Bank of England cuts rates by 50bps to 1.5%. 8th Jan 2008
Bank of England cuts rates by 50bps to 1.5%. 8th Jan 2008
Today the Bank of England’s monetary policy committee reduced Base lending rates by 50 basis points to 1.5%. Accompanying the rate reduction was the following commentary. “The Bank of England’s Monetary Policy Committee today voted to reduce the official Bank Rate paid on commercial bank reserves by 0.5 percentage points to 1.5%. “The world economy appears to be undergoing an unusually sharp and synchronised downturn. Measures of business and consumer confidence have fallen markedly. World trade growth this year is likely to be the weakest for some considerable time.
“In the United Kingdom, business surveys suggest that the pace of contraction in activity increased during the fourth quarter of 2008 and that output is likely to continue to fall sharply during the first part of this year. Surveys of retailers and reports from the Bank’s regional Agents imply that consumer spending has weakened. The outlook for business and residential investment has deteriorated. And the availability of credit to both households and businesses has tightened further, pointing to the need for further measures to increase the flow of lending to the non-financial sector. But the substantial depreciation in sterling over recent months may help to moderate the impact on UK net exports of the slowdown in global growth.
“CPI inflation fell to 4.1% in November. Inflation is expected to fall further, reflecting waning contributions from retail energy and food prices and the direct impact of the temporary reduction in Value Added Tax. Measures of inflation expectations have come down. And pay growth remains subdued. But the depreciation in sterling will boost the cost of imports. At its January meeting, the Committee noted that the recent easing in monetary and fiscal policy, the substantial fall in sterling and the prospective decline in inflation would together provide a considerable stimulus to activity as the year progressed.
“Nevertheless, the Committee judged that, looking through the volatility in inflation associated with the movements in Value Added Tax, there remained a significant risk of undershooting the 2% CPI inflation target in the medium term at the existing level of Bank Rate. Accordingly, the Committee concluded that a further reduction in Bank Rate of 0.5 percentage points to 1.5% was necessary to meet the target in the medium term.”
This was the seventh rate reduction since June 2007 when rates were cut by 25 basis points from a cyclical high of 5.75%. The path of reductions, in the wake of the escalating financial turmoil, accelerated from August 2007 and have fallen 350 basis points since that meeting. Today’s cut of 50 basis points was on the lower side of expectations. Although the majority of polled economists were expecting a half point, the risk was skewed to a bigger reduction with the one month SONIA gap trading a little over 75bps points immediately prior to the decision.
Bank of England cuts rates by 50bps to 1.5%. 8th Jan 2008
Chancellor of the Exchequer, Alistair Darling, immediately urged retail banks to pass on the full 50bps through lower borrowing and mortgage rates, we feel it is unlikely that the entire banking sector will play ball, though early signs are encouraging.
We again feel the current policy response of both the Bank of England and the US authorities is extremely misguided and will have very ugly consequences over the next couple of years. The inexorable drift to Quantitative easing in the UK to follow the lead of the new Obama administration is likely to lead to a severe inflationary problem going forward – the markets persistence with deflation now is as misguided as it’s predilection with inflation a year ago. I am amazed by the constant references to the Japanese deflationary fight post the property and Nikkei collapse of the late 1980’s and the move to QE in the early part of this century.
Firstly, one can hardly claim the measure was a success. Japanese Y-O-Y CPI was stuck in a (1.6%) to 0.8% range for the entire period of QE and the dynamics of the global credit crunch make comparisons between the two problems rather immaterial. Firstly, the Japanese populace had a much higher tendency to save, and secondly, they always had a vehicle in which to place their money – namely the carry trade. The period of QE saw Yen on a trade weighted basis drop around 28% and the extreme severity of the carry trade unwind in the second part of 2008 shows what a fruitless pursuit the policy was.
Now, as noted above, the populace of the UK and US are not historically savers and the given the lack of available returns from extraordinarily unattractive Government bond curves, one would not be blamed for being drawn into the benefits of getting the printing presses rolling and encouraging even more borrowing to reflate the economy. The problem lies in the financing of the gigantic budget deficit this policy is going to cause.
The Tax take in the UK, a country so dependent on the City of London and the service sector is shrinking incredibly fast from a corporation tax and income tax perspective (not to mention the VAT gimmick, which didn’t really help Woolworths, Adams, Whittards and those retailers who will join them over coming months). Social security payments, owing to a rise in Unemployment which should continue well into 2010, will continue to rise, so the budgetary position is deteriorating even before we look at producing a bigger debt burden than we have ever known. With Germany receiving under EUR5.25bn in bids for its EUR6bn 10 year auction yesterday (this is Germany remember, not Italy or Greece), our call that the UK will fail on a Gilt auction during the year is getting more coverage in the wider media and we feel, that this will occur during the second half of 2009, if not sooner.
If they can’t sell bonds, they will print money. Yvette Cooper of the UK Treasury and Alistair Darling both said QE was a ‘Hypothetical Debate’ today, strange they used the same phrase in different locations – could it be that they have already had that ‘hypothetical debate’? (That makes it a debate that is no longer hypothetical I guess!). When the printing presses get rolling, as they look certain to do now despite the thinly veiled Labour rhetoric, we risk a further dislocation of Sterling in the currency markets.
The weakness of the pound is already being felt in the retail sector, which will give first notice to those believing Kaletsky in The Times today that it is inflation, not deflation we are headed towards. The two biggest tour operators in the UK have already indicated Summer holiday prices will be between 10 and 12% higher than in 2008 and struggling high street retailers who sell pretty much exclusively things that are manufactured outside of the UK will need to increase prices or go under (I suggest any Europeans looking to take advantage of UK shop prices do so by the end of February before consumer durables start to rise rapidly in price). With the US also committed to a policy that will debase the currency and all commodities priced in the Greenback this will further exacerbate the strains in the retail system.
If this is the wrong policy, then what should we do? Tim Congdon talked of direct lending to business by the Government in the Telegraph yesterday, which was an innovative solution recommended by a very good strategist I know over a year ago – just after UK Plc bought the perfect vehicle for such a strategy, Northern Rock. (Good call Patrick). Something similar looks likely to be employed in Germany, but I fear Brown and Darling have nailed their Saltire to the mast and would rather pour money into certain Scottish based financial institutions than look at something genuinely innovative.
What the politicians and central bankers should be coming to terms with is that a non-activist strategy would have turned out to be less damaging to the economy than the current plan of dishing out free drink to alcoholics. What we need is a period of time, sobriety if you like, where trust in institutions can be rebuilt and those that have been running irresponsible, over leveraged business models are allowed to fail. Only when we know who we can safely lend to will we safely lend and no amount of devalued £10 notes and rates at 315 year lows will alter that. Not one advocate of the current stimulus methodology can answer the most important question. HOW MUCH WILL YOU EVENTUALLY NEED? If the answer to that is ‘We’re not sure’ then the risks of currency collapse and hyperinflation and riots in the streets are simply not worth taking.
We maintain our view that the Pound and FTSE (Inflation adjusted) will head much lower over the next 5 years and that long Gilt yields will be driven much higher by a buyers strike in the second half of this year. There is a major risk of calling in the IMF.
Bank of England cuts rates by 50bps to 1.5%. 8th Jan 2008