Posts Tagged ‘Central bank’

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As far as the Bank of England is concerned, the inflation panic is over for now. You may recall that many feared that one of Mark Carney’s first acts as governor of the Bank of England would be to put pen to paper and knock off a quick letter to George Osborne explaining why he was doing such a bad job at keeping inflation close to target. If inflation moves by more than one percentage point above the 2 per cent target, the UK’s most powerful central bank is required to write a letter of explanation to the chancellor.

As it turned out, inflation was 2.8 per cent in June – less than was feared and 0.2 percentage points down on the level that would have triggered a letter. This week the data for August was out, and this time inflation was just 2.7 per cent.

Will it continue to fall? Answer: unless something odd happens, surely yes. For one thing sterling is up, and recently rose to its highest level against the euro and dollar since January. For another thing, past movements in commodity prices suggest food inflation should fall sharply.

But thirdly, sheer maths seems to make it inevitable. Last autumn the UK saw prices rise quite sharply – up 1.5 per cent between August and December. Between May and August, prices rose by just 0.2 per cent. If the inflation rate we have seen over the last three months continues for the next three months, annual inflation will fall to just 1.3 per cent.

Now look at house prices and apply the same approach.

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According to the ONS, house prices rose by 3.1 per cent in the year to July. But between August and December last year, houses prices fell slightly. If house prices rise at the same pace seen in the past five months over the next five months, then that will mean house price inflation will be running at 9.4 per cent by December.

Yesterday’s ‘Daily Mail’ headlined: “Property price bubble is a MYTH”, and described the latest 3.3 per cent house price inflation rate as “modest”. But simple maths shows why this will change very soon and a bubble is, in fact, being created in our midst.

© Investment & Business News 2013

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It is the new way of doing central banking. It is called forward guidance. It means that central bankers are telling us what they are going to do in the future under different circumstances. In one fell swoop they have done away with an industry; an industry called predicting interest rates. It has become a game, and in some cases a business. The media fill their pages with predictions on which way interest rates are going next. Now we know, if the data says one thing, rates will go in a certain direction. Yet here we are, just a few weeks into the era of forward guidance, and already cracks are appearing. As for the markets, rather than becoming more stable and predictable, they have become more nervous than ever.

“I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said,” or so once and somewhat famously said the former Chairman of the US Federal Reserve Alan Greenspan. This was the era when Mr Greenspan was set on a pedestal so high that it is a wonder he didn’t need an oxygen mask and climbing ropes. What the markets really loved was the way in which Mr Greenspan had a veneer of knowing something they didn’t know; of having a plan – a cunning plan if you will – that always worked the way it was supposed to.

The finance crisis of 2008, and the fact that we appeared to miss a meltdown in capitalism by a whisker did leave Mr Greenspan’s reputation a little in tatters. Ben Bernanke, his replacement at the Fed, made a great play of saying what he thought; of letting us in, as it were, on his rationale. At first it didn’t go down well. The markets concluded he didn’t really seem to know what he was doing. It is the tragedy of the modern age. All of us stumble around in the dark most of the time, but we just don’t like to admit to it. And when our leaders admit to it, we think they are weak and uncertain.

These days, however, Ben’s stock is high. It was he, first among the central bankers, who came up with the idea of forward guidance, when he revealed that the Fed would keep pumping money into the economy via QE for as long as unemployment remained high. Now they are all at it. The Bank of England – under the leadership of Mark Carney – is now saying that rates will stay at half a per cent as long as unemployment is over 7 per cent.

It is just that the minutes from the latest Bank of England Monetary Policy Committee (MPC) meeting revealed that one member of the committee – Martin Weale – voted against the policy. It was not so much the idea of forward guidance he was against, it was the perceived timing. He appeared to fear that the 7 per cent target was too loose. Er, or maybe you could say that actually he was against forward guidance, because he wants a policy that one might describe as always flexible.

His dissent is important, because it rather put a question mark over the viability of the policy. You can interpret the Bank of England as saying if the economy does this, we will definitely do that, unless, that is, we change our mind. There are also hints that UK unemployment is set to fall much more rapidly than has been assumed. A survey from the CIPD and the latest Purchasing Managers’ Index both point to positive changes in UK unemployment in the pipeline. See: The UK jobs market boost . This has led to speculation that rates might be rising much sooner than the Bank of England has been suggesting.

