Bank of England Increases QE £50BN

The Bank of England has left interest rates unchanged. However, it has increased quantitative easing by £50BN over the next four months.

The rationale for turning on the printing presses again being the persistent lack of economic growth, slowing export markets and weak business indicators.

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Interest Rates Under Review

The MPC has placed its interest rate of 0.5% "under review", as per the Minutes of the Monetary Policy Committee Meeting held on 6 & 7 June 2012.

The reason for the "under review" status being the ongoing deterioration of the economic situation in Europe, and "weaker economic data from the United States and emerging economies".

"Overall, the Committee judged that, at the present time, a further reduction in Bank Rate would not have any advantages over an expansion of the asset purchase programme, though it would keep the position under review."

This means that it is highly likely that rates will be reduced in the very near future.

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Bank of England Disconnected From Reality

The Bank of England, in its latest Quarterly Bulletin, has demonstrated that it is somewhat disconnected from reality and displays a mack of understanding of human nature.

In the bulletin, the Bank warns that “saving appears to be too low”:

“If current households choose not to pass on those gains to later generations, they may be able to spend more and save less. Future generations, however, will need to save more for their retirement or work longer.”

That is all very well, maybe. However the Bank appears to have forgotten that UK interest rates (0.5%) are at the lowest they have been for years.

Add to that the fact that we are being told that we will have to endure years of austerity and, like it or not, people's reaction will be very human; namely to enjoy the good times (ie spend) whilst they still can.

Economic cycles and people's reactions to them are driven by emotions not logic.

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The Naked Greed of Banks

Banks still seem to be operating with their heads in the sand.

"A customer borrowing £100 for 28 days without the consent of Santander would repay £200, for example.

That is the equivalent annualised percentage rate, or APR, of 819,100%.

Comparisons between banks and so-called payday lenders showed that the annualised percentage rate charged for borrowing £100 over 28 days varied from 969% to 819,100%.....

No payday loan lender charged an APR of more than 5,000% but two banks - Santander and Lloyds TSB - charged an equivalent APR of more than 300,000%. 

Santander told the BBC: "It's is confusing to compare payday loans with overdrafts on current accounts because an unauthorised overdraft charge is for unauthorised use of a current account while a payday loan is an agreed loan facility."

Barclays would charge a customer using a personal reserve - a pre-agreed emergency borrowing facility - £22 for every five consecutive working days they were in it. This means customers would pay £88 on top of the £100 capital after 28 days - an equivalent APR of 366,000%."

Source BBC

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Double Dip Recession Looms

The Telegraph reports that the West is facing the threat of a double-dip recession; after key measures of confidence collapsed in both the United States and Europe, with Germany suffering the steepest one-month fall since records began in the 1970s.



Whilst the USA is mulling a further round of QE, Europe is frozen like a rabbit in the headlights. Member states are bickering as to what should be done, the ECB has blundered by increasing rates this year and Germany is a house divided as the true costs of the Euro expiration are becoming apparent.



Unlesds both the USA and Europe act in unison the double dip is a certainty.

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US Rates Frozen Until 2013

US interest rates will be kept at record low levels for at least another two years, the Federal Reserve said yesterday.



Now if only the ECB could make the same sort of announcement, then we might see a bottoming out of the falling global markets.



Sadly the ECB is completely disconnected from the real world.

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Real long term interest rates and recessions

- by New Deal democrat

One Salient Oversight is a kindred blogger who also dissects historical patterns of economic expansion and contraction. He tracks three series, two of which are virtually identical to the "Kasriel Recession Warning Indicator." Based on those, he believes that a recession will start between Q4 of this year and Q4 of next year.

Like Kasriel, he relies upon the yield curve (inverted vs. positive), and real inflation-adjusted money supply (except he uses real monetary base vs. Kasriel's real M1).

His third indicator is real long term interest rates. Specifically, whether 10 year treasuries are yielding more or less than the inflation rate. It is specifically this indicator which has, according to his model, turned negative, presaging a recession. Here's his graph showing the real 10 year treasury yields for the last several years, showing it has been below the rate of inflation for the last 3 months:



One Salient Oversight's point is that a negative real long term interest rate doesn't always occur before a recession, but rather since 1954, whenever the rate does turn negative, a recession has always followed. You can see his in-depth graphic parsing of this indicator here.

