The European Central Bank is likely to mimic the Grand Old Duke of York today

8th December 2011 by Shaun Richards

Today sees policy meetings at both the Bank of England and the European Central Bank and we could see moves from both although action from the European Central Bank is much more likely, indeed very likely. I think that the ECB is more likely to follow the example of the Reserve Bank of Australia which cut rates by 0.25% this week than the Reserve Bank of New Zealand which lefts its interest-rates unchanged at 2.5%.

How times have changed since the spring

If we recall in the spring/early summer of this year the ECB raised interest-rates twice by 0.25% and therefore raised from 1% to 1.5%. Indeed it was only on the 7th of July of this year that it made the latter upwards move and told us this.

Upward pressure on inflation, mainly from energy and commodity prices, is also still discernible in the earlier stages of the production process. It remains of paramount importance that the rise in HICP inflation does not translate into second-round effects in price and wage-setting behaviour and lead to broad-based inflationary pressures. Inflation expectations must remain firmly anchored in line with the Governing Council’s aim of maintaining inflation rates below, but close to, 2% over the medium term.

At that meeting the inflation rate in the Euro zone was 2.7% and it is now 3%. So what happened to the philosophy of setting interest-rates to control inflation you may ask? You may also ask what happened to the independence of the ECB as it has always been very strong on inflation control but now seems to be kow-towing to the objectives of its political masters.

Care is needed here as at the time of the interest-rate rises I pointed out that they were clearly inappropriate for Greece Ireland and Portugal and maybe one or two others such as Spain and Italy. But of course in a 17 nation currency you are going to be incredibly lucky if you can make a move to suit everyone…..So like virtually every discussion on the Euro zone these days you find yourself at the thorny topic of the failure to achieve fiscal union.

A move already made- Thank You Uncle Sam

The ECB has already acted this week to help the bank liquidity crisis in Europe. It did not get the prominence in the media I felt it deserved but it provided 50.7 billion US dollars of 84 day liquidity. Perhaps in these days of numerical inflation 50 billion isn’t what it was! This was from the central bank liquidity swaps I have been discussing for a couple of months and as the funds are in effect borrowed from the US Federal Reserve if the crisis was a western film this stage would see the arrival of the US Cavalry! Whether this will turn out to be Little Big Horn or a triumph remains to be seen.

At the bottom of this we see a European banking system which is in distress and as an example of this even after that move emergency overnight borrowing from the ECB has risen to 9.4 billion Euros in spite of the fact that there is a penalty for using this facility as it costs 0.75% more than the official rate. In some ways there is an even bigger problem than that because Europe’s banks have deposited some 324.5 billion Euros with the ECB overnight.

The real problem with this is that the ECB is fast on its way to become the European interbank market and rather than being a central bank is becoming a transmission mechanism for more than just its own policies. If we recall it was a failure of the interbank market which led to credit crunch one.

For those wondering about where the 50.7 billion Euros went I would supect that some at least would have been taken up by French banks.


So the ECB finds itself in between a rock (the banking crisis and the peripheral Euro zone sovereign crisis) and a hard place (its inflation strategy). With the economic outlook worsening in some countries such as Spain quite quickly the ECB is likely to say today that it expects inflation to fall and accordingly is likely to cut its official interest-rate to 1% and hope that not too many people spot that it has copied the marching strategy of the Grand Old Duke of York!

Oh, the grand old Duke of York,
He had ten thousand men,
He marched them up to the top of
The hill and he marched
Them down again. 

And when they were up they were up.
And when they were down they were down.
And when they were only half way up,
They were neither up nor down.

In addition we are very likely to see a technical move to extend the term of the long-term repo operations of the ECB.Here I am afraid we can recall the Grand old Duke of York again as the ECB had been taking these things away and now finds itself reinstating them. We are back to my theme of exit strategies or rather the inability of central banks to be able to enact them. If anything bothers me at this time I think that this bothers me the most, regular readers will recall I wrote an article on whether Quantitative Easing would become never-ending for its supporters and eztraordinary monetaary measures do seem to be progressing on that path.

The longer-term repos will be of the order of 2 years which of course has echoes of the original Irish annoucnement to guarantee its banking system for two years. It is not the same move but it is the same term is it not?