It appears that the industry that grew up predicting what the MPC might do next has changed into one predicting what unemployment will do. If nothing else, jobs have become a more important economic indicator – and maybe that is no bad thing; after all common sense suggests it should be the most important indicator.

In the US, recent data has pointed to a sharp improvement in the jobs outlook, with the latest survey suggesting US unemployment is now at its lowest level since October 2007.

So let’s review the situation. The signs, both in the form of hard data and from surveys, point to a labour market that is improving faster than many had dared to hope for. That means monetary policy might be tightened faster than many had feared. The markets are spooked by it all. ‘Better than they dared hope for’ jobs data turned out to be less of a boon than ‘rates rising faster than they had feared’, – at least that is what they are saying at the moment.

But then the markets are fickle and how they react one day can be quite different on another. If you think the markets are making themselves clear, it probably means you “misunderstood what they are saying”.

© Investment & Business News 2013

There have been times in the past when the markets got it into their collective head that it was time for buying, even though there were good reasons to think it was really a time for panicking. Take 2007: in that year, the Dow Jones passed a new all-time high, and the FTSE 100 came close to passing its all-time high.

These promising stock market peaks occurred after the run on Northern Rock; after the phrase ‘credit crunch’ crept into popular parlance. Back then the markets were in the mood for interpreting all news – good or bad – as if it was a reason to buy. Their logic went like this: if the news was bad that meant interest rates might fall, so buy; if the news was good, they bought because, well… because the news was good.

There have been times since when it felt a bit like that all over again, but this year, it has been rather odd.

The Dow Jones began 2013 with a score of 13,104, peaked at 15,409 on May 28 (the previous all-time high was 14,164 set in 2007). The index then fell back, falling to under 15,000 and at the time of writing stands at 15,135.

For the FTSE 100 things were a lot more volatile. The index began 2013 with a reading of 5,897, peaked on May 22 with a reading of 6,804 (against an all-time high of 6,930 set on December 30 1999), before falling back to 6,029 on June 24, and at the time of writing is at 15,135.

In Japan things have been more even extreme. With the Nikkei 225 rising from 10,401 on January 1, to 15,627 on May 22 and then 12,834 a week or so ago.

It is not hard to find an explanation but it is harder to find one that makes sense.

Because the news out of the US has been so good, the Fed is now talking about reining-in QE, and upping interest rates in 2015.

The markets do not like it.

The jury is out on how much QE has had to do with equities surging so high. QE has driven asset prices upwards, but then valuations to earnings, especially in the UK, do not look excessive.

One of the worries is that while the US economy may boom, the more indebted regions of the world simply cannot afford higher interest rates.

The Bank of England and the ECB recently went out of their way to emphasise that they have no plans to tighten monetary policy and that what they do is not dictated by the Fed.

But, supposing interest rates rise in the US, and money therefore flows into the US from the rest of the world. In response and to stop currencies falling too sharply against the dollar, we may see other central banks up rates. To make matters worse, the Central Bank in China seems to be tightening monetary policy. This may be a good thing for China, and indeed for the global economy in the long term, but for much of the world the timing is not good.

Some have had a nasty attack of déjà vu. When the Fed upped rates in 2004, one eventual consequence was money flooding out of South East Asia into the US, which led to the Asian crisis of 1997.

But then again there are differences this time. In Asia, especially among the so-called ASEAN countries of Malaysia, Indonesia, the Philippines and Thailand, internal savings are much higher and the countries are less reliant on overseas credit.

Across the world some countries are more vulnerable than others. Brazil may be the most vulnerable of the BRICS; Turkey seems to have high exposure, and worryingly – given the political situation – so does Egypt.

Many countries in emerging Europe seem exposed, as do the PIIGs – of course, and so do Sweden and the Netherlands. Household debt and house prices are high in Canada and Australia, and then there is the UK. See: Is that a sword of Damocles hanging over the UK housing market? 

