October 6, 2008 | posted by Michael Baxter in rate of interest | comments (1) |

It is funny how Gordon Brown’s best move seems to have been his decision not to make decisions in future. When he made the Bank of England independent, it appears he heralded a new era – the seeds were sown for the victory over inflation. Interest rate decisions would never again be subjected to short-term political considerations.

But it has changed now. It appears arguments for an independent central bank are so very last week.

In the US, the Fed has a dual responsibility – to keep the lid on inflation but to encourage growth too. Many are now arguing the Bank of England’s brief should be similarly changed.

That is to make sure the Bank of England focuses on inflation, and forgets about growth, for as long as growth is strong anyway.

We are now witnessing what happens when the full force of the media turns on a bank that focuses on long-term considerations.

This weekend, quite respected commentators argued that Mervyn King, governor at the Bank of England, has been behind the curve.

Well, maybe he was, but quite frankly so was everyone, Mr King’s critics especially so.

It seems inevitable that the rate of interest will fall. The Bank of England’s Monetary Policy Committee is meeting on Thursday, it will take a very brave committee indeed not to cut rates. Indeed, rates may well fall by half a per cent.

Don’t be surprised if rates fall below 3 per cent next year.

Of course, some will immediately go out and see this as a reason to expect surging house prices again.

But they will be wrong. Falling interest rates at a times like these are a sign of desperation – and the need for desperate measures is a bad thing, not something to be celebrated.

When stocks rise on news of big rate cuts, just remember that.

Besides, right now, the real problem is one of a shortage of credit. Who cares what the official rate of interest is, if you can’t get a loan, or if you do, the spread between rates available from the banks and official interest rates is so large?

Maybe the real problem with interest rate policy in recent years was that it was too low to encourage savings. And maybe, actually, that is the real problem behind the credit crisis now. Banks did not have enough money they could call upon from customers’ deposit accounts to meet demand for loans, so they went elsewhere for their money.

For years, interest rates were too low, The irony is, that as the queue of commentators wanting to put the boot into Mr King grows, their accusation is almost the precise opposite of the truth.

Monetary policy was too lax for years.

Will cuts in interest rates solve the problem now?

We have a crisis born of too much debt; getting people borrowing again will not solve that.

It is not to say interest rate cuts are not a good idea right now, but it is wrong to think they will make that much difference in the short-term.

September 5, 2008 | posted by Michael Baxter in rate of interest | comments (0) |

As you probably know, both the ECB and Bank of England chose to leave interest rates alone yesterday. Yet strangely, while the central banks stay put, commercial banks are cutting rates.

According to Reuters, the average rate on a two-year mortgage is now at the level seen before the credit crunch.

Meanwhile, the Abbey has joined Lloyds TSB and Halifax in dropping rates in the last few days.

But this is the snag. Rates may be falling, but it’s tough getting the loan. As Ray Boulger, of John Charcol said: “Anybody who had a deposit of less than 10 per cent will still struggle to get a mortgage.”

And that in a nutshell is the issue.

The media and analysts are writing reams on which way next for interest rates, but that seems almost irrelevant. The Bank of England could slash rates tomorrow and it is far from certain the move would make much of a difference at all. The issue now is not the cost of money, but its availability.

There seems to be a certain misunderstanding on the role of interest rates in controlling inflation. When Mrs T came to Downing Street with all her bold ideas about monetary policy, the idea then was that the money supply controlled inflation.

The author of this article was studying economics at the time, and his professor used to say: “The question is not whether the money supply controls inflation, it is whether it is possible to control the money supply.”

Interest rates can affect demand for money, which in turn can affect money supply, in turn influencing inflation. But right now, supply is low, irrespective of demand.

For as long as credit remains crunched, the factors that determine inflation in the long-term will recede.

July 23, 2008 | posted by Michael Baxter in rate of interest | comments (0) |

The latest minutes from the Bank of England Monetary Policy committee showed the truth in those words from Churchill: “If you put two economists in a room, you get two opinions.” Well it wasn’t quite like that, the nine members of the Monetary Policy Committee voted three ways. Tim Besley voted for an interest rate rise. David Blanchflower voted for a cut – something he usually does, and the rest voted to keep rates on hold.