The Bank of England

Traditionally one would expect the Bank of England to do little in the run-up to Christmas. It does of course have an ongoing expansionary policy as already this week it has purchased some £5.1 billion of UK government bonds or gilts as part of its plan to own an extra £75 billion of them. So far it has bought approximately £45 billion of this which leaves some £30 billion or around 6 weeks worth depending on how it decides to act over the Christmas break. So if it really wanted to send a signal it could announce more purchases today.

As a technical issue it is not always finding it easy to buy the bonds it wants as some holders are there for the long-term (for example annuity providers) so I doubt  we will see an acceleration in the rate of purchases but perhaps them going on for longer. A question of nuance here.

Do the latest economic figures count?

One which should does not seem to as the current official target for inflation is 2% and the actual rate is 5%! If you recall the letter I received from the Financial Secretary from the Treasury told us this.

The MPC is required to achieve an inflation target of 2 per cent as measured by the 12 month increase in the Consumer Price Index.

I will leave readers to their own thoughts as to how an expansionary policy can achieve this from 3% over the target!
Other economic news has been weak though
Only yesterday I reported this

The seasonally adjusted Index of Production fell by 1.7 per cent in October 2011 compared with October 2010.

This week has also seen this from the National Institute for Economic and Socal Research or NIESR.

Our monthly estimates of GDP suggest that output grew by 0.3 per cent in the three months ending in November after growth of 0.4 per cent in the three months ending in October. Economic growth in the UK remains subdued. These data lend support to the further loosening of UK monetary policy.

As you can see they were unable to restrain themselves from offering a policy presciption for today and they will not be alone in this view. However some care is needed as at the NIESR this is a matter of belief and faith as much as opinion!

So we could easily see a round up of the amount of QE2 in the UK to £100 billion or they could wait until January. If things are even more desperate in Europe’s banks than we realise we could join in with an ECB interest-rate cut and reduce to 0.25%. This is a real outlier though and in my opinion would be as likely to spook markets ( as in they would worry about why) as help them, so if we do get it then on reverse logic the metaphor would be , be afraid be very afraid!

13 thoughts on “The European Central Bank is likely to mimic the Grand Old Duke of York today”

  1. Drf says:

    “If anything bothers me at this time I think that this bothers me the
    most, regular readers will recall I wrote an article on whether
    Quantitative Easing would become never-ending for its supporters and
    eztraordinary monetaary measures do seem to be progressing on that path.”  Exactly, Shaun, a clear sign that there is no exit strategy ever intended!  The clear intention is ongoing debasement to get out of the hole they have dug themselves into.  The weird issue in my opinion is why the markets do not seem to anticipate this yet?

    “This is a real outlier though and in my opinion would be as likely to
    spook markets ( as in they would worry about why) as help them, so if we
    do get it then on reverse logic the metaphor would be , be afraid be
    very afraid!” Absolutely, Shaun; I agree entirely, and I am very, very afraid of what these fools are likely to do next!

  2. ExpatInBG says:

    Hi Shaun,

    Australia has some room
    to drop cash rates where arguably NZ should be raising their cash
    rate because they have negative real interest rates.

    Australia cash rate =
    4.25%, inflation = 3.5% (Reserve Bank of Australia)

    NZ cash rate = 2.5%,
    inflation = 4.6% (Reserve Bank of NZ)

    The Australians may
    have lost the rugby, but their economy is much better than NZ.

  3. Mac says:

    I just don’t get why for a fraction of the QE figures we aren’t
    quietly rebuilding our own economy while we are still out of the markets spotlight
    and have some wriggle room? 

    1. JW says:

      Hi Mac, its because the QE is ‘buying’ the nations debt as Drf described so well yesterday. Technically its keeping bond yield low, but only because most bonds are being bought by the BoE indirectly. So the nations debt is being paid for by the debasement of the currency, ie inflation.
      Shaun’s point is , how do you reverse this? I think he knows as do others that its actually a case of ‘how do you stop doing it?’
      The problem is that UK as well as most western economies , have so much debt, that the only alternative to this policy is severe debt-deflation a la IMF ie Lithuania. Squeeze the economy so much that 30% of your population up sticks and leaves. Not viable for the UK, unless you fancy daily riots ( see Greece).
      So its 30% or so reduction in living standards for the 99%.
      Now we could redesign the whole ‘free market capitalist’ structure, but that is full of hazards as well.
      Alternatively Iran could help by lobbing a few nukes about, nothing like a war to overcome these sorts of problems, always worked in the past.

