The Monetary Policy Committee and the European Central Bank meet today which reminds us of the role of central banks

5th August 2010 by Shaun Richards

In a world in which bank statistics and figures are pored over by analysts and economists to try to discover not only which is going on with the individual bank but also the underlying economy this has been a week which should offer some insight. However there is a potential catch. Such is the way that regulators and accountants have interacted that in fact it is hard to infer much at times from looking at some sets of accounts. For example let us take a look at Lloyds Banking Group’s figures from yesterday. There were  three profit figures presented which were £1.6billion, £1.3billion, and £280 million. At least the range this year was only £1.3 billion last year it was £14 billion! Somehow the accounting profession seems to have developed a system which confuses rather than enlightens investors. I notice also that the return to profit (at least all  numbers were a profit this year) for Lloyds was driven by a fall in bad debts to £6.5 billion from £13.4 billion which leads to a whiff at least of financial alchemy in the results. I gather than a fair proportion of the bad debts reported are from commercial property investments in Ireland and will look into this further.

Commodity Prices

After writing on commodity prices yesterday I thought that I would give an update on developments. Overall commodity prices continue to rise with the CRB spot index increasing by 3.23 yesterday to 443.54. One factor in this rise would have been the price of wheat which continued its recent rise and is now at US $7.68 per bushel. As might be expected at a time like this there are all sorts of rumours such as Russia looking to ban exports of grain, however we have a long way to go before we reach the highs of 2008 when the price exceeded US $13 per bushel.

A comment on this blog reminded me that there are quite substantial inventories of grain around the world of around 200 million tons and suggested that much of the current rise is speculation. Well one thing that is for sure is that the inventories are suddenly a lot more valuable and with governments short of cash around the world perhaps they could sell some.

The Monetary Policy Committee

At noon today the Bank of England’s Monetary Policy Committee will publish its interest rate decision following its two-day meeting. We are at one of the points in time when it is possible that all  potential results could be represented, tightening, no change and an easing. Also it will be discussing updating its forecasts as we will soon have its quarterly report on inflation forecasts. There will be some head scratching going on as the recent performance by the MPC in this area has been dreadful. For example a year ago they forecast that inflation would now be less than one per cent whereas it has been over three per cent for some time. Now whilst such a conclusion may not seem a big deal remember that they take policy decisions based on these forecasts. Therefore they would have been setting economic policy expecting lower inflation than exists suggesting that they have set policy to over stimulate the economy. Some feel that the rise in Value Added Tax that took place in January of this year means that in some way this is a less important error. As it was an event known at the time actually to my mind the impact of the rise in VAT should have been  predictable.


The argument for this is simple and has been expressed by Andrew Sentance who has voted for an interest rate rise at the last  meetings. He feels that the number of occasions in recent years where inflation has exceeded its target (41 months out of the last 50) has within it the danger that inflationary expectations will rise. He also feels that the world economy is recovering more strongly than expected. Accordingly he wishes to start to reduce the degree of monetary stimulus in the economy. He is not in the camp of applying a brake he simply wishes to stimulate less.

The case for easing

This is essentially a proactive argument which involves the MPC getting out its crystal ball and looking into the future. Here proponents of further easing see dangers to UK economic growth from several factors. On the worldwide scene we have an apparent slowdown in growth in the United States and the expected impact of the austerity packages which have been implemented in much of Europe. On the domestic front we have the austerity Budget implemented on June 22nd by the UK Coalition Government which they expect to push UK domestic demand lower.

So those in favour of easing will further point out that monetary stimulus takes time to have an impact and that accordingly it would be better to act now and get ahead of events. It is usually considered for example that a monetary stimulus takes around 12 to 18 months to have most of its impact. They are unlikely to argue for a cut in official interest rates as they are already at 0.5% so would be more likely to suggest an increase in Quantitative Easing or asset purchases.

The Most Likely Outcome: Unchanged

As the world economic outlook in the words of Mervyn King the Governor and indeed the Chairman of the Federal Reserve Ben Bernanke is “uncertain” then it is most likely that the MPC will choose in this meeting to do what Sir Humphrey Appleby of Yes Minister called “masterly inaction”.

It is not impossible that the vote will be closer to easing than we might think. After all there is a lot of debate at the moment suggesting that the Federal Reserve may undertake some further monetary stimulus at its meeting next week. So it surprises me that there is not more debate on whether more easing might come from the MPC.

Opinion and Comment

One factor against the easing camp is the forecasting record of the Monetary Policy Committee. After its recently dire performance I would suggest that some humility is required and this would to my mind on its own militate against further easing now. Also it has consistently set policy based on this over-pessimistic basis leading me to conclude that currently we have plenty of monetary stimulus in the UK economy. I think that it would be more logical to look further at the impact of this stimulus before undertaking any more.