Interest rates seem set to rise in the US, and for other reasons they may rise worldwide. See: The Great Reset 

This is down to good news, and is largely positive, but for some countries, companies and people, the news is not so good – not at all.

© Investment & Business News 2013

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During the height of the euro crisis, politicians in Europe, and indeed central bankers, blamed the markets and credit ratings agencies. Yesterday an official at the Fed followed that tactic too.

Richard Fisher, president of the Dallas Federal Reserve, told the ‘FT’: “I do believe that big money does organize itself somewhat like feral hogs. If they detect a weakness or a bad scent, they go after it.”

He also took the opportunity of being interviewed by the ‘FT’ to remind us all about George Soros – the man who shorted sterling in 1992, beat the Bank of England and hastened the UK’s departure from the ERM. He likened today’s feral hogs to Mr Soros, but is that right?

Being a messenger is never a good place to be, not if you bring bad news anyway. When Eurozone politicians blamed credit ratings agencies, and what they called bond vigilantes for the woes in Europe, they were surely deluding themselves. They had fooled themselves into thinking the crisis was less serious than it was, and they thought they could talk until the cows came home. The markets went some way towards correcting their complacency.

By hastening the UK’s departure from the ERM, George Soros probably did the UK a favour.

But what about this time?

Markets are selling because there are fears that interest rates are set to rise. The Fed has said as much, and even in China there are signs of monetary tightening.

But don’t forget that the news out of the US has been good of late. To remind you of two of the highlights: US banks’ profits were at an all-time high in Q1, and US households have cut debt substantially since 2007.

As things stand, the Dow remains substantially up on its start of year position as does the Nikkei 225 in Japan. And that makes sense.

Markets probably overdid their exuberance in May, but both the US and Japan are in a better place now than they were at the beginning of the year.

As far as equities are concerned, in addition to fears about the Fed tightening monetary policy, some are nervous about the possibility that US profits to GDP are set to fall. But in the long run, profits to GDP falling and wages to GDP rising is surely good thing.
Even higher interest rates are a good thing, if higher rates are symptomatic of the economy returning to normal.

But higher interest rates will be bad news for those with high debts, and for that reason the UK and – more so – the Eurozone may lose out.

The FTSE 100 has not performed as well as US markets this year. Unlike the Dow, it never did pass its all-time high. And unlike the Dow, the FTSE 100 has now fallen to within a whisker of its start of year price. That is probably about right.

But at least the UK has its own central bank, free to print money and buy bonds via quantitative easing.

The countries of the indebted Eurozone do not have such a luxury, which is why Europe may yet be the biggest loser.

Image: Pig In Pen by Kim Newberg

© Investment & Business News 2013

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The IMF is a critic. It reckons the US has hit the brakes too fast, and wants to see more stimulus measures. As for the UK, it wants to see more short term borrowing to fund investment into infrastructure. The Bank of International Settlements (BIS), often called the world’s central bank, is a critic too, but for almost the opposite reasons.

Time to stop doing whatever it takes.

In a report out today, the BIS began by referring to Mario Draghi’s famous words when he said: “We will do whatever it takes to save the euro.” The BIS said: “But we are past the height of the crisis, and the goal of policy today is to return to strong and sustainable growth. Authorities need to hasten structural reforms so that economic resources can more easily be used in the most productive manner. Households and firms have to complete the repair of their balance sheets.

Governments must redouble their efforts to ensure the sustainability of their finances. And regulators have to adapt the rules to an increasingly interconnected and complex financial system and ensure that banks set aside sufficient capital to match the associated risks. Only forceful efforts at such repair and reform can return economies to strong and sustainable real growth.”

This is pure austerity economics, right out of the Austrian school of economics.

Then the BIS laid into what are often called the zombies.

It said: “Productivity gains and employment in the major advanced economies have sagged in recent years, especially where pre-crisis growth was severely unbalanced. Before they can return to sustainable growth, these countries will need to reallocate labour and capital across sectors. Structural rigidities that hamper this process are likely to hold back the economy’s productive potential. Both productivity and employment tend to be weaker in economies with rigid product markets than in ones with more flexible ones.

