Thursday, 5 August 2010
It was all so predictable - Bank of England Rate held at 0.5% - August 2010 Update
Firstly, I’m sure the Bank will in their minutes say some lovely things about inflation returning to target over the medium term. Maybe they could even just cut and paste last month’s minutes which included the statement “On balance, most members thought that it was appropriate to leave the stance of monetary policy unchanged. For them, the weight of evidence from both home and abroad continued to indicate that the margin of spare capacity was likely to bear down on inflation and bring it back to the target in the medium term once the impact of temporary factors had worn off. “
This is what they say however I don’t think the message is consistent. Let’s now look at my first chart. This is simply cut from the Bank of England’s Inflation Report however I’ve gone back 12 months to the August 2009 release. In this report they show a lovely fan chart showing what they expect to happen to inflation over the next couple of years. The assumption they made was that interest rates would be held at 0.5% (well they’ve done that so far) and that they would undertake £175 billion of quantitative easing (well they’ve done £200 billion which should if anything give higher inflation expectations). The orange lines are mine.
Back then they predicted by June 2010 the CPI would be at 1.6% nominally, which they clearly have been very wrong about, with the highest upside risk being at 3.2%. My second chart shows the Bank Rate being held at 0.5% and shows the RPI at 5.0% and the CPI at 3.2%. So we are at the Bank’s worst case on the fan chart. As an aside, if in my work life my estimates were out by 100% I would be sacked however that’s for another day. (For completeness chart 3 today shows the long run RPI index as I show every month.) Where it now gets interesting is we stay on the worst case line and have a look where this heads medium term. I’ve never seen a definition from the Bank of England of what medium term is so to make it easy let’s look at what happens over the next year. Firstly inflation dips to maybe 3% by year end and then continues to climb to over 4%. Remember that is not my chart that is direct from the Bank of England and it doesn’t look like inflation returning to target to me.
So inflation is higher than target today and the Bank of England 12 months ago said it would go higher over the next year. Shouldn’t that cause an increase in interest rates?
Secondly, we have just heard the “wonderful” news that GDP for the 2nd quarter of 2010 was 1.1%. I appreciate that this is only preliminary. I think I remember reading it was based on 40% or so of data released. To put this in perspective though I’ve gone back and looked at GDP data since 1955. What do you think the average quarterly GDP figure is? Well it’s 0.58%. So GDP is currently running at twice the average. How far down can they revise it? I wouldn’t think to 0.58% which would be an economy that was neither booming nor busting. Could there be a risk if this continues of creating another boom (which of course will lead to another big bust)?
So GDP is a lot higher than the long run average. Shouldn’t that cause an increase in interest rates?
Thirdly, let’s look at what’s happening in the real world. We have the VAT increase to push up prices coming soon. Next have announced price rises of 8% next year due to higher cotton prices and the VAT increase. Premier Foods, who own the Hovis bread brand, are also starting to suggest that bread prices are going to go up as wheat prices are increasing. Of course, I’ve also mentioned in the past that I can’t see the cost of Chinese made goods going down either with the wage increase pressure that they are seeing.
So all of this looks inflationary. Shouldn’t that cause an increase in interest rates?
But do you know what I don’t like the most. I can live with the Bank stealing from me by inflating away the value of my savings. I can live with the Bank helping the reckless government and excessive borrowers by inflating away their debts. What I don’t like is the risk going forward. Tht is that we end up with yet another boom with these ultra low rates. Then the bubble is pricked and we get the bust. The Bank then has nowhere to go with rates because they are already at record lows. What do they do then? My guess is that they reach for the quantitative easing handle however that starts to sound all a bit Zimbabwe for my liking.
I’d love to hear your thoughts.
As always do your own research.