Thursday, November 6, 2008

Confusion and panic

I'm confused. What were the MPC trying to achieve by their dramatic 1.5 percent rate cut?

Today's press release was a dreadful concoction of confusion and panic. Take, for example, inflation. On the one hand, the statement said that "The past two months have seen a substantial downward shift in the prospects for inflation in the United Kingdom."

A few paragraphs later, we find out that "CPI inflation rose to 5.2% in September." - which was a 16 year high. However, the MPC reassured us that declining food and fuel prices would sort the problem out. As for the collapse of sterling, which has pushed up import prices, again, the message was don't worry.

The MPC calling "mission accomplished" on inflation. Despite the headline inflation rate, the MPC now thinks that there is a substantial risk of inflation overshooting the two percent target. Well, we will see about that.

Growth is now the main objective for the MPC. The credit crunch has done a number on consumption, investment is sliding and it all adds up to a recession. Hence, our rapidly deteriorating economy needs a big number rate cut to save it from disaster. The MPC weren't afraid of bigging it up; they went for a 1.5 percent cut.

What of the banking crisis? Again, we had mixed signals. On the one hand, the MPC reverted to hyperbole, describing the crisis as the worst in a century. On the other hand, they reassured us that recent initiatives were working and that things were improving.

Nevertheless, the MPC warned that credit markets were likely to be restricted for consumers and businesses for some time to come. This begs the question, how would today's cuts, which made the official rate, negative in real terms, help stabilise credit markets. After all, negative rates destroys any incentive to save, and limits the ability of banks to build up household deposits as a healthy alternative to structured finance.

These dramatic gestures often do more harm than good. Rather than reassuring people, big rate cuts send a signal that things are much worse than feared. Unsurprisingly, the FTSE fell almost 6 percent.

Today's cut smacks of panic and confusion. It won't save the economy from recession, it won't help stabilise credit markets and it won't help the MPC meet their inflation target.


  1. I have to say I'm the speed at which commodity prices have fallen makes me very suspicious. I think we will see a total reversal by summer next year. Then we'll be buggered!

  2. Gordon Brown is basically sticking two fingers up at the prudent and praising the reckless.
    This massive rate cut sends out the message "It's OK to spend what you haven't got, because we will bail you out!"
    This insults those that have saved for a rainy day, those that have actually managed their own financial affairs instead of New Labour's "borrow and spend."
    I hope savers, particularly pensioners (who fought for this once great country) manage to bring about some kind of revolt against this utterly corrupt government and get them out for good.
    The country deserves more than this fool Brown and his henchmen.

  3. Well, If Gordon Brown intends to borrow & spend trillions then it makes sense to borrow it at a low rate?

  4. This rate cut is so stupid, I think for a change I shall subscribe to the conspiracy theory:

    1. Banks won't pass on cuts, that's a simple question of economics and experience. They will get richer again.

    2. Politicians will have somebody to blame. Even though they've just enlarged their own powers and robbed the taxpayer by subsidising banks.

    3. In a couple of years' time The Goblin King will join his old mate Tony Bliar on the lecture circuit, collecting £150,000 per speech, 'sponsored' by various banks, consultants etc.

  5. fajensen - the rate at which the UK borrows money from foreigners is not the same as the rate that the BOE sets for Gods sakes !
    The BOE rate (sorry I mean the one that Gordon told them to set it at !) is there purely to re-ignite the housing bubble and make us all wealthy again so we go out and buy hot tubs, Range Rovers and plasma screen TV's.
    If it were that easy, I would set my own rate at 25% and live very well off the interest thank you very much !

  6. The highlight of my day was driving home and hearing Sir Digby Jones on the PM programme saying that the consumer had to do their bit by going out to the shop or some such tosh. He seemed a little confused.

  7. Independent bank of England???

    No way they did this without being lent on by Brown !

    Are we going to see rates rise like this (in 1.5% increments) next year to put a lid on inflation ? No way !

    BUY GOLD !!!! It's the 70's all over again. Boom, bust, interest rates yo yoing.

  8. I have a different view... though I can understand where you're coming from, Alice.

    The best gague to the situation has been the stock markets... which have rallied for six consecutive days "on the hope of a rate cut". The market expected a 0.5% cut, while the doveish commentators and politically inclined called for 1%. I think the BoE has managed a coup... it has, essentially, shown that rate cuts can't fix the economy. Retail borrowing remains expensive (if available at all) and savings rates have disconnected with the base rate (as discussed by Peston on his blog.)

    What is very important to note is that the ECB and BoE rates have crossed... for the first time since the inception of the Euro. This will have a significant implication for Euro denominated finance (such as that used by Santander to go on its recent reckless shopping spree...) A matter of minutes after the BoE slashed, so too did the ECB, but the ECB only cut by 0.5% - leaving the BoE rate 0.25% lower.

    This will, effectively, kill demand for Europeans to invest in Sterling - since Sterling rates (risk adjusted) will be lower than those on the continent. As/when the exchange rate settles, we'll be in an interesting situation where it makes sense for the UK to invest in debt on the continent - rather than the other way around. What this will do to our balance of payments, however, might make your eyes water.

  9. I figured you wouldn't like this rate cut Alice. Nor do I, but for different reasons.

    The central point to grasp is that rate cuts DO NOT stimulate growth. That's because cash is not wealth. Wealth is real things. Productive resources do not grow with the printing of money. Therefore printing more cash (one side of that crappy Keynesian "aggregate demand" thing)has precisely zero impact on the availability of productive resources and therefore zero impact on aggregate growth.

    What it does do is:
    (i) change the allocation of those productive resources in ways other than what the market would want and
    (ii) transfer wealth from savers to borrowers through inflation
    (iii) confuse fools into thinking something good might happen in the real world

    I doubt central banks will ever grasp that monetary policy only ever hurts the real economy.

    I mean, for chrissakes, just put this to the smell test. How on earth would printing more money to lower the base rate have the slightest impact on real actual growth? It's financial aromatherapy

  10. As one of those old guys who saved for his retirement what does one do? Am I to spectate as my savings disappear down a hole. Anyone any ideas?

  11. Barry - I am not quite retirement age but have worked hard and saved.
    If I wanted anything I SAVED UP FOR IT and if I could not afford it, I did without and gave it not a second thought.
    Prudent people would say... but with Gordon Brown at the helm, prudence is a dirty word.
    Borrow (what you can't afford) and spend (others money) is the New Labour mantra.
    If I were you Barry, I would consider moving out of the UK or spend the fuc*ing lot on holidays and then let the state keep you !

  12. I've just splashed out on some nice bikes for the wife and I. Then I'm going out to get outrageously drunk at the weekend.

    Well there's no point in keeping it, is there !