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Saturday 6th August 2016
Hi Friend,
The Bank of England makes a move ...
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The Bank of England moved into action this week. The Governor introduced a “timely coherent and competitive package of measures” to avoid recession. Base rate was cut to 0.25%, an additional £60 billion was allocated to QE and £10 billion was allocated to a Corporate Bond Purchase Scheme.
TLS, the Term Lending Scheme was introduced to improve liquidity in the banking system and ensure rate cuts are passed through to borrowers. Simultaneously the Financial Policy Committee announced a relaxation of leverage ratios and counter cyclical capital buffers to ease liquidity in the banking system.
Ruling out negative rates and helicopter money, “a flight of fancy”, the governor suggested rates cut be cut by a further 15 basis points before the end of the year. Base rate could rest at 0.1% by Christmas. More QE and corporate bond buying remains a further option.
Last month, Andy Haldane, Chief Economist at the Bank called for a sledgehammer to crack a nut in view of the “heady cocktail” of uncertainty about the economy, policy and politics. The Governor and the MPC heeded the call. Base rate was slashed, the MPC was unanimous. Not so in the case of QE and corporate Bond buys, three members of the committee voted no!
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Is the Bank moving too soon ...?
“Changes
in the economy are structural” said the Governor. Crikey, it was just a
referendum vote! We haven even told the EU we are leaving yet! Article
50 may not be invoked until 2017, then will follow five years of
negotiation on exit arrangements and a trade deal. The changes will be structural eventually but we will have up to ten years to adjust to the new
environment.
“Uncertainty may impact on investment, household
spending and housing activity”, warned the Governor, “A fall in Sterling
will push prices higher”. So it may prove, the transmission mechanism
is well documented. Not long to wait though?
The rate cut pushed
Sterling lower. The August Inflation Report forecast lower growth,
rising inflation, job losses and a fall in house prices. Excellent. Not so much a boost to confidence as a self fulfilling prophesy. Consumer
confidence may take a hit if people churn through 68 pages of the latest
Bank update.
The pressure is now on the Chancellor to act in
response. In his letter to the Governor, the Chancellor made it clear “I am prepared to take any necessary steps to support the economy and
create confidence”. Wait for the Autumn statement was
written between the lines.
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Better to wait and see, acting with HMT …
Herein lies the problem, better for
the MPC to hold fire for the moment. Weakness in domestic demand as a
result of lower household spending or a fall in investment activity, is
best met by fiscal action from HM Treasury. Better to wait and see.
Business as usual with a Bank prepared to move in a co-ordinated move
with Treasury would have been a stronger message.
Far from
cracking the sledgehammer, the Old Lady of Threadneedle Street is
flapping a parasol in premature response to a problem which has not
arisen as yet.
Far from presenting “A timely and package of
measures” the Governor is indulging in a premature, over reaction to
sentiment surveys without hard data. The
unreliable boyfriend is reliant on an unreliable data set. The PMI
Markit Composite series on which the Bank is relying, has signaled seven
recessions over the past sixteen years. Only one has come to pass
as yet. The survey data has misfired often since 2000.
“Recent survey data may have overstated a downturn. Over reaction based on limited data will make the situation worse.
So what is really going on?
More
QE, may be a preparation for Infrastructure bonds to be announced by
Treasury as part of the money for nothing - gilts for free plan. Or
maybe the Governor is worried about the "Kindness of Strangers” and the
diminishing appetite of overseas buyers for UK gilts. Last year, foreign
holdings accounted for 25% of UK gilts down from 31% three
years ago. The Debt Management Office has been slow to release the figures for 2016, maybe
the Governor has had a peek!
If the Governor is worried about
the “kindness of strangers”, a policy which pushes 10 year gilts yields
below 0.7% and undermines Sterling is no way to support the “Biggest
Bond Bubble in History”, £1.6 trillion of debt with “inky blots and
rotten bonds sustained".
And what of corporate debt? The market has no need for Bank intervention in the
corporate bond market. The market is worth some £400 billion of which
£150 billion would be eligible within the Bank purchase scheme. £10
billion will be allocated to those firms “making a material contribution
to the UK economy”.
What is the point? Officially, the
objective of the Corporate Bond Purchase Scheme is to “impart monetary
stimulus by lowering yields on corporate bonds, reducing the
cost of borrowing for companies.”
Why so? There is no funding
challenge for large corporates with bond market access. More than
adequate liquidity is already squeezing rates available. So much for the
search for yield. QE has undermined gilts yields, it will now attempt
the same thing for the corporate bond market. The pressure on savers,
investors and pensions funds will intensify.
The 25 basis point
reduction will have little impact on spending on confidence and
investment. We drift nearer and nearer to the NIRP crevasse, trapped on
Planet ZIRP. Bold moves this week heading in one direction but where is
the exit plan?
The time may come when we will have to confront
the “structural” impacts of Brexit but not for years yet. What tools
will then be left in the policy tool box. The sledgehammers and JCBs
will be working overseas. The Old lady will have nothing but toothpicks
and dental floss left in the handbag.
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So what happened to Markets?
Sterling fell against the Dollar to $1.308 from $1.323 and moved down against the Euro at €1.179 from €1.185. The Euro moved up against the Dollar to 1.109 from 1.116.
Oil Price Brent Crude closed at $43.93 from $42.36. The average price in August last year was $46.52.
Markets, were up - The Dow closed up at 18,509 from 18,441. The FTSE closed at 6,793 from 6,724.
Gilts - yields moved down. UK Ten year gilt yields closed at 0.67 from 0.69. US Treasury yields moved to 1.57 from 1.48. Gold closed at $1,337 from $1,350.
John
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