UK News

from MacroScope:

There be feudin’ at the BoE

The once-good relationship between Bank of England Governor Mervyn King and his most likely successor, Deputy Governor Paul Tucker, is coming  under increasing strain, according to a new book by former Daily Telegraph journalist Dan Conaghan.  It  alleges   King’s management style and and alleged disdain for the financial markets is to blame.

While the Bank of England’s Monetary Policy Committee remains reasonably collegiate, on other matters King more than lives up to the description from former chancellor Alistair Darling that he is ‘incredibly stubborn’, says Conaghan, who now worksas an asset manager.

“The governor can be particularly dogmatic,” he told Reuters. “One of the key things … is the attitude to the capital markets. One of my sources described Sir

Mervyn’s attitude as one of disdain. I’ve heard that repeatedly. Paul is much more pragmatic.”

One tangible upshot of this came at the launch of the Bank’s quantitative easing programme in March 2009, which Conaghan said led to an upsurge in failed trades on the British government bond market, until the central bank found a mechanism to lend back some of the gilts it had bought.

More broadly, Conaghan’s book The Bank: Inside the Bank of England describes something approaching a feud growing out of a philosophical split between King – who champions a purist, economics-driven approach – and Tucker, who is closer to financial market participants.

“It is widely acknowledged within the Bank’s upper echelons and elsewhere that the relationship between King and Paul Tucker … has deteriorated over the past few years. One very senior figure at the Bank describes it as being, at times, ‘a battle-ground,’ where the battles over policy, direction and structure are common. Another senior official at the Treasury concedes that they ‘do not get on, to put it mildly’.”

from Breakingviews:

UK banks need government to solve funding squeeze

By George Hay The author is a Reuters Breakingviews columnist. The opinions expressed are his own.The Bank of England is tooling itself up. The UK central bank announced on Dec. 6 a new facility to help domestic lenders if the euro zone crisis causes a fully-fledged freeze in short-term funding markets. But banks may still need more help.

The BoE already has two ways to combat liquidity squeezes. It allows banks to borrow against liquid collateral for three or six months through its Indexed Long-Term Repo (ILTR) auctions. And it allows desperate banks to swap illiquid collateral for gilts for up to a year via its Discount Window Facility (DWF) – in return for a fat fee and big haircuts.

In some senses, the new Extended Collateral Term Repo facility (ECTR) is a halfway house. It uses a similar auction structure to the ILTR but allows banks to pledge DWF-style collateral for a minimum fee of 125 basis points over the BoE’s base rate. As such it goes some way to filling the gap left by the now-defunct Special Liquidity Scheme (SLS), the crisis facility which allowed UK banks to swap illiquid mortgage-backed securities for liquid Treasury Bills for a period of up to three years.

However, the ECTR will only last for thirty days at a time. That may help avoid a collapse, but won’t provide much long-term reassurance. Contrast the BoE’s approach with the European Central Bank, which is currently being pressured to offer facilities that last for two or even three years. Even though the UK is not in the euro zone, its banks are suffering from the same long-term funding drought as their rivals on the continent. That’s worrying because, according to the BoE’s own figures, UK lenders have to roll over 140 billion pounds of term funding next year.

But the central bank has rightly judged that providing long-term bank funding is not its job. That is a task for the UK government, which could re-open its Credit Guarantee Scheme, a 250 billion pound programme that allowed banks to weather the 2008 crisis by issuing new long-term debt insured by the state.

Unlike many European countries, a UK sovereign guarantee still carries credibility – 10-year gilts are currently yielding just 2.3 percent. Now that the BoE has donned its fire-fighting kit, HM Treasury should tool up as well.

from James Saft:

Britain eats (leverages) its young

James Saft is a Reuters columnist. The opinions expressed are his own.

Four years, several failed banks and at least one global recession later, Britain has finally discovered what its young people need: 19-1 leverage.

Britain has announced a new housing initiative, the centerpiece of which is a plan to entice first-time buyers into buying newly-built properties with as little as 5 percent down.