      1. Mac says:

        I do get it JW, its just I think we are mad to carry on down
        the same path, supporting the same policies and instruments which have led us into
        the deep morass we are in now. 

        We don’t need to stop and redesign the whole ‘free market
        capitalist’ structure, that’s called a revolution and we might ultimately get
        there by force of events but that not what I am suggesting. 

        We could however be introducing innovative and imaginative procedures,
        firstly in small measure to see what works, which redistribute the checks,
        levers and balances to more adequately benefit the majority rather than a
        select few! 

        Our leaders couldn’t manage the upside; there is absolutely no
        chance of them being able to manage the downside!  We need to change the pitch and the

  4. Ian_jones says:

    I am glad to see the Germans refusing to go for the QE option. That is only to be use once you cant even afford to pay the interest nevermind the capital. This is the situation in the UK so the BoE tries QE. Unfortunately this just freezes the system as those with cash invest it in tangible assets rather than productive assets. So we get inflation,no growth and declining real incomes. Some people are getting very rich, the majority are paying for it.

    1. Anonymous says:

      Hi Ian

      i havw written about QE on this blog many times and it remains true that there are as many questions as answers. How do you stop doing it is one? And then you get how do you reverse it?In my opinion we should be doing/planning both.

      Yet more money is poured into the financial system via it which gives it an appearance of being healthy when it is a facade hiding real and serious problems.

  5. Edward Webb says:

    Hi Shaun, I’ve been reading your blog for more than a year, and noted how the economy is changing more-or-less in line with what you have predicted. You’ve asked me to post here, so here’s my post.

    Steve Keen recently gave an interview on BBC’s HardTalk about recapitalizing taxpayers instead of banks:

    Full interview:

    While I think he has a point that taxpayers’ money should be used to help taxpayers rather than banks, the money should also be used to help create stronger links to emerging markets and build our manufacturing base instead of our current over-reliance on financial services.

    The question is whether to keep banks alive at government and taxpayers expense, and face a future of stagflation and low/no growth; or whether we should go into the unknown and allow banks to fail, and how to resolve the resulting liquidity crisis.

    The result of this question has to be carefully considered, as without a stable banking system, there would be few avenues to lend to the public. A couple of reports on the BBC indicate this may already be happening:

    ‘Millions turn to payday loans [in next 6 months]’:
    Radio programme about people struggling with debt :

    We have a very serious situation, with public debt growing out of control, and face an extremely difficult year ahead. I think Keen’s analysis is fair (if needs a lot more detail and debate), and will be more likely discussed more widely in the future; but, the would need to be etensive leadership and agreement from countries – some of whom (creditors in particular) who would find change hard to swallow. 

    It’s also against human nature to make radical changes to what was a functioning system:

    … and the pressure to conform is often stronger than the qualities required to lead (and face potential isolation). The question asked is economic; but the answer must be democratic. That would mean meeting with business leaders, entrepreneurs, people from all walks of life and anyone who’s interested, together to create new ideas (radical, controversial or perhaps just sensible) and have our government lead into new territory (and more fully into markets beyond the West), rather than follow into recession.

    I’m interested to know what you think about Keen’s idea, and whether it can help taxpayers, or whether the result would be worse than the current austerity. Also: Do you think that instead of banks lending to the public, in the future approved companies (regulated by the government) could use taxpayers money (that was before used to bail out banks) to lend to taxpayers, in return for reduced tax levels/share of interest? Money would be lent to the fiscally sound; share of losses (if any) would come out of companies’ profits to taxpayers.

    This is a lot to consider; so feel free to respond to the parts you find most relevant.

    1. JW says:

      Doesn’t this all boil down to one thing. ‘Interest’ was charged on loans originally ( a few centuries ago) because of real physical risk of cargoes being lost at sea. Through various circumstances central banks have been invented to issue fiat money ( vertically) and ‘control’ interest rates ( for horizontal money creation through commercial banks). If these were disbanded and the government directly issued ‘money’ with no interest rate you would get to the world Keen is describing. There are vast reams of stuff on this on the web, its become a lot more popular since 2008.
      As every western government is stuffed full of executives from the ‘vampire squid’ and its friends it would need some sort of revolution to get there.
      Personally I suspect one second after ‘nirvana’ some greedy sod ( which could be anyone, as its only human nature) decides to re-invent usury and the slippery slope begins again.