To better look at this relationship, I have broken the relationship down to its two component parts. Here are 10 year treasury rates vs. inflation from 1964 to 1987:



and here is the continuation from 1987 to the present:



One Salient Oversight is indeed correct that during this time, whenever the inflation rate has exceeded the yield in 10 year treasuries, a recession has followed.

But what about before 1954? The "great recession" and its aftermath appear more like pre-WW2 recesions than postwar inflationary recessions brought about by Federal Reserve tightening. Since 10 year treasury data only goes back to the early 1950s, to go back further, you need a proxy that yields the same or similar results.

Indeed, such a proxy exists, in the form of the series LTGOVTBD (long term government bonds) that runs from 1925 to 2000.

First of all, here is the same relationship using LTGOVTBD over the post 1954 era and it almost exactly tracks the 10 year bond series, and makes the same predictions, so we know it is a good proxy:



But here is the problem: from the great depression until 1954, you get almost the exact OPPOSITE result as in the more modern era. Negative real long term rates occur during most of the New Deal, WW2, and immediate post-war era. In fact, they are at their trough at about mid-expansion. And these were the biggest expansions of the entire 20th century:




If we believe that our current situation is more akin to the pre-WW2 situation, negative real interest rates are of no help at all.

Nevertheless I think One Salient Oversight is on to something, especially as ECRI has vehemently denied that an inverted yield curve is part of their analysis, but appears to acknowledge that bonds are a component of their "black box." One big difference is that in the post WW-2 inflationary recessions where the indicator works, bond yields as well as inflation have both spiked higher compared with their 2-5 year average. By contrast, in the New Deal, WW2, and immediate post-war era, interest yields did not spike at all compared with inflation.

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ECB Raises Rates

The European Central Bank (ECB) has raised interest rates by a quarter point to 1.5%, citing its fear of inflation (over recession) as the rationale for the decision.

The ECB's actions have, needless to say, pushed the financially beleaguered Eurozone nations such as Greece and Portugal further towards the precipice.

Cynics are of the view that the ECB's actions deliberately designed to force the weaker nations from the Eurozone.

Whatever the rationale, the decision in the face of the ongoing recession, is utter madness and will end in tears.

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The Greek Tragedy - Another Day Another Downgrade

Another day dawns on the slow motion car crash of Greece's inevitable debt default and yet another downgrade has been made on Greece's debt (B to CCC), this time by Standard and Poor's.

S&P are of the view that Greece's credit outlook was "negative". Hardly surprising, if the ratings agencies keep downgrading the debt.

Do people pay these agencies for this?

Greece's sovereign debt is now the lowest rated in the world. This is what happens when politicians commit major fraud (on a national scale), in order to join the "exclusive" Euro club.

However, do not forget that some organisations and individuals make a very good living out of fluctuations in rates, yields, and prices etc. These fluctuations are driven by sentiment (fuelled by eg ratings) as much as hard "facts".

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What's The Similarity Between Mortgage Providers and Ratings Agencies?

The Telegraph reports that Ray Boulger of mortgage broker John Charcol thinks that house price indices, provided by mortgage providers, are a farce.

"The way providers of house price indices seasonally adjust their figures is a farce (or, seasonally adjusted, a comedy).

In many months the seasonal adjustment skews the real figures so much the result is that the comment generated is often misleading."

The issue runs much deeper than seasonal adjustments.

Mortgage providers' statistics are to the housing market, what ratings agencies' ratings are to sovereign debt. Both parties use their "ratings/stats" to manipulate the market to make money out of it.

Of course the statistics are unreliable!

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Monetarism Rules!

The IMF has given guarded support for the government's plans for reducing the budget deficit (currently £4.8 Trillion).

The IMF's crystal ball gazers are of the view that the economy remains on track for a "moderate" recovery, if interest rates remain low and inflation eases.

However, the IMF also stated that if the high risks of an ongoing slump continue; then the economy should be stimulated with a combination of more quantitative easing and temporary tax cuts.

In other words, the economy may well need a monetarist stimulation rather than a Keynesian one.

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The need for wage-improving, Demand-Side Economics

- by New Deal democrat

From Bonddad: This is, without a doubt, one of the best pieces NDD has ever written. I agree 100% with his conclusions on the topic. While I'll be posting on this topic something later this week, NDD has provided a far more thorough and well-researched article.

