the upside news on the near-term path for inflation.
You see output keeps disappointing and inflation keeps being higher than they expect. This is the real story of the QE era where we do not get the promised increases in output but we do get inflation at a rate higher than it should be considering how weak our recovery from the credit crunch has been.
In my opinion the Bank of England has expanded monetary too much and has failed to press hard enough for economic reform in the UK. Its orbit now covers the Financial Planning Committee for the banking sector and this covers the sector which could most improve our economic activity in the short,medium and long-terms. Yet what did we get from the UK establishment? A Vickers report whose weak reforms were kicked as far as 2019.
In essence we have been taught again the limits of monetary policy and will one day have to face the costs of an “exit strategy” from these failing measures.
There was one change in this months minutes and it was that Adam Posen did not vote for further monetary easing. Perhaps he was mulling this interview he gave to the Guardian back in March 2011.
If I have made the wrong call, not only will I switch my vote; I would not pursue a second term.
This is predicated around inflation falling to 1.5% this summer. Perhaps he has “laid awake at night thinking about it”. Although he may have had a chat with MPC colleague Paul Tucker.
I think inflation might remain above 3% throughout the second quarter of this year, and possibly into the second half of the year
One hundred year Gilts
I gave some views to Russia Today on what I thought on this matter and here is the report. Those who read my post on this subject will not be surprised.