Under the plan both builders and the government would contribute funds to partially indemnify lenders against what I am betting are the inevitable losses. Borrowers, who are almost by definition younger and less well off, will still bear all losses, but will be rewarded with the chance to take out the kind of loan which has proven time and again to be a bad idea.

This is utterly wrongheaded -- the best possible thing that can happen for first-time buyers, and arguably for most Britons, is for housing prices to fall to a level commensurate with earnings.

Why are houses in Britain so difficult to afford? Partly because of problems with supply, issues that the housing plan takes some steps, almost certainly insufficient ones, to address. And also because Britons, first out of necessity and then in the fever of greed, borrowed so much money in order to wedge themselves into what little housing was available that they drove prices up to unaffordable levels.

Again, as in Europe and the U.S., we have governments which, when confronted with problems that are fundamentally about debt, decide that piling yet more debt on top is the answer. Like the European Financial Stability Facility, which has proved utterly ineffective in supporting Italian debt, this plan too will fail, but not before many people will be tempted into taking on houses and debts they ought not to risk.

from Breakingviews:

Becalmed UK in danger of double dip

By Ian Campbell The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The UK economy looks dangerously becalmed. While GDP did increase a good-looking 0.5 percent in the third quarter, the number was flattered by a catch up from a royal wedding-distracted spring. Besides, there has only been a 0.5 percent rise over the full year. And now a euro zone storm is brewing. That Tuesday's UK manufacturing survey for October dropped to the lowest level for over two years is no coincidence -- but is alarming.

It was always going to be tough for the British recovery to pick up pace. It has to deal with many adverse currents: tighter fiscal policy, depressed wages and high global commodity prices. Strong export demand would have helped. But now recession threatens the euro zone, the UK's largest trading partner. The single currency zone has to deal with financial sector stress and fiscal tightening, and its central bank has been less accommodating than the Bank of England.

British policymakers will come under pressure to do more. The Bank of England has already responded to the European threat, and more promptly than the European Central Bank, by launching a 75 billion pound QE2 lifeboat. George Osborne, the Chancellor, promises more help on what he calls "credit easing" later this month. But it is hard to be optimistic that either policy will achieve much. Mervyn King thought QE2 would help avert worse credit tightening.

Another dip into recession will be hard to avoid. That will be arduous -- above all for the 2.6 million unemployed Britons. The malaise will put political pressure on the government to take a risk on fiscal policy. A fiscal U-turn, a tax cut or additional government spending in employment-generating capital projects, would be more likely to get the economy moving again.

The government is understandably reluctant. The fiscal deficit is obscenely big and its opponents will say "we told you so". But, as in any emergency, plans change when things go bad. The risk for the UK government is that things will get considerably worse.

from Breakingviews:

UK will get QE2 – but may need fiscal help too

The odds are moving rapidly towards a launch of QE2 in the UK. A second bout of quantitative easing - printing money - would be controversial. But a fragile economy needs extreme treatment - monetarily, and probably fiscally, too.

Britain's substantial home-grown problems are being exacerbated by crisis in the euro zone. UK unemployment crossed 2.5 million in the three months to July. Activity in services, the bulk of the economy, almost contracted in August. Wages, up just 1.7 percent in the past year, are falling fast in real terms, impoverishing consumers and threatening deflation. And exports are stalling: the euro zone is the UK's main trade partner.

Inflation, 4.5 percent now and likely to go higher in September, is the obvious obstacle to still looser money. But in January it should drop to about 3.5 percent as this year's sales-tax increase drops out of the equation. In any case, it is not inflation but the threat of renewed recession that is now the Bank of England's foremost terror. GDP growth may already be negative.

Policymakers will have to do more. Adam Posen, the BoE's chief dove, has suggested a new public bank. This quick and unfashionable Fannie Mae-like step seems unlikely. QE2, probably to the tune of about 50 billion pounds, is the obvious emergency remedy.