Similarly, employment rates tend to be lower where labour markets are more rigid.Conversely, countries with flexible labour markets recover more quickly from severely imbalanced downturns. They also create more jobs. Reforms that enhance the flexibility of labour and product markets could be swiftly rewarded with improved growth and employment.”

So what is it really saying?

Firstly, that QE has run its course, and monetary policy needs to return to normal. Secondly, that we need to see more creative destruction; let businesses fail, because the vacuum that is created can be filled by more efficient firms, and productivity will start to improve.

But is that really right? The BIS might be saying that QE has done its job, and now it is time to go back to normal, but frankly it never was a fan of QE in the first place. It may say that now is the time for governments to pay back debts, but then it also said that last year and the year before.

It is suggesting that as the economy changes, now is the time to implement the changes that it wanted to see implemented even before the economy had changed.

Do we really need to see create destruction? Take one sector, as an example, the UK High Street. This has seen rather a lot of destruction to date, precious little creativity has followed.

Then again, the recovery does appear to be starting in the US, and say one thing for the US, it does have an extraordinary ability to reinvent itself.

Being a cynic is fun. It is a good laugh, finding the flaws in any hint of optimism. And many have had a ball of a time laughing at the argument that it is good news on the US economy that lies behind the Fed announcing plans to ease back on QE.

But actually, there really has been good news coming out of the US of late. And with signs that US manufacturing is finding new opportunities, even that 3D printing may create new jobs, we could even be at the early stages of seeing something of a reversal of what we have seen in recent years of the trend of growing inequality.

The BIS might be right to say we are approaching the time when the US needs to see monetary policy return to normal – but that is happening anyway.

But the euro needs is own version of QE, proper QE that is, not Draghi playing with words. Japan’s experiment in Abeonomics needs to be given more time, and QE needs to be used more imaginatively to directly fund investment in the UK.

History tells us, that monetary policy has often been reversed too soon while an economy recovered from a depression recession/depression. Right now, there is a real danger that monetary policy will be tightened too soon. And the BIS seems to be oblivious to this risk.

© Investment & Business News 2013

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Be under no doubt, record low interest rates and quantitative easing are the main reasons why equities are riding high at the moment. There is this view that central banks control interest rates; that they can determine flows of money. So why panic about rising rates spoiling the party? Central banks will only do this once the economy is back on its feet. It is just that there are reasons to think this analysis is wrong.

It is remarkable how, in this post financial crisis era, central banks still seem to operate under a kind of halo. The media and organisations such as the IMF still suggest that these central bankers are like mini gods, moving the pieces of the economy around. They are like Zeus in one of those old Hollywood movies, in which the gods of Olympus (played by the likes of Lawrence Olivier), controlled the movements of mortal man in much the same way a croupier moves chips across a roulette board.

Maybe the truth is that central banks have about as much power as Zeus does in the real world, which is to say that the sense of the central bank’s omnipotence is based on a myth.

So did central banks create the financial crisis of 2008 by letting interest rates fall too low, or were their actions largely irrelevant? Maybe the real reason why inflation fell during the 1990s and noughties was that the Internet helped to promote price competition and globalisation – in particular the rise of China – meant cheaper manufactured goods.

At the same times, ageing in Japan, China’s policy of protecting the yuan, and rising corporate profits led to a global savings glut, meaning there was lots of money sloshing around the system, pushing down interest rates. Alan Greenspan himself alluded to it when he was chairman of the Fed and he talked about long-term interest rates set by the markets being lower than short-term rates set by central banks.

But supposing things went into reverse. The Ernst and Young ITEM Club recently forecast that inflation will rise later this decade as wages increase in China, which will lead to rises in the price of manufactured goods. It also forecast that UK bank rates will be increased to 1 per cent in 2015 and to 2 per cent in 2016. On the back of rising interest rates, it forecast that mortgage interest payments will jump 15 per cent in 2015 and by a massive 23.4 per cent in 2016.

But is it possible that it is underestimating the changes that may occur?

Zeus is a myth. We now know that bankers’ hubris gets punished, and maybe central bankers have an Achilles heel. And that heel is that actually, there are forces at work – underlying forces – that are far more important than what members of monetary policy committees say and do.