There has been a secular shift in the American economy going back at least 4 years. The self-congratulatory "great moderation" was really the reflection of wage stagnation for the majority of Americans being masked by increased household debt loads, and the ability to carry those increased debt loads due to the ability to refinance them at lower and lower interest rates.

This secular shift is a phenomenon I first wrote about at great length in 2007, asking Are Hard Times Near? That pessimistic prediction has been answered in a thunderclap-like affirmative ever since. I have returned to this issue several times during the last four years, writing last year under similar circumstances to our present slowdown that wage stagnation was the greatest threat to the recovery.

Simply put, when there is only 1-2% wage growth per year, any inflationary spike - even a 3% spike due to energy increases - is enough to cause the economy to stall. There can be no long-term, sustained recovery for the large majority of Americans unless there is real, long-term wage growth. Thus, while at one level the current slowdown or stall is the result of an energy price shock, on another level it was predictable (and predicted by others and me) due to prices faced by consumers rising faster than their disposable incomes.

In summary, American consumers:
* have not had an increase in household wealth
* have been unable to refinance at lower interest rates for more than 3 years
* have been unable to tap into increased wealth via stock or house price appreciation above previous levels
* and have chosen instead to cut back significantly on debt (more than 1/2%)

only three times in the last 31 years: during the recessions of 1981-2, 1990-1, and the "great recession" of 2008-09.

This result can be easily seen by showing real, inflation-adjusted YoY hourly wages, and also the effect of declining vs. stalling interest rates.

Before looking at the graphs showing those long-term trends up until now, first let me show you what I said back in August 2007 on the cusp of the "great recession":

The American consumer has had largely stagnant wages since 1974.... [F]rom 1980 through 2006, the median income of an American household has risen only from $39,700 to $48,200 in real terms .... Consumers have responded generally by taking on more and more debt. Total household debt service has risen from 16% in 1980 to 19.4% in 2006.

Fortunately for consumers, there has been a generation-long decline in interest rates since they peaked at 15.21% for the 30 year US Treasury bond in October 1981. This has allowed consumers to refinance their debts at ever lower rates every few years. They have also been assisted by a bull market in stocks that took the S & P 500 from 102 in 1982 to 1553 in 2000, and the subsequent housing boom/bubble.

There are signs that this "Great Disinflation" of declining interest rates is coming to an end. Only twice in the last 27 years has the consumer been unable to refinance debt or tap into his or her stock or house ATM.... [T]he 3rd and final time is almost certainly near.

.... If consumers are unable to tap the value of assets, or to refinance, then without improvements in wages, they will pull back and cause a consumer-led recession. Since 1980, this has only happened twice: in the deep Reagan recession of 1981-82, and again briefly from July 1990 to March 1991.

.... [T]he failure of interest rates to make new lows signifies that any continued deterioration in house prices, or significant and sustained decrease in stock prices, will likely give rise to an imminent recession danger sign.

The YoY% change in real, inflation adjusted hourly earnings for the last 30 years is shown in this graph:



With the exception of the late 1990's tech boom, and those times in the last 10 years when energy prices briefly reversed, real hourly income has made no progress at all. The 1981-82, 1990, and 2008-09 recessions have all been accompanied by declines in real hourly income.

Now, let's show how mortgage rates have behaved since peaking in the early 1980's:



Notice that there has been a general 30 year long decline in rates, punctuated by stagnant rates in the late 1980s, most of the 1990s, and the housing bubble era.

Here is a slighly different look, showing the year-over-year change in mortgage rates:



Now, let's put the two series together, showing real YoY% wage changes in blue, and YoY changes in mortgage rates in red:



This graph shows that stagnant or rising mortgage rates occurred at the same time as stagnant or declining real incomes (generally, when the red line is higher than the blue line in the graph above) during mid-cycle slowdowns at on the eve of or start of the post-1980 recessions. This was true by the end of 2007, it was true in last summer, and it has been true for the last few months.

Thus, only one month after the story quoted above, in September 2007, with new data showing that households were beginning to shun debt, it seemed clear that under the above criteria, consumers were signalling recession:

In order to avoid a recession, house price declines must stop, stock market gains must accelerate, or household income must increase significantly. Failing at least one these three things, if households have continued to cut back on debt, as appears likely, America will probably enter (or may already have entered) only its 3rd consumer recession since 1980.

