20th April 2010 by Shaun Richards
Yesterday saw a further deterioration in the financial position of Greece. I think that this was caused by two main factors. Firstly investors are becoming more and more concerned by the risk of a further run on her banks. Secondly the dithering over whether there is going to be a rescue deal for her or not appears to just go on and on. I have discussed in previous articles the fact that Greece and the euro zone are playing what is in effect a game of poker for very high stakes and it would appear that by not actively calling for rescue Greece’s government are trying to raise the stakes one more notch. It is, in my view, a very dangerous gamble.
One other factor has emerged in the weakening of the Greek banks and that is that information has emerged from Deutsche bank that they hold 8% of the Greek bond market which is 38.4 billion euros. As you can imagine there will be losses on this portfolio. The net effect of all this was that the Athens stock markets fell by 2.6% yesterday as measured by the ASE index. Two of Greece’s bigger banks EFG Eurobank and Alpha bank were downgraded by Nomura and fell by 4% and 1.7% respectively. Greek ten-year government bond yields rose to over 7.6% and the spread with ten-year German bunds rose to over 4.5%.
We see today an issue of 3 month treasury bills in Greece and this will be keenly watched for obvious reasons. Last weeks issue of 6 month and 12 month treasury bills were 6/7 times oversubscribed but then we saw yields on them rise as somehow or the other all these extra buyers appeared to change their mind. I will be watching to see how this issue of 1.5 billion euros goes today and just as a benchmark last week Greek issued at 4.55% (6 months) and 4.85%(12 months). One would ordinarily expect 3 month rates to be slightly lower and the last sale on January 19th took place at 1.67%.
Today sees the inflation figures for March 2010 in the UK. These are significant because the UK has shown disturbing signs of returning to inflation levels higher than those of her peers. They are also significant because we are going through a period where inflation is exceeding its target. Adding to this comes a failure of economic policy because many economists and the Bank of England were expecting UK inflation to be low or even negative (disinflation) at this time. Seeing as they set interest rates on a time horizon aiming around 18/24 months in the future then sustained rises in inflation represent a clear policy mistake. Regular readers of my articles will know that I have been concerned that we are in danger of letting the inflation genie out of the bag. When the inflation figures for February (23rd February) came out I wrote on this subject as follows.
Today’s inflation figures showed an interesting picture. I am sure many will concentrate on the fall in the Consumer Price Index to 3% in February and it may escape them to point out it is still 1% over target. They may miss the fact that the Retail Price Index for all items remains at 3.7%. Our previous measure which was used to target inflation was Retail Price Index excluding mortgage interest payment which is at 4.2% and fell by 0.4% compared with January. So it exceeds its “target” (2.5%) by more than the current measure
It did not surprise me to see many economists claiming that the UK’s dalliance with inflation was over as there is an element of saving face here when you look at their past forecasts. However I expressed concerns for the future pattern of inflation on the 1st April.
Inflation has in fact exceeded its target quite substantially when you consider that we have just gone through a year where economic output dropped by almost 5%. Last month inflation was 3% on the target measure and the month before it was 3.5%. With petrol prices having risen quite strongly so far this year there are reasons for thinking that inflation may well be higher this year than one would expect if one just looked at our economic growth figures. After all fuel prices influence many others as they feed through the economy.
Such thoughts were then added to by our producer price figures for March which showed signs of an oil price driven acceleration in input and output inflation. Indeed output price inflation rose to 5% and input price inflation rose to 10.1%. These figures on the 9th April led me to wonder about our Monetary Policy Committee.
Also it would appear if you look at the evidence that its policy on inflation is asymmetric as it keeps going over target and was reduced pretty much to panic measures when it thought targeted inflation would be under its target.
Today’s Consumer Price Inflation Figures
These are very poor and are worse than the market was expecting. Consumer Price Inflation (CPI) has risen to 3.4% up from 3% in February and as this is 1.4% over its targeted level under ordinary circumstances the Governor of the Bank of England would have already written an explanatory letter to the Chancellor of the Exchequer (it is usually sent a day early).However his letter from February 2010 is still valid so in fact he will only have to write a new one if CPI remains more than 1% over target next month too.
The reasons for the rise are “widespread” according to the Office for National Statistics with housing and household services (gas prices) being the highest contributor. Other fuel prices rose and increased transport costs but this was not the largest contributor.
Retail Price Index
In the year to March, Retail Price Index annual inflation was 4.4 per cent, up from 3.7 per cent in February. The main factors affecting the CPI also affected the RPI. Additionally there was significant upward pressure to the change in the RPI annual rate from housing as the impact of falling mortgage rates from a year ago fell out of the numbers.
Our Old Target RPIX
RPIX inflation – the all items RPI excluding mortgage interest payments – was 4.8 per cent in March, up from 4.2 per cent in February. Perhaps the most revealing of all the numbers as this was our previous inflation target and was set at 2.5% so it is some 2.3% over its target.
These are poor figures and to my mind they call into question the credibility of the Monetary Policy Committee. As I remarked above they moved into panic mode when they felt that the UK economy might move into negative inflation (disinflation) but seem rather complacent when it rises to the upside. Their policy of Quantitative Easing has on their own (original) definition not appeared to have done much to help the UK economy but the way asset price bubbles have risen it would appear that it has contributed to a rise in UK inflation. It is not the first time in UK economic history that a monetary policy has had a monetary rather than a real economy response.
Should this rise in inflation prove to continue then we are giving ourselves a problem. One of the ways the UK economy could improve over the next year is to take advantage of the drop in our exchange rate since 2007 and export more and import less. However export-led growth is less likely if we allow ourselves to fritter away the competitive advantage gained from this depreciation by having higher inflation than our peers. These inflation figures are 2% higher than the most recent figures for the euro zone which were 1.4% for February.
Even these much lower figures of 1.4% for the Euro zone disturbed Jurgen Stark who is an executive board member of the European Central Bank who said in a speech last week according to the FT that inflation risks “seem to be tilted to the upside”. He followed this up with
“A multi speed recovery of the world economy, with some regions growing fast, while the recovery in others remains rather slow, has the potential to exert upward pressure on prices. In the same vein, we also need to monitor very closely the possible adverse impact from fiscal developments on the inflation outlook.”
Imagine what he would be saying if Euro zone inflation was at our levels…
My question to our Monetary Policy Committee is how long is a temporary blip?
I felt that when the inflation targeting system was changed in the UK it was a policy error and I feel that this years figures are confirming this. When it was changed I argued that there were two main flaws.
1. The gap between the new and old target should have been more like 0.75% rather than 0.5%
2. There is a difference in the standard deviation of the two measures with RPIX being likely to have a higher measure on this than CPI. In other words for the same rise (fall) in inflation we are likely to see a bigger move in RPI than CPI.
Unfortunately I was only one voice but this years numbers are reinforcing my original criticisms of the change. Our current inflation measure is 1.4% over target and our previous measure is 2.3% over target. Seeing as they are supposed to be measuring the same concept this is quite a difference!