Sunday, December 09, 2007
A well-judged jab of confidence for the UK
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


The pebble I started rolling down the hill this time last week, calling for an interest-rate cut by the Bank of England, had turned into a boulder by Thursday lunchtime. The noise was deafening. Some say monetary policy is dull. Not these days.

The Bank, when it cut from 5.75% to 5.5%, was in tune with outside opinion. As well as the shadow monetary policy committee (MPC), which meets under the auspices of the Institute of Economic Affairs and whose deliberations are first reported here, the Times MPC voted for a cut. So did the Cazenove MPC, an in-house group run by our most blue-blooded of stockbrokers. There may be other MPCs out there I do not know about.

The Organisation for Economic Co-operation and Development, in its end-of-year economic outlook, revealed that it had factored in a December rate cut. Short of the Queen raising a 5.5% flag over Buckingham Palace, this is the nearest thing you get to an official endorsement.

The OECD, by the way, predicts 2% growth next year. One interesting feature of its forecast is that it thinks the saving ratio will decline further, from 3.3% to 2.7%, suggesting recent scares will not lead to an outbreak of household prudence. Both the Treasury and the Bank expect the ratio to rise.

Anyway, the weight of opinion favoured a cut, providing the Bank with an alibi if things go wrong. That, it seems to me, is unlikely. By the time the committee met, the case for a cut was overwhelming, though a good half of City economists did not expect it. We will see how overwhelming it was when the minutes are published in 10 days. It will be interesting to see if this was an occasion when the governor, Mervyn King, allowed himself to be outvoted.

Some commentators said that whether or not the Bank cut rates last week was a matter of life or death. I am tempted to adapt the legendary saying of the late Bill Shankly, former Liverpool manager, and say that it was much more important than that.

In time-honoured newspaper fashion, I had done the preparatory work for two columns this week, the one you are reading and a far more critical one. Had the MPC not cut, I would have concluded that this was a bad end to a bad year for the Bank. Happily, that one will never see the light of day.

In the grand scheme of things, whether the cut came last week or early next year probably does not matter hugely. The signal the Bank gave was, however, quite important at a time of rapidly weakening business and consumer confidence. To have remained aloof when the case for cutting was so strong could have given us a grimmer winter than necessary and increased the extent of the cuts needed next year. Sometimes the Bank has to show that it is responsive; that it cares.

As it was, this was a timely flu jab for the economy, and we can look forward to at least a couple more booster injections in 2008, with the next likely in February.

There will be those who say that the cut was all about rescuing the housing market. But the MPC, its evidence buttressed by the reports from its regional agents, was much more concerned about a broader-based slowdown in consumer and business spending that it thinks is unwinding. The economy is not falling off a cliff but it is slowing at least as sharply as the Bank expected in its inflation report last month.

As importantly, MPC members were concerned about the impact of what they described as a deterioration in conditions in financial markets and a tightening of credit availability. They do not use the word crisis, but we can.

As I said last week, when money- market interest rates are a percentage point above Bank rate, there has been an unintended tightening of policy. Fears the rate cut would not be passed on due to money-market turbulence appear unfounded. Both Halifax and Nationwide announced immediate, and matching, mortgage-rate cuts.

Has the Bank taken its eye off the inflation ball? A slowing economy will ease domestically generated inflation pressures (I exclude price rises that are "administered", such as rail fares, or emanate from the public sector). In the case of energy and food, a slowing world economy is what is needed.

The recent fall in oil prices from $99 a barrel to about $90 is partly based on expectations of slower global economic growth, which is why the Organisation of Petroleum Exporting Countries chose not to raise output last week. Other commodities are off their highs, in some cases significantly so. These markets are volatile but are no longer pointing relentlessly upwards and the Bank's rationale, that slower growth will ease inflationary pressures, was correct.

Finally, how weak is the housing market? Very weak indeed, according to Halifax, Britain's biggest mortgage lender, with prices down by 2.4% in the latest three months, equivalent to a near-10% annualised fall.

That compares, curiously, with a 1.5% rise by Nationwide over the same period. The Halifax series can be a bit volatile, though the bank, now HBOS (Halifax Bank of Scotland), said it had detected nothing odd in the numbers.

House prices on its measure started weakening back in September before they really should have done based on past relationships between prices, mortgage approvals and the Royal Institution of Chartered Surveyors' polls of its members. September was also probably too soon for a significant Northern Rock effect on market confidence.

So, while the housing market is undoubtedly weak, Halifax is probably overstating it. And, despite the weakness, Martin Ellis, its chief economist, expects prices to be flat next year.

Some will say mortgage lenders never predict house-price falls, but they do. In 2004, Halifax predicted a 2% fall for 2005 and, going further back, it had a 1989 forecast of a 10% drop in prices during 1990. On both occasions it was too gloomy prices rose.

Whether it is too gloomy or too optimistic this time depends, first, on the Bank's willingness to show more of Thursday's flexibility on rates and, second, on the duration and severity of the credit crisis. But the Bank has made a good start.