This was the final shoe to drop. Household debt deleveraging in the face of stagnant wages and the inability to refinance has been the harbinger of all post-1980 recessions. Here is how household deleveraging stands as of the last report (4Q 2010):

I revisited the issue of real wage growth as a necessity for sustained economic growth in May 2009 even as I foresaw the bottoming of the recession:

the indicators studied from the Deflationary period of 1920-1950 suggest that the GDP might stop contracting in about Q3 2009, and start to actually grow.

But then what?

Whether the bottom of the trough of this decline in economic activity is in a few months, or if it is a year or two or more away, the fact remains that, with anemic wage growth to say the least, any incipient recovery ... would be short lived, strangled by the inflation caused by its own increase in demand. If the inflation rate agains exceeds wage growth, consumers will simply cut back again, plunging the economy into another leg down of a "W"-shaped recession.

.... In summary, from here on ... we're not going to see any sustained recovery in the American economy until average Americans see a real and sustained increase in their compensation for labor -- for the first time in over 35 years.

But there is still one more chance ... [i]f long term interest rates do decline again, consumers may yet have one more chance to refinance their spending for the next few years.

.... While if lower mortgage rates persist, there will be space for an economic breather, the paradigm of my 2007 piece remains true. So long as real wages remain stagnant, any recovery which might start will be vulnerable to every uptick in inflation and interest rates, and will be shallow, weak, and probably short-lived. The Great Disinflation of Interest Rates is Ending, the long-term structural problems of our economy have become immediate problems as well, and no long-term recovery is going to take root without real wage growth.

Luckily, as shown in the first graph of 30 year mortgages shown above, consumers did indeed get yet one more chance to refinance in 2010. But the problem with stagnating real wages surfaced again during the summer slowdown last year:

[T]he economic recovery is in a very tight spot -- precisely because average American consumers also remain in a very tight spot. [There has been] wage growth of about 1.5% for the last year. Under those circumstances, even 2% inflation is too much for them to withstand -- without the ability to refinance debt, their disposable income simply isn't keeping up....

So with paltry income increases of about 1.5%, there are only two ways to sustain the recovery for very long: (1) the inflation rate remains in a very narrow window of 0-1.5%; (2) some asset held widely by average consumers appreciates in value. or (3) another opportunity arises to refinance mortgage debt.

I thik we can all agree that number (2) doesn't look like it's going to happen. That leaves either number (1) or number (3).

....The price of Oil in particular will determine if inflation can remain in the "sweet spot" necessary given low wage growth

.... [O]nly a very narrow window of inflation is helpful to the recovery, and if the unlikely event of decent wage increases doesn't happen, that kind of extremely tame inflation is dependent most of all on energy prices....

This is a very small needle to thread - so the biggest danger to sustaining the recovery.

I have quoted my earlier material at length to show you that this isn't some new theory. I've been writing about it since before the "great recession" and indeed predicted both the beginning and bottom of the recession in large part based on this paradigm. It has proven itself empirically in the real world.

When interest rates fall to new lows, consumers respond aggressively by refinancing debt, freeing up more spending power. When that isn't available, and when households can't cash in on rising asset prices (e.g.,houses or stocks) even inflation of only 2% can be enough in the face of stagnant real wages to choke off any real increase in consumer spending and the economy stalls - or worse.

Aside from the need to prevent repeated energy price shocks throwing the country into recessions, among the most pressing priorities is the need to replace "supply side" economics with "demand side" economics that tilt the scales in favor of real, sustained wage increases for average Americans. Without that, there can be no long-term strong recovery or expansion.

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Chinese Whispers

It seems that it is not just Portugal, Ireland, Greece and Spain (aka "PIGS") that are under the gimlet eyes of the ratings agencies.

The UK has now also come under attack from the ratings agencies. Bloomberg reports that Dagong Global Credit Rating Co., one of China's official ratings firms, has cut its credit rating for the UK by one notch to A+.

Dagong cite the UK's deteriorating ability to repay debt, much the same reason used by other agencies when they downgraded the "PIGS".

However, we are not alone, the firm also reduced its rating on the US to A+ from AA last November citing a deteriorating intent and ability to repay debt.

Cynics might argue that ratings agencies' ratings/prophecies more often than not become self fulfilling, as the very act of downgrading a country increases that country's costs of borrowing.

