The UK economy:What is the Bank of England doing?

18th March 2010 by Shaun Richards

Yesterday we did not only see unemployment figures for the UK but we also got some minutes from the Monetary Policy Committee and a consultative paper from the Bank of England which may have considerable implications for the banking sector. However just returning to the unemployment figures there is a lot more going on than just a fall in unemployment as measured by the job seekers allowance figures and by the Labour Force Survey.

1. Employment has also fallen

2. Total hours worked fell by 4.6 million over the quarter to January 2010.

3. The inactivity rate has risen and it accounts for the conundrum of employment and unemployment both falling. According to the Office of National Statistics this is mostly due to more people studying and becoming students. On the newswires this morning I saw that the Universities budget is being cut by some £449 million. So you like me are probably wondering exactly how these two facts can co-exist.

4. Public Sector employment is 6.1 million and has risen by 7000 since September 2009.


So whilst I am pleased for those that have returned to work as you look deeper into the numbers there are inconsistencies. Hours worked are falling still and I am very uncomfortable with the rise in the economically inactive. I am sure George Orwell would have loved such a phrase.

On the positive side private-sector employers appear to be more flexible in terms of shorter-time working and holding onto staff. This flexibility is good for our economy and is a partial reason for why unemployment has not hit the heights predicted. However going forward for this to be sustained there will need to be a genuine pick-up in the economy as jobs cannot be hoarded for ever. On the downside is the return to union militancy as demonstrated by the Unite union at British Airways, I do not think there is ever a good time for a strike but the current economic circumstances are clearly a bad one.

What did we learn from the Bank of England?

The minutes of the Monetary Policy Committee (MPC) are starting to show some more nerves about inflation. There appears to be the beginning of a disagreement as whilst the vote was unanimous.

Members drew different inferences about how the balance of risks to inflation was evolving. Some members considered that the upside risks to inflation had increased slightly over the month; others felt that the balance of risks had not changed materially

We do not get a split of numbers but we do get  a nod towards output gap theory (which so far in this crisis rather than being a help has in my view been misleading)

On the other hand, the prospect of a substantial and sustained margin of spare capacity in the economy and downside risks to demand implied a risk that inflation might fall persistently below target in the medium term

There was a mention also to the dangers of a falling exchange rate

The depreciation of sterling since the start of the year was likely to put additional upwards pressure on inflation over coming months

There was also a disturbing statement which can come under several categories for example bizarre or confused ( I am being polite)

Yields on UK government bonds had risen. Ten year ahead nominal forward rates had increased

by around 30 basis points, while real forward rates had risen by rather less. Uncertainty about UK

fiscal prospects could have contributed to that rise. The suspension of the MPC’s asset purchases had

not had much impact on the gilt market.


1. It is clear that one or two members of the MPC are starting to take their role a little more seriously in terms of the inflation target. But all we have is talk not action.

2. The intellectual contortions required to explain the misguided policy of Quantitative Easing go on. I do remember saying in a previous article that they would but the one quoted above is extraordinary you see if they really were that good at understanding markets they  would be good enough to replace Warren Buffet!

3. If you go back to 1997 one of the reasons for the creation of the MPC was that it would take politicians out of the process over monetary policy responding to economic activity as they tend to delay policy responses which involve tightening. Yet the current level of inflation shows that around 18 months ago the MPC did exactly that as inflation is considerably above target (in this instance they should have cut less rather than raised rates). Also there are clear reasons for expecting it to continue but they have failed to respond to the fall in sterlings exchange rate or the pick-up in Producer Price Inflation. These are prima facie policy errors and if they were football mangers they would have been sacked. Or looking at it another way they are doing such a poor job that there might have been a cry for politicians to take the job back if they were not currently so discredited.

A clear example of their muddle is that the 25% fall in sterlings exchange rate in 2007/08 instituted no policy response and yet now a drop of about a fifth of the size.

