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!