Wednesday, 19 January 2011
No UK interest rate rise in 2011
There are two complicating factors though, first is the impact of global commodities, whose price is in a speculative bubble and are not a good determinant for long term inflation (see 2008 spikes in Oil etc which quickly tailed off). Secondly is the presence of Quantitative Easing by the Bank of England. The Bank of England has a helpful pamphlet explaining QE to the masses; I note it does not have a similar one explaining how this wondrous mechanism can be unwound. Charlie Bean of the Bank of England last year said that the bank has a choice in either raising rates or removing Quantitative Easing first. This was to allay fears in the Gilt market about a bond glut as the Government continues with its record breaking PSBR.
So the Bank, assuming it decides to ignore commodity prices is left looking at the UK economy for some guidelines as to whether to raise rates, leaven them or undo QE. Some of the recent figures in monetary terms make for poor reading too. The November MQ, M2, M3 and M4 measures of money in the economy all fell - not consistent with strong growth in the economy and we have had a harsh winter since then too.
City Analysts too are stuck as to what to suggest, although The FT has quotes today from a number of City economists, amongst which there is a great divide but one has some answers on the Bank of England current thinking:
"Philip Shaw, economist at Investec, is far from convinced that the UK economy is yet robust enough to withstand rate increases. He suggests that one solution to the MPC’s dilemma could be to keep interest rates steady, but to start to reverse some of the “quantitative easing” asset purchases undertaken through 2009 and 2010.
“This would represent a change in the MPC’s exit strategy, which is to move interest rates up to a certain level first, and then to start selling gilts – but we think this would be a way of maintaining its credibility while capping the downside risks to the real economy.
“The MPC could quite easily reverse £25bn-£50bn over a three-month period, which would give it some breathing space.”
The Bank has a big dilemma though, raising rates slows private sector borrowing down, reversing QE pushes long term market rates up as gilt yields rise as the price of gilts falls due to over supply in the market. Both kind of achieve what the bank wants; but both also reduce the velocity of money in the economy which does not seem sensible if the monetary base of the Country is falling; an economy can't grow if there is no new money being created.
As such, the Bank will leave rates and QE unchanged for a few more months yet. Then as Phillip Shaw says the temptation to slowly unwind QE will be big. Firstly it can be done in small amounts and secondly it is more PR friendly and 99% of people don't understand what it is anyway. Finally, QE is very distorting to the economy and so reducing it will be a good first step to normalising the UK economy (not good for CU's share portfolio though!).
My guess is that this will take place in the Spring and Summer and at the same time the Bank can see whether its inflation predictions are right or wrong as usual. What this does mean though is that interest rate rises on a big scale are very unlikely. There maybe one 0.25% or so to show willing but nothing more.
I am not panicking today because the paper are talking about 175 basis point rises; it just won't happen that way in this financially crashed economy.