A forecast for policy action from the US Federal Reserve, the Bank of England and the European Central Bank

4th April 2011 by Shaun Richards

After the concentration on the peripheral nations of the Euro zone last week with Portugal and Ireland both having a bad week the emphasis moves this week to two of the central banks in Europe. Firstly we have the European Central Bank which is the central bank for the seventeen nations of the Euro zone. Unless something extraordinary happens in world markets it is likely to raise its official interest-rate from 1% to 1.25% on Thursday. This will be presented as being in response to an increase in inflation in the Euro zone which was estimated by Eurostat as being at 2.6% late last week. Such a move may well fit the core nations and certainly does fit Germany but will not fit Portugal,Ireland or Greece and will do Spain’s troubled mortgage and housing market no good at all.

The Bank of England

By contrast the Bank of England may raise interest-rates but is much less likely to. In the past it has often used Gross Domestic Product figures as a rationale for moves and our official measure on this front has a latest report of -0.5% from the last quarter of 2010. accordingly the three members who voted for an interest-rate rise at the last meeting are likely to struggle to find support. The factor most likely to sway the other members might be that the ECB is expected to move and that even some members of the US Federal Reserve are talking about interest-rate rises later in 2011. However for the UK any rise is more likely to come in May which comes after the first report for GDP in the first quarter of 2011.


There is food for reflection here as the UK and the Euro zone have the same inflation measure. So we can see that the ECB considers an inflation rate of 2.6% to be a level to be too high and one that requires a response, whereas the Bank of England by contrast appears willing to accept an inflation rate of 4.4% without a policy response. Not only is one rate 1.8% higher than the other but we also have had the unedifying sight of various members of the Monetary Policy Committee claiming that raising interest-rates would not help with our inflation problem.

They have simply “forgotten” the impact of a proposed tightening of policy on their currency. Since the ECB has proposed a more hardline stance the Euro has strengthenedand the Pound has weakened. For example since then the pound has fallen against the Euro from 1.18 to 1.135 for a fall of 4% in a month. As most commodity prices are priced in US dollars an anti-inflationary effect comes most strongly here. We see that since its announcement the Euro has risen from 1.3775 to 1.4228 against the US dollar whilst the Pound has fallen from 1.63 to 1.615.

If you think about it some more the performance of the Euro has probably been weakened by the continued and indeed escalating problems of Portugal Ireland and Greece so we can conclude that on a “ceteris paribus” basis the exchange rate effect would have been stronger although as I have just demonstrated it has had a solid effect in a calendar month. Of course in the real world we have no way of measuring the effect of the Euro zone crisis.

Institutionalised Inflation in the UK

Another problem for the Bank of England thesis that inflation is an external problem which is cannot influence has come from the price of a humble postage stamp. The price of a first class stamp has risen from 41 pence to 46 pence this morning for a rise of just over 12% and the price of a second class stamp has risen from 32 pence to 36 pence for a rise of 12.5%. These prices are for small letters as a few years ago some new sizes were increased as a way of again raising the price. Following this trend a first-class, large letter stamp has risen from 66 pence to 75 pence which is 13.5% and a second class one from 51 pence to 58 pence for a rise of 13.7%. According to the BBC part of the Royal Mail explanation is this.

With the sharp declines in mail volume, our revenues are falling.

Only a monopoly can think like this! Anybody else would be concerned about the effect of raising prices on the mail volume which is now likely to fall further. By this logic you could justify increases until in the end only one stamp is posted as they get so expensive!


I have argued before that the UK is suffering from an epidemic of institutionalised inflation which often comes in areas which for those concerned are very difficult to avoid. The postage stamp is one example and rail and tube fares are another. I have taken this one step further to say that in my opinion one of the roles of our “inflation watchdog” the Monetary Policy Committee should be to argue and battle against such inflation . I would do so if I was on it. It is not something that responds to an interest-rate rise and so one needs other tactics. However the effects of it can cause more inflation as costs rise.

The US Economy: The Employment Report

Friday saw the latest report from the Bureau of Labor Statistics on this front so over to them.

Nonfarm payroll employment increased by 216,000 in March, and the unemployment rate was little changed at 8.8 percent.

The BLS is a little confusing with the way it reports matters so let me make it clear that the unemployment rate had fallen from 8.9% to 8.8%. So we start with a broadly pleasing headline set of numbers which are added to by some small favourable revisions for the employment numbers for January and February which totalled 7,000.

