No rate rise

If not now, then when?

The MPC again ducked out of the difficult but necessary task of raising the bank rate. It is not obvious what they are waiting for. Inflationary pressures have grown considerably stronger over the last six months. The MC have just sat there in their oak panelled meeting room, watching passively as the rest of us have inflation hit five percent.

Wishful thinking won't deliver price stability. Talking tough doesn't do it either. The only known cure for rapidly rising prices is higher interest rates.

Great shot

Libya's main oil terminal was in flames on Wednesday night after Muammer Gaddafi's airforce bombed the complex, in an escalation that pushed the cost of the benchmark Brent above $115 a barrel

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Libyan oil wasn't the only thing destroyed by Ghaddafi's planes. The Bank of England's inflation forecasts also took a direct hit.

Playing catch up with Inflation

"We (the monetary policy committee) would be better placed to head off the upside pressures on inflation which are now apparent if we had taken earlier policy action.

And the risk is that when policy tightening does start, it will be overdue and the MPC will be playing catch-up – which is not a good scenario for recovery prospects."

Andrew Sentance, external member of the Bank of England's monetary policy committee

The monetary miracle is over

One should never underestimate the importance of luck. For almost a decade, the Bank of England proved to be very fortunate. It managed to simultaneously keep interest rates low, dramatically increase the money supply, and at the same time meet its inflation target.

How did it pull off this monetary miracle? The chart above provides a comprehensive explanation. It breaks the CPI inflation rate down into two components; the rate for services, which are mostly produced domestically; and rate for goods, which are almost entirely imported into the UK.

As the chart illustrates, prices for domestically produced services have grown fairly consistently at between three and four percent a year. This is far in excess of the Bank of England's inflation target. Prices of goods, on the other hand, were falling between 2000 and 2006, exerting powerful downward pressure on the aggregate inflation rate.

Food prices - lets talk timing before we talk about the weather

Over the weekend, I wrote a post on the recent surge in world food prices. Happily, it turned up as a link on a number of websites, so was one of my more widely read pieces. The post argued that the recent food price shock was primarily due to the world wide decline in interest rates.

This isn't a terribly popular view. The prevailing wisdom says that world food markets have undergone a radical structural change. On the demand side, Asia is growing, both in economic terms and waist bands. The continent is munching on burgers and pastries and it now firmly on the road towards obesity; a path that Western economies have been treading for nearly half a century.

UK service sector facing mounting cost pressures

The ONS have developed, on an experimental basis, a price series tracking services producer prices. As the name suggests, this series captures the cost pressures confronting firms in the service sector.

Recent movements in the series tell an interesting story. First, prior to the crisis, the service sector was facing mounting inflationary pressures. Second, once the crisis took hold, prices came crashing down. Third, in 2010 cost pressures have again emerged.

The services producer price inflation rate is far lower than that facing the manufacturing sector. There, the recent surge in energy and commodity prices has been a major driver of higher producer price inflation.

Nevertheless, the sudden reappearance of inflation in the service sector is further evidence that pricing pressures are building in the UK.

The oil price bubble

The crisis in Egypt is doing wonders for the price of oil. As demonstrators filled the streets of Cairo, the price of Brent crude hit $100 a barrel, its highest level for two years.

However, it would be misleading to think that the political crises in North Africa is the main driver behind the recent spike in oil prices. The crisis has helped over the last month or so, but the market has been trending upwards since the summer.

Cheap money, lots of speculation and a growing expectations of inflation - these are the factors driving the price of oil higher.

Eurozone inflation creeps upwards

In December, the Eurozone inflation rate crept above the 2 percent target. Higher food and energy prices were the primary reason for the above target out-turn. However, if these items are extracted from the Eurozone CPI, then inflation was broadly flat at around 1 percent

Debloating

The bloated banking system is about to shrink. What is the right verb to describe this process? To debloat, perhaps. So, lets conjugate...

I debloat;
you debloat
He debloats,
She debloats..etc

From the Mail.....

More than a third of the Halifax branch network faces closure by its owner Lloyds in one of the biggest bank culls in history. The move, which immediately sparked bitter criticism, would wipe out 550 small branches and 'agency counters' inside the offices of estate agents, solicitors and financial consultants.

It would cause huge job losses and intensify fears that the historic Halifax name may disappear completely. Altogether, the Halifax, once Britain's biggest building society, has about 1,300 branches.

