Month: May 2014

Europe agonistes

The European Parliamentary Elections, which start in the UK on Thursday and continue elsewhere through to Sunday are unlikely to affect markets immediately. Here in the UK we face the strange prospect of the largest share of the vote going to a party of protest without practical policies and whose MEPs do not always turn up to parliamentary sessions. UKIP under Nigel Farage has done well to characterise the EU as the source of all ills but, of course, this is more like a lightening-rod for much wider anger and fears over relentless economic and social change and the failure of the Tories and Labour to explain or deliver on their promises. Immigration is proving double-edged as although many voters are clearly worried about it, most also seem unhappy with comments from more excitable UKIP candidates. Globalisation in the widest sense is the real culprit for those who are nationalistic, worried about house prices and/or public services or merely nostalgic.

For the record, as a strong advocate on both economic and political grounds of the UK’s membership of the EU, I intend to vote Lib Dem this week. Protectionist voices are becoming shriller around the world and it would be naïve to believe that countries outside Europe cannot wait to enter into bilateral agreements with the UK. My vote is not a ringing endorsement of the EU as it is now but more in the belief that the UK can only promote necessary reforms from within.  As a secondary issue, it is a pat on the back to the Lib Dems for having the courage to change from being the party of endless protest (with good and bad policies all mixed up) and join a coalition government, which history will probably judge much more kindly than most current commentators.

More important than UKIP’s performance will be how well the anti-EMU parties fare in France and Italy, which is quite likely to signal a new episode in the euro soap opera. The latest batch of economic indicators suggests that the governing parties in most countries are unlikely to receive resounding votes of confidence. The numbers in the table below speak largely for themselves but some additional comments may be helpful:

  • All GDP figures are flattered by disinflation/deflation because the calculation of ‘real GDP’ involves adjusting nominal GDP by the CPI. In the table Italy, Portugal and France are the worst performing but Finland, Greece and Cyprus are in recession while Bulgaria, Denmark, Estonia, Croatia, Austria, and Romania are struggling to varying degrees to generate much growth.
  • The soft Industrial Production numbers point ominously to ‘chill winds’ from Asia reducing exports but also to warm real winds in Europe that reduced demand for energy output.
  • Only Austria gets close to Germany’s Unemployment figure and altogether 12 out of 28 countries are at over 9%.
  • Italy and Portugal are not the only countries experiencing deflation. Hungary, Croatia, Slovakia, Bulgaria and, inevitably, Cyprus and Greece are too.
  • Ireland and Portugal have been restored to favour in the bond market along with Italy and Spain while France continues to be deemed the next best thing to Germany. Nevertheless, they are struggling with their Public Finances as are Belgium, Slovenia and (again) Cyprus and Greece. However, Germany is not alone in being on top of its deficit and debts.
  • The question arises as to whether the German economy is sufficiently locomotive to prop up the rest for long as it is clearly not helping them to grow. Will it want to try if others baulk at implementing overdue structural reforms?
  • The table also shows why the UK offers Germany the most hope for a growth partnership and, of course, vice versa. This is not really ironic as it explains exactly why Mrs Merkel is working hard to keep the UK inside the EU and why also even French will agree to talk after the UK election in May 2015.

blog chart


More on goodbye to QE

In my debut blog yesterday, which looked forward to today’s publication of latest Bank of England Quarterly Inflation Report I suggested that no further clues would be forthcoming as to the date of the first Bank Rate increase other than building into the Bank’s forecasts market expectations for spring 2015. I claim no special credit for being correct on that count but it is worth noting again just how keen Mr Carney is to postpone that ‘dies irae dies illa’!


What was of more interest to me was looking for more evidence that the MPC might be turning its back on QE and I reckon there were some pretty heavy hints that the Committee has already done so. The following extract is taken from the Box on page 41. The emphases are mine.


‘’Bank staff analysis suggests that the peak cumulative impact of the MPC’s asset purchases on the level of real GDP was around 2½%. As purchases are assumed to take around two years to feed through fully to activity, that peak impact probably occurred during 2013. In the MPC’s projections the stock of purchased assets is assumed to remain at £375 billion throughout the forecast period. Over the forecast period, therefore, the support to the level of activity from asset purchases is assumed to wane.


In the February Report, the MPC stated that it intends to maintain the stock, including reinvesting the cash flows associated with all maturing gilts held in the APF, at least until Bank Rate has been raised from its current rate of 0.5%. Beyond that point, as MPC members have previously set out in

individual speeches and testimony there are a number of considerations that will affect its decisions as to how to tighten policy.


  • Bank Rate will be the active marginal instrument for monetary policy.

• In order to be able to use Bank Rate as an active tool in response to adverse shocks to activity, the MPC is likely to defer sales of assets at least until Bank Rate has reached alevel from which it could be cut materially, were more stimulus to be required.

  • Some reduction in the stock of assets could be achieved without active sales, as the gilts in the portfolio mature.