As to tightening now this leaves me in a slight quandary. I wrote on here at the turn of the year that I favoured a reduction in the level of stimulus in the UK economy as I feared an uptick in inflation and accordingly I would have raised the official interest rate to 1.5% to try to reduce the impact of this on inflationary expectations. However as the lags in monetary policy are long and variable I do wonder if the time to raise may have passed as there is now evidence of a possible worldwide slowdown in economic growth. If I move from what I would have done to today’s reality I would still join Andrew Sentance and vote for a small rise in rates as I feel that continually letting inflation exceed its target and not responding is a policy error.

Other World Central Banks

The Federal Reserve

Here we have another example of the “uncertainty” that is currently prevalent. We see the Federal Reserve this week actually trialling measures to reduce the level of monetary stimulus in the US economy at the same time as speculation increases that at its meeting next week it will in fact try to stimulate the US economy again. So whilst there is speculation concerning QE 2.0 or QE lite to use a couple of the suggested titles which involve either more stimulus or more inventive ways of applying the exiting stimulus measures. 

As I have written before the Federal Reserve has found that its plans for 2010 have gone somewhat awry. Having planned to reduce its stimulus measures it has endgamed itself for now, because if it stopped these moves it would reveal its hand and yet at the same time it is concerned by economic events…..

The European Central Bank

This situation is slightly different as it is only on May 10th this year that the ECB found itself implementing a QE type policy to try to help the peripheral nations in the euro zone. So in its timetable it ended up being over a year behind the Bank of England and the Federal Reserve. In effect as it too was planning a reduction in stimulus measures it was in my view forced into a u-turn by the euro zone politicians.

However behind this in more technical areas which are likely to be outside the influence of politicians it has been making some moves. For example its 12 month long term refinancing operation expired at the beginning of July with only a 3 month replacement. Also its weekly operations have been draining funds from the system as an example of this we saw that this weeks Main Refinancing Operation amounted to some 155 billion Euros whereas last weeks was 190 billion Euros. The rise in euro zone interbank rates such as 3 month Euribor which is now 0.9% could be part of a withdrawal policy by the ECB.

So in today’s announcement the ECB is likely to have an unchanged policy regime but it may come with hints of more withdrawals of stimulus measures.


At this moment in time we find the worlds main central banks probably as uncertain as they have been during this economic crisis. The most recent economic data available presents a troubled picture for the world economy but it is not yet definitive. It would be strange to say the least if we saw a planned reduction in measures from the ECB this week and an increase in them from the Federal Reserve next week.

The Monetary Policy Committee has a slightly different problem as inflation has been more of a problem in the UK than elsewhere and it has performed poorly on this front. However it is likely if anything to continue on its recent path of seeing its job as supporting the economy rather than aiming at an inflation target. To my mind this questions its whole reason for being as politicians and government could do that with probably not dissimilar results.

I will update later on the results of the meetings.

Bank of England’s Monetary Policy Committee  August 2010 Meeting Result

The Bank of England’s Monetary Policy Committee today voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5%. The Committee also voted to maintain the stock of asset purchases financed by the issuance of central bank reserves at £200 billion. So no great surprise and we will have to wait two weeks to see if there were any dissenters to this result.

European Central Bank August 2010 Meeting Result

The ECB voted to day to keep its official interest rate at 1%. I will update if there is any particular news from the Press Conference it holds after announcinmg the vote.

President Putin bans grain exports from Russia

Russia has announced it will impose an export ban on grain and grain products from August 15th to December 31st  as a response to the effect of the country’s worst drought in half a century on its expected wheat crop. A more preferable move would have been for world bodies to have got together and used some of the approximately 200 million tons of grain stocks which exist to stop panic moves like this but sadly this seems unlikely, although of course it does beg the question of what the purpose of such stocks is/are.

Of course if speculation is at the route of this I suppose that conspiracy theorists might start to wonder if the buyers have been oligarchs…Either way the price of wheat is now above US $8 per bushel.

8 thoughts on “The Monetary Policy Committee and the European Central Bank meet today which reminds us of the role of central banks”

  1. Graeme B says:

    ‘However as the lags in monetary policy are long and variable I do wonder if the time to raise may have passed as there is now evidence of a possible worldwide slowdown in economic growth.’ I completely agree, although I am not sure that such a low base rate serves to stimulate much lending anyway. A base rate lower than say 1.5-2% seems to be overkill – no-one ever offers loans at such rates (the only purpose could be to surreptitiously bail out banks by increasing their margins at the expense of savers). I worry about the MPC’s remit to specifically target CPI as well. Perhaps this is part of the problem? CPI and RPI are lagging indicators, and perhaps it would be better to focus more on the money supply?