As we review the data further we see some impacts which are not so favourable and these will be familiar to those who have followed the development of this situation. Those who are in part-time work for whatever reason (voluntary or compulsory) increased to 8.43 million in March from 8.34 million in February. This situation had been showing signs of an improvement but as you can see turned down in March.  The number of long-term unemployed which is defined as 6 months also rose from 5,933,000 to 6,122,000 or just over 3%. Not only is the outright level a concern it is rising and such a pattern is not typical of previous recessions.


I have introduced a measure in the past called U-6. The reason for this is that it covers a wider measure of unemployment than the headline figure as it covers part-time work and what it calls those “marginally attached” to the workforce. Here we saw some good news as in spite of the rise in part-time work U-6 fell from 15.9% to 15.7%.

However the good tone set by the headline numbers and by U-6 is to some extent offset by the fact that part-time and long-term unemployment are rising again. Indeed there is for the headline figures the rather troubling behaviour of the participation rate to explain. If we look at the past the participation rate in the US economy has been 66 to 67% and whilst it was stable last month it has fallen to 64.2% over the credit crunch. If I explain that this represents the percentage of people of working age in the labour force and we remember that fact that the US labour force is say 150 million then a lot of people have left the labour force and the unemployment numbers take a completely different tack.

If we now take a look at these numbers from the aspect of the US Federal Reserve or central bank what can we deduce? This is important as they have said many times that the unemployment/employment situation is the main driver of economic policy at this time. If we look at the non-farm payroll numbers the average improvement over the last 3 months is about 160,000 and over the last 6 months is around 156,000. Hardly a stellar improvement is it?

So whilst we can expect the Federal Reserve to claim that their policy has led to an improvement in the unemployment/employment situation when they are alone late at night they will not be so sure. In my opinion this means that they are unlikely to end their current programme of asset purchases called QE2 and QE-lite early. I suspect they will be worried that if they do they are not sure what will happen next. Also so far no-one on the current voting panel has voted against QE2 so it would take quite a turn-around in view for their to be an overall vote to end QE2 suceeding on April 27th. More likely one or two may vote for an early end but I expect the majority to continue the current programme until its scheduled ned in June and for the unusual Press Conference on April 27th to be an explanation of how the policy will run-off.

Let me be clear that I am not a supporter of QE2 and I would have voted no. I am merely projecting forwards what I feel the current voting members of the FOMC will do. I also fear for what might happen as the world tries to wean itself off this programme and suspect the voting members will also feel this, although they are unlikley to admit as much…

There is much food for thought in another report of the US economy which was published on Friday. The ISM report told us that the US economy continues to grow but that costs and prices are continuing to accelerate as the Prices Paid index  increased again from 82.0 to 85. So some growth is being accompanied by rising cost pressures. So in the short-term I do not expect QE2’s end to be immediately followed by QE3 but I do expect a volatile period after QE2 ends.

The Price of Crude Oil Rises Again

The price of a barrel of crude oil which in terms of its Brent benchmark had been stable at around US $115 started to rise again on Wednesday. As I type this it has risen to US $119.37. If we look back ayearwe can see that it has risen by more than 40% over this period with much of the growth taking place since the beginning of December 2010.

If this carries on for much longer then we will see it have more and more of an impact as the price move gets factored into longer-term contracts. This makes me think of the many commenators who assured us that this move was temporary. And it makes me think of the Bank of England which at least has the opportunity to try to change our exchange rate to help with this issue whereas as the price is in US dollars the Federal Reserve does not have.

2 thoughts on “A forecast for policy action from the US Federal Reserve, the Bank of England and the European Central Bank”

  1. Anonymous says:

    I feel a bit sorry for the MPC. Many of them would clearly like to raise rates but they have been told not to by the government, whose political objectives (no short term crashes in the housing market etc) are in total opposition to the Bank’s.
    Facing in two directions at once is never easy, and it’s obvious that M. King is not finding it a comfortable experience.
    That said, I think the Bank will have to do something soon. If the ECB moves rates up, that will put a lot of pressure on the Pound, which, as we have seen, does little for exports but a lot for import costs.

  2. Ian_jones says:

    The MPC is inflating away debt, there is no other reason. They are using every ounce of the MPC’s credibility to try and get the price level to a point where debt is not excessive as a proportion of general prices and keeping interest rates low to let debtors pay down debt. The question is do they understand the end result will be much higher interest rates and inflation, in other words the 1970’s returned? I believe they are just hoping something like a war comes along to bail them out of the history books.

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