The depreciation of sterling since the start of the year was likely to put additional upwards pressure on inflation over coming months

A  Revealing Move by the Bank of England

We are in a period where central banks are “normalising” their policy measures as part of a withdrawal from the emergency situation of the last 2 years. However the Bank of England is looking to widen the pool of collateral it accepts according to a working paper it has published. This is significant because it pre-crisis was quite restrictive in what it accepted and during the crisis it widened it. So there is your answer as part of a post-crisis retrenchment it should be reducing not widening. Why then?

Accepting raw loans would also ensure that securities taken in the Bank’s operations have a genuine private sector demand rather than comprising ‘phantom’ securities created only for use in central bank operations

So the Bank of England feels that it has received “phantom securities” or in plain English securities have been created to allow institutions to access (very cheap) liquidity. Really?

Now here’s another thought for you, is this also a way of allowing the banks to access liquidity when factors such as the Special Liquidity Scheme end? There is the possibility that our commercial banking sector will find this very valuable indeed.

Public Finances

After disappointing numbers for January 2010 I waited for the February numbers this morning to see what the trend is. It turns out that they are indeed high as we borrowed some £12.4 billion which makes £131.8 billion for the year so far. For comparison we borrowed £8.8 billion in February 2009. Some economists were expecting an even higher number. Net debt is now 60.3% of Gross Domestic Product.

There was some good news for January’s figures as the number was revised down by approximately £4 billion to a deficit of £43 million.

What does this mean?

One needs to be careful but there is now the serious possibility of an undershoot of the predicted deficit for this fiscal year. March is normally a heavy spending month with 2009 bringing a deficit of some £20 billion and with the weakened economy one would expect it to be higher than that this year. So I would imagine that Chancellor Darling is coming under pressure from his neighbour to pull something out of the hat in next week’s budget.

As to reasons for this we probably saw one yesterday when claims on job seekers allowance fell again. Apart from that I have to confess to some surprise as the recession has been deeper than expected which would lead to the conclusion that the government’s figures might turn out worse than expected. At least past history would predict that… Perhaps the Treasury has subjected us to some expectations manipulation. I will look deeper into this.

UK Exports

I am grateful to the FT for this next piece of data. We export more to the PIGS (Portugal, Ireland,Greece and Spain) than we do to the BRICS (Brazil, Russia, India and China) as for example we export twice as much to Spain as we do to China. So here is a partial explanation for our failure to take advantage of our currency depreciation.



14 thoughts on “The UK economy:What is the Bank of England doing?”

  1. Drf says:

    “Or looking at it another way they are doing such a poor job that there might have been a cry for politicians to take the job back if they were not currently so discredited.” They (or at least Brown) already have/has. He built in the option for him to do that at any time. That may be why some MPC members are becoming evidently uneasy, since they can now see what the outcome of this political tinkering is going to be?

    “Apart from that I have to confess to some surprise as the recession has been deeper than expected which would lead to the conclusion that the government’s figures might turn out worse than expected. At least past history would predict that… Perhaps the Treasury has subjected us to some expectations manipulation. I will look deeper into this.” Of course anyone will be surprised if they do not yet accept the extent of political manipulation which is going on, particularly with government issued statistics! It is not a matter of manipulating expectations; it is a matter of manipulating statistics.

    Why do you think the inflation item basket has just been revised just before an election? Brown has an election to fight. The choice of different items to include is made very carefully to reduce the inflation numbers which would otherwise be higher. (It is a case of the new improved chocolate bar all over again! Because it is new and improved the fact that the weight of actual chocolate in it is now 2/3rds of the original is not an increase in price – but a decrease as seen by the ONS, because it has improved features!)

    The present government is the most devious and deceitful government this country has ever had in power; they will stop at nothing to use tricks to try and conceal and distort the true results of what they have done. You must take all government issued statistics with a pinch of salt at present.

    However, fortunately there is a limited time for which they can continue to do this. Eventually truth will out, as with all Ponzi schemes!

  2. andy of yarm says:

    The ONS will end up m

  3. andy of yarm says:

    Ooops pressed the wrong button.The ONS looks even more discredited than the FSA. In particular they have failed to insist that all liabilities of more than 12 months (including variants of PFI) are calculated as Net Present Value liabilities in the public debt .to domestic players it an open secret that the burden of interest cost is vastly understated if you count only gilt coupons.