But the minutes from the meeting held earlier in the month also said: “Any change in rates would be better communicated alongside the Bank’s August Inflation Report,” leading to speculation other members of the MPC considered upping rates, but just want a bit more data first.

Meanwhile, profits at Yahoo were down. In all, net income fell 18.6 per cent. The Yahoo poor quarter differed with Google which saw a big leap in profits. This begs the question, then why doesn’t Yahoo just agree to merge with Microsoft. The giant software company offered to buy the company at $31 a share. At close yesterday, Yahoo shares were trading at less than $22.

It seems part of the problem is Microsoft’s somewhat aggressive approach. Its boss Steve Ballmer is known for playing hardball, and maybe Yahoo’s co-founder Jerry Yang needs his hands held, and soft words of love spoken, rather than hearing Ballmer’s more aggressive phraseology.

Mind you, they do say you should keep your friends close, but your enemies even closer. Maybe that is why it has allowed Carl Icahn, and two of his chums, seats on the board. Icahn, also known for his lack of tolerance, wants to see Yahoo sell out, lock, stock and barrel to Microsoft.

The two companies need each other. Both are losing ground to Google so fast that if they don’t come to some accord soon, a merger would be little more than irrelevant.

Lastly, BP, it appears, has finally given up all hope of having a say over the management of TNK-BP. The Russian based company no longer has any BP staff left.

Trouble is, BP staff had to leave the country as they had no work visa. But then again, they had no work visa because the company said it didn’t want them – even though the contract seemed to say otherwise.

President Medvedev is supposed to be pro business. But it seems he is more pro business done the Russian way.

It is truly scandalous the way Russia is running roughshod over western business interests. Russia has the potential to be the world’s food basket. But this latest saga adds more evidence to the growing fears it just can’t be trusted.

On the other hand, it was truly scandalous how western business treated Russia a few years ago. And indeed, for that matter, how the IMF treated Russia in 1998.

What goes around comes around. And right now we are seeing the consequences of policy errors ten years ago. A wounded bear is dangerous. In the late 1990s we should have rushed to its aid; instead, we tied the bear up and baited it with our hounds of business and money.

If you really want to know the true cause of this financial crisis, it lies in major policy mistakes made ten years ago. This was when the IMF turned its back on Asia and Russia and created an artificial boom in the West, run on debt.

Churchill didn’t just say: “If you put two economists in a room, you get two opinions;” he added: “unless one of them is Lord Keynes, in which case you get three opinions.”

The truth is, the West applied Keynes’ policies to itself, and recommended the opposite approach in the Far East and Russia. Both policies were wrong.

June 2, 2008 | posted by Michael Baxter in rate of interest | comments (0) |

But while people ask of oil, will it, or won’t it, maybe it’s time to look elsewhere.

Inflation maybe be up a tad in the UK, maybe the Bank of England’s governor will be writing to the chancellor soon, and inflation may be showing nasty signs in the Eurozone and US, but the real fears must relate to the rest of the world.

Take Argentina. Officially, prices are rising by 8.9 per cent. That is bad, but wait until you hear this. Today, the Telegraph reported on a claim made by union staff of the statistics office there, that actually the figures are being deliberately distorted. The true inflation rate is 40 per cent, and the country’s government is trying to use inflation as a way of paying off debt, so they say.

Then there’s China. Behind the Great Wall prices are rising by 8.5 per cent, but the official rate of interest is just 7.47 per cent.

In Thailand, inflation has soared to 6.2 per cent, yet the interest rate is just 3.25 per cent.

In fact, according to Bloomberg, in no less than 11 Asian economies real interest rates are negative.

Now we have been here before.  Negative interest rates are not unprecedented, back in 1975 UK inflation was 24.2 per cent, but the rate of interest that year ranged from just under 10 per cent to 12 per cent. So that means the real rate of interest was around minus 14 per cent.

It is nothing like that, but right now in the US the real interest rate is negative too.

The low real US and UK interest rates are leading to falls in the pound and the dollar, which in turn will bring inflationary pressure down the line.  