PS: Tesco made an interesting excursion into the macroeconomic debate last week. When issuing its third-quarter results, Britain's biggest retailer, which accounts for nearly a third of supermarket sales, poured scorn on the idea that fast-rising food prices posed a serious inflation threat.

In the 13 weeks to November 24, Tesco's overall prices were up by 0.8% on a year earlier, with non-food prices declining and food prices, it is thought, up by just over 2%. A year ago its annual inflation rates were higher both for overall sales and for food.

How does Tesco's experience compare with the wider economy? We won't get the November inflation figures until December 18, and they are bound to have been affected by the rise in petrol prices. Taking September and October together, however, whole-economy food prices were 4.5% up on a year earlier, double the Tesco rise.

What about the broader picture? It is certainly true that, despite worries about the end of the so-called China effect on goods prices, they are still falling, with consumer durables about 2% lower than a year ago and clothing and footwear down more than 4%. Even so, it is hard to find anything in the official numbers that comes close to Tesco's 0.8% figure for overall inflation, excluding petrol. The nearest equivalent, excluding energy and most household services, is running at just under 2%.

How does Tesco do it? Through a combination of efficiency and negotiating deals with suppliers as some of them know only too well the company claims. Whatever the cause, the task of Mervyn King and his colleagues would be a lot easier if we had Tesco-style inflation throughout the economy.

From The Sunday Times, December 9 2007


Comments are now open

Posted by: David Smith at December 9, 2007 12:31 PM

Hello David

Will this rate cut really achieve anything given that Libor has barely budged? Maybe it is still early days, but there has at leat been no immediate evidence that this cut has prompted banks to start lending to each other again.

Perhaps it will really turn the screw on those banks that rely heavily on money markets for mortgage funding but have a lot of borrowers on BoE base rate-linked mortgages.

As for your point about Halifax and Nationwide cutting mortgage rates - as I understand both institutions cut their SRVs (from 7.75pc to 7.5pc in Halifax's case). I don't expect many borrowers are on these rates, given how uncompetitive they are. And those that are have probably just come off 2-year fixes at around 4.5pc. A 0.25pc reduction on this is going to make the difference between head above and below water for a very small proportion of these borrowers, I would suggest.

Posted by: Top Cat at December 9, 2007 02:13 PM

I'm not sure about the rest of the economy but the housing market (within the M25) is falling off a cliff at the moment. The market peaked just before the summer holidays and has been softening since. The Northern Rock story caused the final few first time buyers to take flight and there are no signs of any pick up in sight. Speak to Estate Agents and they will tell you that they are currently working hard to reduce asking prices. Most will also confess that price reductions need to be in the region of 10% to attract any interest.
The residential auction market is a good indicator of whats happening at the sharp end.A major auction in London this week only managed to sell 40% of lots offered in the room. It was reported in the Estates Gazette recently that the traders and dealers in the auction rooms were giving some support to the market. If even those hard nosed buyers lack the confidence to raise their hands then further evidence is provided for the crash camp.
I wouldn't pay too much attention to the Halifax, Nationwide et al surveys. They weren't able to tell us the true picture in London six months ago (when price rises were running at 3-5% per month) and they aren't showing us the true picture today.

Posted by: Paulo at December 9, 2007 02:45 PM

The rate cut will take time, of course, and there will be others. But fixed rates are also coming down because of falling swap rates. The housing market is indeed very soft at the moment, and will be for the rest of the winter, but I don't pay much attention to anybody's claims to give an overview of the entire market within the M25, and the idea that prices are falling of a cliff. In some areas they're falling, in other areas they're flat, and in some places they are still rising. The house price indices, of course, try to give a national picture.

Posted by: David Smith at December 9, 2007 04:00 PM

Hello again David,

Thanks for your reply. Could you tell me which swap rates I should be looking at to get an idea of what should be happening to fixed-rate mortgage rates? And what is the relative influence of these rates and libor rates?


Posted by: Top Cat at December 9, 2007 05:17 PM

Two-year swaps are what you need to look at for two-year fixes. I should add that in many cases, lenders are using the fall in swap rates to increase their margins, so aren't passing on the drop. You'll also have seen the big increases in arrangement fees among some lenders.

Posted by: David Smith at December 9, 2007 05:32 PM

Nice column David, as usual. Like the info on Tesco, good stuff ;-D

Top Cat, the libor had come down very slightly prior to the rate cut being announced. After the rate cut, 3 month short sterling was SMASHED down below the equilivent price for libor. Monday you will see libor, I guess, around 10 points worse.

It's very unusual for short sterling to have reacted in this way following a rate cut. Unlike David, my feeling is that the way Merv and his men have handled this rate decision has made the waters as muddy as ever. I hope I'm wrong, and fingers crossed they are starting to get their foot on the ball and realise the risks we face in 2008, but going by money market reactions I don't think they are...