    Once is Greece issue is finalised (another story) attention will surely turn to a rigourous example of how the UK can service its liabilities in a low/no growth environment.The conclusion likely to be “it can’t”.

    Somewhere in the ONS I bet there is a smoking gun report that lays bare the total public liability position of HMG. It will emerge by hook or crook.

  4. Johan_Heuvel says:

    This all sounds rather worrying. Is there no independend inflation data? As a net importer nation, the devaluation of the Pound should surely have had a much larger impact. Devaluation helps best if you are already a net exporter. Is there any data on UK demographics in relation to the current housing market? Is the market prepared for a shift in the number of single homes and young families? This year we will see the first start of the Baby boom shift. So another real estate shock might be in the books. All be it not all real estate, maybe dedicated pensioner housing might rise and family homes might crash. Depending on the current supply and current changing build up of the market. Is the UK government taking this into account in their forecasts?
    Not seeing any mention of demographic shifts worries me.

  5. Mac says:

    Can anyone really be surprised with ONS manipulation for political purpose when we see the unelected Dark Lord at the centre of government? Unlike Drf I cannot see that changing significantly whoever wins the next election!
    Like Johan I am worried about the impact of demographics and the baby boomers but it their spending habits which primarily concern me and the effect that will have on the economy as a whole. I don’t think it can be understated. It is probably the last group with any ‘real’ spending power and they are about to exit the market. The baby boomer generation and their purchasing powers have been in their zenith but are now probably starting to tail off as they look towards providing more for their retirement. They have been the spenders with most disposable incomes and probably the driver for the consumer boom we have witnessed. Historically, consumers in their forties and early fifties spend the most money. This is when most people move up to bigger homes, furnish those homes, and support their growing children’s economic needs for goods and services, including education. It’s also when most people reach their peak earnings, thus reinforcing the propensity to spend. Add into that mix the inheritance game and we see a generation inheriting positive cash flow being replaced by a generation using inherited cash to repay debt.

  6. Drf says:

    Marc: I did not imply that anything within the ONS would change if a different party wins the next election. Like you I do not believe anything will change, unless we had some completely new Honest politicians who cleared out those responsible at the ONS for deliberately manipulating data for political purposes. (That is as likely as pigs learning to fly!) I also believe that we have to remember that it was Thatcher who became the first UK leader to increase the structural level of deceit and manipulation of official government statistics for political purposes, as a step function. Even then we did not see anything like the level of deceit which we have now!

    What I did point out was that there is always a time limit on Ponzi schemes. They all collapse and the truth is revealed eventually. No one can say when this will occur in this case.

    I agree entirely with your observations re baby boomers and the demographic changes imminent. However, I believe you also must take into account in this scenario the problem which over 50s have if they lose their job in recessions. Despite supposed anti-age discrimination legislation they are still severely discriminated against in job applications. The legislation does not work, and that is hardly surprising because it was so watered down by the government as to become ineffective. Once baby boomers lose their job they now end up on the road to destitution unless they have accumulated sufficient capital and pension rights to maintain their standard of living.

  7. Drf says:

    Sorry, I have just posted my last comment as a reply to “Marc”. Of course I meant Mac, but cannot now change it. My apologies.

  8. Mac says:

    Not a problem Drf.
    I thought you were implying a change was imminent, and by association after the election, that’s all.

    On the baby boomer question I think they have had quite an easy ride, and I am one of them, with company/personal pensions etc built into our retirement. Far easier than what is going to be the case onwards anyway. Course that is going to depend largely on specific performances but we are generalising. BTW look at public sector pension deficits, the figures are astronomical! The ‘economically inactives’ I know are largely from this generation who by default or purpose have left the labour market. I completely agree with your remarks when this age group are forced out of the labour market.

    1. Hi Mac

      I will get onto pension schemes and have been intending too for some time. You see I have worked in that sphere and have passed the Chartered Insurance Institutes exams so I can discuss it from knowledge of the schemes and economics. However so much is happening that it is hard to cover everything! There is much that is very wrong and I am afraid that if you ask the wrong questions and send actuaries off to calculate the answers you get the sort of mess we have which is quite an achievement when many of our schemes were in good shape10/15 years ago….