    2. Anonymous says:

      Hi Edward

      Thank you for the compliment and welcome to the commenting part of my blog.In case anybody is wondering about your introduction let me point out that you asked me this question on twitter to which I replied that Steve Keen’s analysis deserved a lot more than 140 characters.

      I will mull it over so more but I do have some initial thoughts.

      1. I do not think that Steve Keen has explained here whether he includes savers in his creditors. As I read it his views on them seem to be missing.

      It is my view that savers are getting a raw deal out of current policy and would be in danger of getting a raw deal out of his response which would be inflationary.

      To go forwards ( to boldly go as Star Trek put it) we need a deal for savers too.

      2. I agree that the banking sector needs complete reform. I think he rejects capitalism too quickly as the too big to fail culture has not given it a chance. I would for example have let Northern Rock fail and protected small/retail depositors.

      One of the ironies of a relatively purist capitalist approach is that right now the consequences would be similar to Marxism as I would be burning capital in the banking sector. By this I mean that in the specific case of RBS frankly we may as well nationalise it and I do mean that that would entail wiping the shareholders  out.This would end the false market in them we have right now

      3. He does not seem to deal with moral hazard in these issues and does not appear to have a mechanism to stop this happening again. I did a post on this where after a forensic accounting of bank books I suggested that investment banking should be  partnership based on not based on shares and that directors should be subject to a new responsibility for grand negligence which in the extreme should be a criminal offence.

      Care is needed as he was in an interview and may have forgotten things. I have heard Sarah Montague of this before and she has been out of her depth and for example interviewed Kyle Bass very poorly.

      An example of this is her forgetting that the Nazi’s called themselves the “National Socialist” party. It is a common BBC blindspot to only see one rather than both sides of the coin.

      Steve may have indirectly replied to this with “And economics departments were the source of that bad thinking.” as the BBC economic output does follow that route but I may be reading too much into that being a dig rather than a statement of fact.

      So in conclusion a fair bit of analysis that I agree with but in my view we have a fair bit of agreement but also some important differences.

      1. Sean Fernyhough says:


        Look at Steve’s output on – particularly the recent presentations at Cambridge Uni (these may now be pages 2 or 3). 

        I’ve been following Steve since early 2009 and I think the interviewing probably took him away from what he was trying to say and it was a bit of a “battle” to use the reply to each question to get back to what he was trying to say.

        Steve can speak for himself – to say the least – but I would say the following:

        I don’t think he is rejecting capitalism.  What he does say is that it’s virtues do not lie in it’s stability and moderating behaviour.

        He would agree that the rules of capitalism are not being followed in the matter of the insolvent banks – and that this is prolonging the economic crisis.

        I think that his response to the moral hazard question he would say that the long term exponential growth of private debt has created problems with solutions where moral hazards abound. In particular he would say that mere deficit spending cannot get us out of this situation because the private sector debt overhang is so seriously large.  

        With regards to savers specifically we have system threatening-economic crisis – without economic recovery their savings will continue to receive poor and negative returns. 

        Steve’s conclusions are rooted in his economic model, which are still in development – another reason why the interview was difficult.  His economic model is interesting in that it can reproduce the Great Moderation as well as the Great Recession.    It also shows that moderating in the rate of private sector deleveraging has a stimulating effect on economic activity –  therefore he predicted that the improvement in economic numbers 12 months ago would be temporary.  He has also used the model to provide conclusions that show that if the bank bail-out had been used to bail-out the economy then the outcome for everyone – apart from banks – would have been better than what we have had.

        Lastly I would say that the comment about Economics Departments is central to a lot of what Steve is saying.

        Of course if you are in our currnet sceanrio debt forgiveness will not occur because those debts are bank assets.

        In other words things will have to get a whole lot worse.    


  6. Sean Fernyhough says:

    I notice that Osborne has been reading Rogoff.  I dug the article article up from 2008:

Leave a Reply

Your email address will not be published. Required fields are marked *