• Any asset sales will be conducted in an orderly programme over a period of time so as not to disrupt the gilt market and cause a sharp tightening in monetary conditions. The Bank will liaise with the Debt Management Office when deciding any programme of sales.


All else equal, any reduction in the stock of purchased assets is likely to be associated with a lower path of Bank Rate than would otherwise have been the case.’’


The real show in town remains, of course, the  massive QE programme in the US. The FOMC hawks will be preparing their own arguments but it is likely that comments such as those above (together with the Bank staff papers on money and money creation I mentioned yesterday) will be cited as ‘evidence for the prosecution’.  The same can be said for hawks on the ECB governing council who may well go along with interest rate cuts and even some form of focused Funding for Lending Scheme for SMEs but will surely fight hard to prevent any major EMU government bond purchasing programme.


So it really does look like goodbye to QE! Except in Asia but that is another story!

Goodbye QE?

For some, the latest Bank of England Quarterly Inflation Report may be a non-event but I shall be concentrating on a potentially highly significant sub-plot.

  • While the report itself will surely be silent on the subject Mr Carney will be harried for clues for the date of the first increase in Base Rates. He is unlikely to oblige other than to point out that the Bank is basing its forecasts on market expectations for spring 2015.
  • It seems clear that a majority of the MPC want to hold off for as long as possible. The economy may be faring unexpectedly well but it is still likely to be held back by major public spending cuts and prolonged stagnation in Europe.
  • Another reason for holding off might be the planned revision of the National Accounts, which will affect GDP, business investment, savings and government debt. These are intended to be accounting adjustments only but could dramatically change the perception of the UK economy by businesses, consumers, investors and even economists (including those on the MPC).
  • The main objective remains to encourage companies and consumers to borrow, invest and spend with the confidence that rates will remain low for several years. However, low Base Rates can also provide lenders, especially the major banks but also new market entrants such as ‘crowdfunders’, with higher margins.
  • The attraction of encouraging lenders takes on added significance in the context of two Bank staff papers to be included in the Q1 Report but which have already been published. These papers set out to explain ‘money and money creation in the modern economy’. In particular, they seek to correct two ‘common misconceptions’.
  • The first correction is that it is bank loans that drive fractional reserve banking and money creation and not customer deposits. The second correction is that it is the banks themselves that determine the level of reserves at the Bank of England and the latter is therefore, not able to apply a so-called ‘money multiplier’ to generate directly more bank lending and create more money.
  • These corrections are important as they explain why the MPC has been so anxious to encourage bank lending and, more controversially, why the QE programme has been held at £375bn since July 2012. There appears to be little point in the Bank’s buying more assets if the resulting bank deposits would not lead to more bank loans to finance investment and consumption. This is central to a sub-plot that may come to the fore in the coming months and not just in the UK.
  • The key question now is what have the sellers of the gilts to the Bank done with the proceeds? Clearly, the money is not fuelling cost inflation as QE is supposed to do but at least some of it has fuelled increases in real estate and share prices to an extent that some people call ‘bubbles’.
  • Many so-called inflation ‘hawks’ are calling for immediate interest rate rises to prick the asset price bubbles and also head off future cost inflation. While the MPC is unlikely to oblige the hawks for the time being on interest rates the Committee may well be moving to a position where there will be no more QE. There could even be a further twist in that the current practice of replacing any holding within the £375bn portfolio would be ended before the first interest rate rise, which could then be delayed further in 2015 and perhaps beyond.

Of course, the Bank’s QE programme is small beer compared to that in the US. Most people, including me, deem that the FOMC’s interventions in 2008-9 staved off an even more calamitous financial collapse than that which occurred. Since then various economists have raised increasingly controversial criticism:

  • QE may or may not have helped in the first shock of the crisis but has been irrelevant since. It should be said that this is in direct contradiction to two MPC papers claiming that both GDP and the CPI were boosted in the UK
  • QE has not generated sufficient feelings of well-being amongst companies to make them invest and hire or amongst ordinary consumers to borrow and spend.
  • QE has been consistently ineffective in combatting disinflation but instead the proceeds of asset sales have been applied to real estate and equities, creating potential price bubbles.
  • The real beneficiaries of QE have been banks (which have applied sale proceeds to bolster their capital base rather than increase lending), companies (which have taken advantage of initially soft shares prices to apply profits to buy-backs rather than new investment and/or hires) and the super-rich (whose appetite for more houses, cars and yachts are clearly finite).
  • Cranking up the controversy, some economists assert that the fact that none of QE beneficiaries (banks, companies and the super-rich) have actually been spending their proceeds has fed through to disinflationary if not outright deflationary expectations, which in turn are discouraging consumption and business investment.
  • Just for good measure, a recent paper from the St Louis Fed has raised the theoretical possibility that holding official rates at minimal levels for a prolonged period may also start to fuel deflationary expectations and discourage consumption and business investment.

Understandably, the central bankers are not willing to admit publicly that they have made mistakes. However, as discussed above, it does seem that the MPC has turned its back on more QE and the taper suggests that the FOMC is heading that way too.