This time it is different

Between 1964 and 2007, the UK fiscal deficit averaged 2.7 percent of GDP. Some years it was higher, others it was lower.

However, no government ever attempted to push the deficit into double digits.

Until now......

It is only a matter of time

When the UK finally slips into a government borrowing crisis, what is the likelihood that we will be told that it was totally unforeseeable? "We never realized that government bond yields could increase to 10 percent overnight".

July's public finance numbers were truly awful. In a normal July, the government runs a surplus. The reason for this seasonality is straightforward. The corporate sector often pays its taxes on a three monthly basis, and July is a big tax month.

However, this July the government ran up a deficit of ₤5 billion. So far this year, the deficit is running at ₤43 billion. This number will soon start to rocket. Typically the government receives most of its revenues in the between January to April as the tax year ends. The last six months of the year, the government always runs a deficit.

The writing is now on the wall for government finances. The UK deficit is unsustainably large. The clock is ticking. Something big is going to happen within the next 12-18 months.

We are now looking at three scenarios. Under the first scenario, the government stops spending, raises taxes and reduces the deficit through an emergency budget. Under the current government this is extremely unlikely, but I still hold out hope that Cameron and Osbourne will do the patriotic thing when they are elected next summer.

In scenario two, the private sector call time on the deficit and refuse to lend more money. Interest rates on government debt will rise and the government will get the message and revert to option one. Be warned. This could happen quickly and may be linked to a sterling crisis.

In scenario three, the Bank of England continues to buy government debt with newly printed cash. The private sector gently exits from the UK bond market as King and the MPC monetize the deficit. This is basically the Zimbabwean economic model. It is likely to have the same devastating effects on growth and living standards here in the UK if the Bank of England and the government persist with quantitative easing.

However, there are precious few signs that the monkeys running monetary and fiscal policy are thinking beyond a nine month horizon. The UK economy is now drifting into some very dangerous territory, and when we do nosedive into a crisis, be ready for the "I didn't see it coming" excuses.

B&B - huge losses for the taxpayer

I feel nauseous every time I hear the name "Bradford & Bingley". It is state-owned and it is, financially speaking, a stinking heap of toxic crap. It is not something that I can easily ignore since this mess now firmly belongs to UK taxpayers.

It has just announced a further £160 million of losses. Moreover, 40 percent of its mortgage book is now mired in negative equity. That is what you get when 60 percent of your loans were extended to buy-to-let and 20 per cent were self-certified loans.

However, I suspect that the B&B isn't something that can be safely filed away. It is not something that can be explained away as a past mistake. It As we move away from the terrifying events of September 2008, those commitments to tighten up banking sector supervision are being quietly watered down. Furthermore,We have yet to see a major overhaul of the FSA.

In short, five or ten years down the line, we could easily see another B&B turn up at the doorstep of her majesty's treasury, demanding a bailout.

Such complacency

Bernanke consistently got it wrong before the US housing bubble burst. Now, he is pumping up the money supply to revive the economy. Since his judgement has been so poor in the past, does anyone have any confidence that he is getting it right now?

UK house price to earnings ratio converging to long run average

According to the Halifax, the long run price to earnings ratio is almost exactly four. Currently, the ratio is 4.33, falling from an all time high of almost six.

The Halifax ratio was calculated using ₤36,576, which is apparently the national average wage for a man in full time employment. (I will let the obvious sexist implications of using that measure pass). The average house price is estimated to be ₤159,623.

What do you think? Is the crash over, and the boom about to begin? Should we believe the Halifax numbers?

Loan shark who charged 2,437 per cent

Obviously, Mr. Kiely didn't hear about the Bank of England's zero interest rate policy. From the Telegraph....

John Kiely, a loan shark, was branded a "ruthless individual" by a judge in Manchester as he was jailed. Kiely, 36, was sentenced to five years at Manchester Minshull Street Crown Court for offences including blackmail and illegal money lending.

Judge Adrian Smith told multi-millionaire Kiely: "It's clear to me you are a ruthless individual who has displayed a high degree of criminal sophistication." Kiely charged up to 2,437 per cent interest on loans and used an army of enforcers to collect debts owed by poor families on Manchester housing estates, the jury that convicted him last month heard.

One of his victims, Donna Ockerby, 45, claimed she was left fearing for her life and was forced to move to a secret location to escape him. Kiely was convicted of two counts of blackmail for his actions towards her.