    On the subject of QE, I’ve been thinking about its purported mechanism of increasing lending – namely, increasing deposits at banks and thus allowing them to make more loans backed by these reserves. Correct me if I’m wrong though, there doesn’t seem to be a mandatory reserve requirement in the UK anyway – commercial banks are only required to hold a ‘prudential’ level of reserves (i.e. they can create as much loan money as they judge safe). The real criterion that restricts lending seems to be capital requirements, i.e. equity / Tier 1, which is a measure of bank solvency, and is unaffected by the volume of deposits (which are other peoples’ money after all!). Have I missed something here?

    1. Hi Graeme
      Actually I think that one of the main reasons for the current very low level of interest rates is to provide a backdoor bailout for the banks. This is an ever more familiar theme as one surveys the economic landscape and this weeks figures have left me with an unsettling thought. As so much has gone into boosting bank profits why are they not higher?

      As to inflation targetting I think that there are 3 main issues which have led to problems.
      1. A downwards creep in standards as definitions are modified. For example the switch from RPIX to CPI in 2003 and the recent extension of the uses of CPI which plainly is because it produces lower numbers. This reduces credibility.
      2. The fact that for the period of the credit crunch the MPC has only given lip service to inflation targetting and is in effect targetting GDP growth.
      3. It is plain that asset prices need to be included and probably exchange rates too as we go forward to get a better idea of monetary and price conditions. As to money supply we have tried that in the UK and the problem was a combination of Goodhart’s Law and disintermediation unfortunately…

      As to reserve requirements the the Bank of England has not operated such a policy for quite some time. Whilst there are requirements for banks in how they behave with the Bank they do not have to hold a certain % of their assets there for that purpose. The restrictions on their lending at this time are capital ratios and I would suggest market perception of how much of their lending is financed by deposits and finally how likely they feel it is that they will be supported by the UK taxpayer.

  2. Graeme B says:

    So in your opinion, is the most likely outcome here stagflation? I can’t see imminent signs of a wage-price spiral, or of rapid demand recovery. The bond markets still seem to be signalling deflation ahead, but I don’t see how this could persist with Bernanke and Summers in charge of the world’s reserve currency.

    On a related note, how would you recommend hedging against stagflation when gold is already over-priced? (not that it couldn’t go higher!) perhaps essential commodities like… wheat? oil? shame about the end of index-linked savings certificates – I’m apprehensive about buying index-linked gilts.

    1. Hi Graeme
      I think that certainly for the UK stagflation is more likely than is being appreciated. We seem to have entered a period of time where everyone is concentrating on extreme possibilities as in some form of double-dip/depression or things collapsing towards hyper-inflation. This is a real change in psychology as usually people ignore the extreme possibilities so it is a clear feature of one of the ways the credit crunch has changed things, for now anyway.
      It is quite possible that we will have slow growth for a while as the worlds zombie banks grind on and refrain from lending. The UK has shown that it is quite possible for us to have inflation even when GDP falls substantially yet virtually no-one seems to join the dots. Another curiousity is that even after the recent UK growth figures which were very good for Q2 so few people seem to believe that the economy might be on the verge of a decent recovery….
      With the end of index linked national savings certificates for now it is now difficult to hedge against stagflation as index linked gilts can fall and so run risks if we should go into a deflationary scenario unlike the certificates. I think there may well be a time going forward when index linked gilts become cheaper than now but that is only surmise and is a disturbing thought for a man who holds funds with them in!

  3. Graeme B says:

    The BoE pension fund seem to think linkers are a good idea if that offers any comfort…

  4. SeanBroseley says:

    Russian ban on exports + worldwide sitting on reserves = speculation will prosper

  5. SeanBroseley says:

    One way of treating your central banker:

  6. Carys says:

    As far as I can tell from my perch in Spain, the whole ‘denial of inflation’ thing is a political response to a very tricky situation. Somehow the BoE has to try to dampen down inflationary expectations because it has publicly sold itself the idea that interest rates must be kept low and therefore cannot raise them. I have never understood why they need to be quite so low as they are (though I concede they have to be very low by historical standards), but the base rate is at least a certain figure. Inflation as experienced by the real world is definitely not at the level the various indices show, and it seems to me to be virtually impossible to square the various factory input and output indices with what the ONS is showing, even allowing for a very long lag between factory prices and consumer prices. Time will tell but I think there will have to be a rise in the base rate quite soon and at that point the BoE will blithely say that inflation has suddenly got out of hand… and that something had to be done. Sterling may, at that point, start to recover a bit.

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