Alan Greenspan once said it is the job of central bankers to take away the punch bowl as the party gets started. Maybe changes across the global economy will do this anyway, no matter how much gin and vodka central bankers pour into the QE punchbowl.

© Investment & Business News 2013

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It is the great dread. Right now, inflationary pressures are weak in the Eurozone, and deflation is seriously looking like it is back on the agenda. But suppose, just suppose, that from out of nowhere inflation starts to rise, and central banks find that, in order to keep it in check, not only must the rate of interest rise, but the real rate of interest – that is to say relative to inflation – must rise too. It won’t happen, you might say. Why should inflation rear its ugly head at times like these? Well, don’t go so fast.

There are deeper forces at work, and there are reasons to think that in the next few years inflation may return. This is why.

During the boom years central bankers must have had sore vertebrae. They must have because economists, and finance ministers around the world kept slapping it. To let you into a secret, it seems that to an extent central bankers also slapped their own backs – albeit in a subtle way. Mervyn King gave Alan Greenspan’s spine a good tingling; Greenspan let his hand fall upon Mervyn’s spinal column.

The IMF was at it too, slapping away. Why such so much friendly smacking? It all boils down to NICE: that is to say non-inflationary, continuously expansionary. During the noughties, and indeed the late 1990s, economies in the developed world (with the exception of Japan) enjoyed the best of both worlds: strong growth, but modest inflation. Central banks were held up as the reason. Even Gordon Brown received some praise for giving the Bank of England independence, and giving it free rein to do what was right.

These days, central bankers’ savvy is not quite so appreciated, but even so, only a few months ago, they were being cited as the main reason why inflation across the world is so low.

But here is an alternative view for you. Maybe there was another cause of such low inflation. Perhaps there were even two main causes: globalisation and technology. The Internet created unprecedented price competition, while technology helped more efficient production, which led to lower costs. And the rise of emerging markets led to far cheaper manufactured goods, which were imported by the West from factories in Asia.

The part played by commodities in all this confused the picture. The rise of China may have meant cheaper manufactured goods, but also led to a rise in demand for oil, metal and then food. So we had downward inflation pressure on manufactured goods, and upward pressure on commodities. This confused the picture, and may have fooled central bankers, leading them to make mistakes.

But are the forces putting downward pressure on prices still in action? Maybe the Internet effect in creating price pressure via the magic competition was a one-off.

Now take globalisation. Earlier this week, LGIM economist James Carrick suggested that many of the forces that helped globalisation push down on prices are moving into reverse.

He said: “LGIM research shows that [the] increase in global import penetration effectively reached a plateau in 2006, largely due to changes in the Chinese economy. This has grown massively since joining the WTO, but it is also maturing quickly. Greater use of technology and more sophisticated production capabilities mean that China is getting richer and its workers are paid more.

“If the benefits of shifting basic assembly work to China are decreasing, companies will keep production closer to home, an effect we are seeing already with Mexico no longer losing market share in the US. This ultimately means firms can’t keep cutting costs by using cheaper suppliers and therefore will result in higher inflation.”

Mr Carrick reckons there are already signs of this change in the nature of globalisation putting upward pressure on inflation. Well maybe, but to be frank it is early days. We are talking about a trend that may take several years before it becomes obvious.

But would a rise in inflation be a bad thing? After all, inflation is a good way to reduce the real value of debt.

It depends. If we get wage inflation too, then household debt will suddenly look more manageable, and nominal government tax receipts will rise, making government debt look less frightening.

But…suppose wages don’t rise. Suppose prices rise, making us all worse off, interest rates rise making those with debts even worse off, but wages rise more slowly. That would be a nasty set of circumstances.

One thing seems likely. If inflation does start to pick up substantially later this decade, bond prices will suddenly look way too expensive, and we may well see their values crash.

Central banks may have less say over inflation than they are given credit for and QE may be less inflationary than it is assumed. But QE has forced up asset prices, and if external factors then cause a crash, the fall-out would be very unpleasant. If all this happened, maybe, as a punishment, we would need to give central bankers a good flogging.

© Investment & Business News 2013