Mrs Ockerby, an auxiliary nurse, borrowed £300 from "Johnny Boy Kiely" to pay for her wedding dress in January 2007 because she was "absolutely desperate", the jury heard. He dispensed the money from a roll of £20 notes from his black Range Rover, complete with the personalised number plate "B0Y".

Mrs Ockerby said she faced aggressive demands for money when she struggled to repay her debt because her working hours were cut. On one occasion Kiely turned up unannounced at her semi-detached house and grabbed hold of her. Another time he turned up and banged on her door early in the morning, the court heard. Mrs Ockerby told the jury she feared for her life when a concrete block was thrown at her window just hours after a debt collector called.

Lets roll those loaded dice

There is something deeply disturbing about this chart. It shows that mortgage approvals have picked up over the last four months. While lending activity hasn't yet reached the levels seen during the bubble, there is no doubt that banks are returning to the housing market.

This chart is disturbing because mortgage lending is the only credit market that has seen a pick up in activity. Credit to the corporate sector is contracting. Firms are, on a net basis, actually paying loans back. Things aren't much better for consumers. Interest rate spreads on credit cards have actually increased, and consumer credit growth is close to zero.

So why are banks ready to return to the housing market and at the same time abandon other credit activities? Well, I have my answer. This is a classic case of moral hazard.

Regardless of what the government said in public, the recent bailout had only one objective in mind - put a floor under house prices. The liquidity support and the guarantees were all aimed at stabilizing the housing market. In effect, the government offered to insure banks and their property speculating clientele. The message from Brown and Darling is clear - "we will support house prices no matter how much it will cost".

Banks have picked up on this commitment. Bankers understand all too clearly that the government didn't offer any real support to corporate or consumer lending. Only property matters. Therefore, it is rational for banks to return to mortgage lending while at the same time, cut back on other credit activities.

With this huge de facto insurance contract in their back pocket, banks are cranking up another housing bubble, and it is happening with the financial support of the taxpayer. Moreover, as recent RICS data suggests, there is army of potential house buyers out there ready to dive in and speculate again on property prices.

It is the rational response. After all, we have a government that is ready to guarantee that no one will lose if they speculate on housing. If there are any losses, the government will ensure that the hapless taxpayer will pick up the bill.

US real estate lending growing at 6.4 percent

There are many occasions when I wonder just how serious was this credit crunch. Here is a good example - US real estate lending by banks.

This chart tracks the annual change in real estate lending. Currently, it is running at about 6.4 percent. Moreover, at no time did it ever actually decline. As such, it was always possible for US borrowers with good credit ratings to get new mortgages.

We can't keep spending like this.....

During the boom years, Brown boosted public expenditure dramatically. Between 2004-8, New Labour increased the budget by 28 percent. In 2005 alone, the budget increased by over 8.1 percent.

When the economy was growing at 3 percent, Brown could plausibly argue that these increases were affordable. Today, he has no such defence. The economy is shrinking, yet New Labour have just kept on spending. This year, the government plans to increase expenditure by a staggering 6.5 percent, while next year, it will grow by a scarcely credible 8.2 percent.

The UK economy simply can not afford these extraordinary increases in public expenditure. Something has to give, and come the next election, it is likely to be Brown. The UK electorate simply will not stand for this kind of wanton recklessness.

Will VAT go up in the New Year?

Harman says the planned post-Christmas VAT hike is "under review". Darling says the tax hike must proceed. Who are we to believe? My money is on Harman.

The decision to cut VAT in the first place was ill-conceived. It was supposedly done to encourage a pre-christmas shopping boom. It did nothing of the sort. GDP has continued to contract for the nine months after Darling cut 2.5 percentage points off this vital revenue raising tax.

The cut did, of course, create a huge hole in the public sector accounts. If Harman gets her way, and delays this planned increase, next year's fiscal deficit can only become larger. It was already projected to be well over 12 percent, even with the anticipated increase in the VAT rate.

However, there will be an election half way through next year. New Labour has already abandoned any serious attempt to maintain fiscal discipline. The VAT rise will come just six months before the election.

It will be painful and unpopular, which means that New Labour will do what it always does - delay the pain and hope for the best. There will be no VAT increase next January.

We were warned

"Growing domestic and international debt has created the conditions for global and financial crises".

Bank for International Settlements, 2005