But there are big doubts over how much money printing can achieve. It may bolster bank confidence, and could drive 10-year gilt yields well below 2 percent. But whether it will stimulate mortgage or business lending is questionable - especially if banks continue to struggle with the euro zone crisis. The BoE risks pushing on a string, as the economist Keynes warned.

That leaves fiscal policy. The UK has been right to focus on reducing an intolerable deficit. But a fiscal rejig, as Barack Obama is pursuing in the United States, may also be necessary. The government could stick to departmental spending cuts while also cutting taxes for the low-paid to stimulate spending, and investing in infrastructure and social housing to spur employment.

Europe's negative forces are strong. Counteracting them is likely to necessitate more policy activism.

from MacroScope:

BoE rate decision has echoes of Jan 2007

By Sumanta Dey in Bangalore

The BoE is expected to keep rates on hold at its monthly meeting today. Sixty-two out of 63 economists polled by Reuters expect such an outcome. Statistically speaking, that is more than a fair majority. But are we in for another upset like the one more than four years back? At that time, Simon Ward of Henderson Global Investors was the only economist correctly calling a rate hike.

There are a number of spooky similarities today that point to an almost identical scenario.

Leading up to January 2007, inflation in the UK was almost 3 percent, well above the bank's 2 percent target. January 2011 inflation read at 4 percent. Then, Simon Ward forecasted the BoE to raise rates by 25 basis points in January, and placed a 55 percent probability on it -- the only one out of 50 economists . Last week, he made exactly the same call for the outcome at this meeting and was the only one who saw a hike in rates today out of 63 economists.

Ward, speaking in his Money Moves Markets journal last week, had this to say:

“The February MPC minutes revealed that, in addition to the three members voting for an immediate interest rate rise, at least two others believed that the case for an increase had strengthened.

“The question for the waverers this month is ‘why wait?’”

from MacroScope:

Broadbent’s BoE appointment keeps hawks in health

Ben Broadbent’s appointment to the Monetary Policy Committee ought to dispel any notions that the Bank of England would be left short of hawks after the departure of Andrew Sentance.

A brief look at the history of Reuters polls shows that Goldman Sachs' UK economists – led by Broadbent – were uber-hawkish in their outlook for British interest rates early last year.

In January 2010, Goldman predicted rates would rise to 1.5 percent by end of the second quarter of last year, and 2.5 percent going into 2011 -- hugely out of step with both the consensus and as it turned out, reality. Rates went nowhere last year, and are still at a record low of 0.5 percent.

Towards the end of 2011, Broadbent’s team moderated their forecasts significantly, coming in line with the consensus for an interest rate hike coming deep into this year.

But his latest set of forecasts resumed a hawkish tone, with an expectation for three 25 basis point rate hikes this year, and a further four in 2012. The consensus view from a Reuters poll on March 3, by comparison, was more restrained: a quarter-point hike to 0.75 percent by the end of the third quarter, before finishing this year at 1.0 percent.

With thanks to Sumanta Dey and Sarmista Sen from the Bangalore Polling Unit

Britons face rising price pain

– Fiona Shaikh is Reuters’ Economic Correspondent, based in London. –

Stubbornly high inflation has proved something of an inconvenience for the Bank of England over the last year, but the unrelenting rise in prices is turning out to be a real headache for ordinary Britons — one which is likely to get worse before it gets any better.

Consumer price inflation — the headline measure targeted by the central bank — accelerated to 4 percent last month, the  highest in more than two years and double the BoE’s target.

A great deal of the rise will have been down to the 2-1/2 percentage point rise in value added tax at the start of this year — a one-off move that will drop out of the statistics next year and mechanically bring headline inflation back down again.

But that will come as little comfort to most people at a time when wages are rising at half the rate of prices and energy bills are rising.

Consumer morale is already in the doldrums and the misery is likely to get worse once the government’s public spending cuts kick-in in earnest.