Were the agencies to abuse their power, there would be opportunities for individuals, companies and countries connected with them to make a lot of money at the expense of others.

Needless to say, as with other aspects of the global financial services industry, the behaviour, quality and ethics of these agencies is beyond reproach.

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Interest Rates Hold Steady

As predicted the MPC have not raised interest rates, they remain (as they have done for the past 27 months) at 0.5%.

The decision to freeze rates is hardly surprising given the state of the economy and level of indebtedness.

However, do not expect the ECB to be so "alive" to the economic problems of the real world. It is highly likely that the ECB will continue to tilt at windmills, and push for higher rates, in its fanatical and mistimed battle against inflation.

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King Warns On Rate Rise

Mervyn King, Governor of the Bank of England and deputy chair of the European Systemic Risk Board (ESRB), issued a warning whilst speaking yesterday at the European Parliament that a rise in long-term interest rates would have "severe" consequences.

King's rationale being that the level of indebtedness would be increased by any rise in rates.

Given that the comments come ahead of this week's MPC rate setting meeting, it is being interpreted as a signal that UK rates will remain at 0.5% for the time being.

Whilst the MPC may well see the dangers of an increase in rates, no such "real world" understanding is apparent in the actions and attitude of the ECB who fear only inflation and ignore recession. Sadly for the people of Europe, the ECB are determined to press forward with higher rates irrespective of the damage that these increases will do the the European economy and to the citizens of Europe.

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Inflation Falls

The Office for National Statistics (ONS) report that consumer price inflation (CPI) fell to 4% in March, contrary to the expectations of "experts" who were looking for a figure of around 4.4%.

Retail price inflation (RPI) also fell to 5.3%.

The reason for the fall is being attributed to the price war being waged between supermarkets, which has pushed down the cost of food and drink. Additionally, the rise in VAT has probably now worked its way through the system.

It would be folly indeed, given the poor sales figures being reported by the high street stores, for the Bank of England to raise interest rates in the near future.

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Moody's Downgrade Greece

Moody's have downgraded Greece's credit rating from B1 from Ba1. This has caused a spike in yields on the country's bonds and will of course add to pressure on the Euro, as the risk of Greek default grows.

Add in the fact that the Irish economy is on the verge of collapse and that the ECB (for reasons that are unclear to any sane person) have raised interest rates, and it is clear that the Euro's days are looking increasingly numbered.

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The Miguided Hawks of The MPC

The Telegraph reports that according to the latest MPC minutes, released today, the Bank of England chief economist Spencer Dale has joined Martin Weale and Andrew Sentance in calling for an interest rate rise.

The "hawks" deem inflation to be a significant threat to the economy.

They are wrong:

1 The impact of the austerity budget has yet to be felt, once that kicks in there will be a significant deflationary pressure on the economy.

2 The economy is teetering on the edge of another recession, any upward increase in interest rates will push the economy over the edge.

3 An inflation rate of 4%-5% is bearable for a year or so.

4 The "inflation" that the MPC hawks fear is largely down to the rise in VAT in January, and the ONS (as per usual) erroneously under reporting inflation (clothing) for several years.

In short, rate should be kept where they are for the time being.

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Inflation

Andrew Sentance, a member of the Bank of England's Monetary Policy Committee (MPC), has broken ranks and publicly accused (at a speech at the Institute for Economic Affairs) Mervyn King and fellow members of the MPC of "selling Britain by the pound".

Sentance is of the view that King and the Bank are far too optimistic about how quickly inflation will fall back to its 2% target, and believes that the MPC has delayed for too long raising interest rates.

He is to my view wrong, any rise in interest rates now before the effects of Osborne's austerity budget kicks in will risk pushing the British economy "over the edge" into another recession. The economy can withstand a short term inflation rate of between 4%-5%, most certainly as there will be strong downward pressure brought to bear on it by the austerity budget.

The MPC should hold its nerve, and keep interest rates as they are for the foreseeable future.

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King Hints At Rate Rises

Mervyn King, Governor of the Bank of England, has hinted in his letter to the Chancellor that there will be interest rate rises (in line with market expectations) during the course of the year.

On the assumption that the "goat's entrails" have been correctly read, then "experts" are predicting three rate rises during the year bringing rates to 1.5%.

We shall see.

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