      1. Mac says:

        ‘There is much that is very wrong and I am afraid that if you ask the wrong questions and send actuaries off to calculate the answers you get the sort of mess we have which is quite an achievement when many of our schemes were in good shape10/15 years ago….’

        Same sort of blank looks when you ask council leaders what plans they have to tackle a monstrous pension deficit. The answer, ‘you have to keep paying into the pot and then we expect central government to bale us out.’ My suggestion that a trip to the physiatrist’s couch was in order if they really believed that was met with stony silence. I closed saying that this whole issue was the elephant in the room which was being ignored at OUR peril. They just don’t get it………
        There would seem to be a Greek tragedy playing out a bit closer to home!

        1. I did chase my Member of Parliament (MP) on the subject of MPs pensions earlier this decade,well before the current expenses furore. I was ahead of the times in that respect! However as one man plugging away it was hard to make headway as I got a reply after about 3/4 months to every letter so it really dragged on. I was referred to the Leader of the House who initially was Harriet Harman if I remember correctly. They had raised their personal contributions by I think 3% but the accelerated benefits they received were worth a lot more in my view, certainly double and more like treble that. I pointed out that if a 3% increase could do this why were final salary schemes under pressure and closing as a 3% increase in contributions would fix them! But in return for logic I got flannel and waffle…

          A few years later the scheme was bailed out by the taxpayer.

  9. Liz says:

    Johan, I’m interested in your views about the housing market’s future prospects, ie your suggestion that pensioner housing will rise in value relative to family homes, which will decline in value as a result of demographics. That was my opinion until now, but I’m beginning to think that because future governments are likely to expect older people to finance all types of care and health provision via equity in their homes then there will be a subtle shift in older people’s behaviour in response. I guess older people will wish to spend a little less on property, rather than more, and leave themselves with cash to spend (or give to family) while still young enough to enjoy it, say in their sixties, rather than have the government effectively confiscate it at a later stage to pay for assistance that is currently “free” at the point of use. If you expect that the government will, for example, put a £5,000 charge on your home when you have a replacement hip operation, then where is the incentive to have a more valuable home rather than a less valuable one?

  10. Johan_Heuvel says:

    Hi Liz,

    what I am expecting is that people will be forced to go to full time care homes for the last years of their lives. Simply because they need the full time care. some might cling on to their current house longer than others, but I am focussing on the law of large numbers. Those facilities are at a lower cost than their current house, but since the total number of baby boomers which will require this care in the end is soo much larger than the young families that will be required to buy the homes of the baby boomers there is a real risk of over supply in the market. I do not think a care system in which their is full time care in the home is a realistic possibility for the masses. Another shift/reaction might be that the children of the baby boomers will live in their parents houses to take care of their parents to prevent the risk of equity loss. One thing is for sure though, the generation replacing the old is smaller and has different needs.

  11. Mac says:

    I am pleased it’s not just me getting the run around off politicians regarding this matter! I really think we need to tackle them at every level, as far as I can see they don’t understand the implications. I my part of the world we have just seen a near 3% rise in our domestic rates, after an especially difficult budgetary round which included cuts in services, whilst at the same time 5M has been thrown into the public sector pension pot. (This figure is generally regarded as a token gesture as the deficit for our council is now over 50% of its combined annual turnover!) Each 1% of rate rise represents about 1.2M gain so around a 3.6M increase. No one seems to see the correlation between these figures much less that one represents an unqualified liability. We are now faced with an unprecedented scramble for the exit by middle and high ranking public servants as they battle to take advantage of the enhanced terms for early retirement they get this year. It would seem reasonable to assume the pension deficit figure is about to get ramped sharply upwards! The National Audit Office has warned about this unfunded public sector time bomb and warns payments could more than triple within 40 years from £25B to £79B. At this rate 100% of our domestic rates will soon be going toward servicing this pension deficit instead of supplying the services we expect.

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