BoE Governor Mervyn King noted last month that Britons have endured the sharpest drop in living standards since the 1920s depression, and the harsh reality is that most people will need to get used to having less as a consequence of a much-needed economic rebalancing.

from MacroScope:

The perils of predicting BoE policy

As we’ve noted extensively, economists often get it wrong. Leaving aside their collective failure to recognise an impending global recession, you might recall a shock interest rate hike from the Bank of England in January 2007.

This was another event that almost every economist polled by Reuters failed to spot, and there are signs that four years on, economists might be setting themselves up for a similar shock.

The consensus from the last Reuters BoE poll last week showed interest rates would stay on hold into the fourth quarter, even though UK money markets have priced in a 100 percent chance of a rate hike by May. Since the January meeting, some of the bank’s Monetary Policy Committee members have publicly stated their determination to fight strong inflation.

But going back to January 2007, the only analyst out of the 50 polled by Reuters who predicted that shock rate hike was Simon Ward, chief economist at Henderson Global Investors. If the MPC does indeed flay analysts’ consensus this year by hiking rates before April, he stands to repeat his 2007 feat by being the only economist in the last poll to forecast a hike in the first quarter.

“I have been a bit mystified as to why other people haven’t shifted (their views) as inflation figures have really shot up over the last few months,” Ward told Reuters.

He suspects a somewhat dovish speech last month from BoE Governor Mervyn King wrong-footed economists, based on the presumption that King wouldn’t have sounded so dovish unless he was confident that rates would stay on hold for a long time.

“I think that interpretation was incorrect, and King has been outvoted in the past. It’s not like the U.S., where there’s a certain amount of pressure to follow the chairman’s lead,” said Ward.

from The Great Debate UK:

Are interest rates set to rise?

Whenever he approaches a bend, an F1 driver has to make a fine judgment: brake too soon and he loses vital momentum, too late and he risks losing control altogether, with possibly fatal consequences.

For the past year, the MPC has been getting closer to the bend – the point at which it will have to raise interest rates – so, as each month passes without a touch on the brakes, the balance of risk changes as the danger of losing control of inflation increases.

Unfortunately, this is where the analogy breaks down, because no racing driver ever has to cope with conditions as foggy as do economic policymakers. On the one hand, the signals from the real economy are mixed.The preliminary estimate of fourth quarter GDP showed a 0.5 percent contraction – but these estimates are prone to revision at the best of times, and with the exceptional weather conditions at the end of the year it is hard to have much confidence on this occasion. On the other hand, the inflation danger has been ever-present and growing, and the Bank of England’s 2 percent target has been more or less junked.

Consider the market data. If we look at the index-linked bond market, we see, on the one hand, a real rate which is zero or even negative and, on the other hand, an expected inflation rate rising from about 3 percent to above 4 percent over the next 20 years, which suggests only one thing: stagflation for the foreseeable future.

Against this, Bank of England apologists offer a number of decreasingly plausible excuses to explain why inflation is only a temporary problem, some of which amount to saying “it’s high because it’s high”. For example, blaming inflation on rising commodity prices in world markets is all very well, but if the value of the pound had risen on world markets rather than fallen, the impact on our own price level would have been far smaller – and the fall in the exchange rate is of course a direct consequence of the Bank’s own expansionary monetary policy (Quantitative Easing etc).

In fact, in our own modest way we have contributed to the rise in primary product prices, which has been mostly caused by the American version of QE, flooding the world (especially the Far East) with liquidity and generating a continual excess demand for soft and hard commodities, while the less prosperous parts of the Third World struggle to keep up with the cost of basic foodstuffs.

Against this, if there really is excess capacity in the UK, we should see the underlying inflation rate in the domestic economy falling or even negative. I differ from most of my profession, however, in questioning how much excess capacity we actually have at the moment, especially in the labour market. It remains easy and attractive for discouraged workers to drop out of the labour force into one of the available long term benefit categories (early retirement, disability etc), and the market will have been tightened somewhat by the clampdown on work permits for non-EU residents. Moreover, there are signs that the fall in the value of the Pound has benefitted the manufacturing sector (as it should), which is good news for the economy but will have added a little to inflationary pressures.