But on the other hand, high inflation in Asia could eventually make the local currencies fall.

If Chinese inflation continues to outpace US and UK inflation, then at some time in the not too distant future, its currency, the yuan, may look too expensive, and the pressure may be for it to fall, rather than rise as US politicians are demanding.

And back to the UK, last week the CBI revealed its latest retail survey, and it showed that 56 per cent more retailers said that they raised prices this month than reported cutting them.  This is the highest ratio since May 1992.

The trouble is surely this.

For ten years we had low inflation, thanks to external factors – cheap oil, cheap imports from China and India, the Internet enforcing unprecedented price competition.   We became spoilt.  Rates were slashed because inflation was low and cut down rates could be justified.

Governments spent, consumers spent, asset prices leapt in price,  consumer borrowing just rose and rose.

Central banks and policy makers seemed to convince themselves low inflation was down to them.  It wasn’t.

Now, inflation is occurring because the real factors that kept prices down no longer apply. 

Consumer spending at the levels it reached in 2007 is not sustainable.  If it were to continue at that level, inflation would indeed rise.

Inflation remains a threat for as long as policy makers try to see a return to those days.

If instead the economy moves to a sustainable level – with spending less than income, with savings at the level they should be at, given the pending pension crisis, then inflation pressures will ease.  Oil will fall in price, so will the cost of food.

Economic growth should come from investment feeding innovation, not through mass credit card spending.

But do policy makers dare take the necessary steps?

April 10, 2008 | posted by Michael Baxter in rate of interest | comments (0) |

And finally, we couldn’t leave you without mentioning today’s meeting at the Bank of England.

Most economists expect to see a quarter of a per cent cut, some think the cut could be even bigger – although there are still those who fear that inflationary pressures mean rates should be left alone.

To an extent, it seems irrelevant.  We have seen money markets go to the opposite extreme from the position they occupied three years or so ago.    You will probably recall Alan Greenspan talking about a conundrum. At the time, the long-term rate of interest set by money markets was at a similar level to the rate set by the Fed – it even dipped lower.     This was known as a reverted curve.  It was called a conundrum, because in the past such a phenomenon seemed to occur shortly before a recession, something Greenspan thought was unlikely.

Actually, although Mr Greenspan called this a conundrum, he chose these words more to try and focus press and market attention, than because he didn’t know what was happening.    The truth was that money was flooding in from overseas –from Japan, from China and from OPEC countries.  The rate of interest set by the markets was low because the supply of money was so plentiful.  Mr Greenspan knew this.

Now, things are tight.   As you know, many banks have been upping mortgage rates of late, LIBOR rates have remained high.   Even if the Bank of England were to slash rates today, don’t expect the cost of borrowing for Joe public to fall any time soon.

That’s not to say markets won’t react; eventually – they will.  And that brings us to the pound.

Yesterday, the pound fell to another all-time low against the euro.  The reason: expectation of a fall in interest rates. 

With inflation rising in the Eurozone, and with the region in reasonable shape – although Spain, Ireland and Italy have their fair share of problems, it seems likely the rate of interest in the Eurozone will stay on hold for a while.  In fact, there is an outside chance that by the year’s end, the British rate of interest set by the Bank of England could be lower than the Eurozone rate.

When the rate of interest falls in a country, it becomes less attractive as a host for money deposits, so money leaves, causing the currency to fall.  It was expectation of this that led to the recent falls in sterling. 

A lower pound could be good for the UK.  We are more reliant on overseas trade than the US, and so a falling pound may have a bigger impact upon British exports than a falling dollar on US exports. 

But don’t underestimate the importance of the US on worldwide trade.     As the US slows, so will trade. The effect won’t be immediate – but the global economy has relied upon the US consumer for a long time. The jury is out as to whether the US consumer has paused for breath, or is in bigger trouble than that – but it is naive to assume the global economy can shrug off the effects of a slowing US. The IMF put the chances at one in four that global growth will fall below 3 per cent this year – and by some definitions that is a recession.

Now is not the time for the UK to pin its hopes on an export-led recovery, prompted by a falling pound.