Posted by: James Trouble at December 9, 2007 06:06 PM

James Trouble, my understanding is that short sterling was smashed down in price, which means a corresponding INCREASE in yield and therefore expect to see 3m LIBOR move higher if anything.

That's what I heard anyway, if you could point to the data that would be useful.

Posted by: Minh at December 9, 2007 06:53 PM

I think that's what he was saying too ...

Posted by: David Smith at December 9, 2007 08:24 PM

Yeah, sorry Minh, worse libor means it will move higher, short sterling getting weaker is same direction as libor going up. If you catch my drift, which I hope you do...

I can't give time and sales though, you'll just have to take my word for it.

Posted by: James Trouble at December 9, 2007 08:59 PM

Is high LIBOR just a temporary blip caused by banks hoarding cash prior to results reporting early in 2008 ?
After reporting, the banks could therefore be more confident about lending to one another or not as the case may be ?
Hence the premium of LIBOR over base will reduce after the end of the bank reporting season.

Posted by: Nick Thorne at December 9, 2007 10:37 PM

To Nick Thorne - I am not aware of any regular seasonal blow-out in the base rate/libor spread. Perhaps someone else can correct me though.

Posted by: Top Cat at December 9, 2007 10:56 PM

James - I see - I took "worse" to mean lower. Just checking! Anyway we will see what today's print is, should be very interesting.

Nick/Top Cat - There's usually no seasonal increase in LIBOR like we are seeing as the moment. The banks' story that they are just hoarding cash for reporting season is incorrect IMO. We just had a further $10bn writedown from UBS. The banks don't believe each others balance sheets. End of year accounts is unlikely to change that (unless they all come out and announce massive losses, but then that creates other problems). The big 4 auditors are even holding an emergency meeting with the government at the moment to establish how they should value this junk! Plus lots of the banks have dodgy off-balance-sheet vehicles which could need to be brought back onto balance sheet at any moment. I don't think end of year accounts will change anything - the banks still don't believe each other.

Posted by: Minh at December 10, 2007 08:03 AM

Most of my large circle of business contacts were dismayed by the cut - we need to see the BoE taking a tough line against inflation.

According to the ONS, UK factory gate inflation (Nov) has hit a 16-year high.

Raw material costs are also rising faster than analysts expected.

Inflationary pressures are building strongly. The BoE appears to have taken its eye off the ball - I have meetings scheduled with them next week, and will be driving this point home in no uncertain terms.

Posted by: Mr Naresh Radson at December 10, 2007 10:46 AM

I wouldn't get too concerned by the producer price numbers. They cover only manufacturing, sadly only a small proportion of the economy, and they largely reflect the spike in oil prices to nearly $100 a barrel, some of which has now been reversed. Underlying output price inflation actually fell a little. The next CPI and RPI figures will be similarly affected but the Bank has to look forward. Unless earnings growth responds this time, inflation is not going to be the MPC's problem in the coming year.

Posted by: David Smith at December 10, 2007 11:00 AM

Minh, from what you are saying, it sounds like the banks have lost confidence in the auditing system.
So the "A well-judged jab of confidence for the UK" as this article is entitled will need more than MPC IR changes to be effective.
The emergency meeting of the "Big 4" and their subsequent actions & conclusions will prove a more effective "confidence jab".

Posted by: Nick Thorne at December 10, 2007 12:31 PM

in response to Tescos, low inflation rate. have they took into account the reduction in pack sizes for food and flowers.

Posted by: supermarket supplier at December 10, 2007 04:46 PM

I hope so, though their figures are not subject to same statistical rigour and scrutiny as those produced by the Office for National Statistics. I imagine they have achieved low inflation partly by squeezing people like you.

Posted by: David Smith at December 10, 2007 05:10 PM

Interesting to see Martin Ellis, chief economist of the Halifax, saying that he expected UK inflation to reach 4% during 2008[according to the Yorkshire Evening Post].

Posted by: Mr Naresh Radson at December 10, 2007 07:06 PM

He's talking about RPI, which would imply a lower rate than this year:

Posted by: David Smith at December 10, 2007 10:46 PM

'Inflation is likely to "get a little bit worse than the last couple of years" according to Mr Ellis'

Posted by: Piers Ponsenby-Smythe at December 11, 2007 07:38 AM

The Yorkshire Evening Post seems to be the place to be. This is from the HBOS report:

"Inflation measured by the headline retail price index is likely to move slightly above 4% during 2008. Headline inflation was as high as 4.8% in March 2007, before drifting back 4% in the second half of the year. The recent sharp increase in energy prices, with oil moving to record highs around US$100 per barrel, is likely to be the key driver of inflation in 2008. Other commodity prices, including food prices which are rising at their highest rate for 6 years in the UK - remain on an upward trend and are also likely to add to inflationary pressures. However, wage pressures remain muted with earnings growth likely to hold around 4% during 2008 as a weaker economic backdrop prevents wage inflation accelerating. This should prevent a significant pick-up in inflation during the year."

Posted by: David Smith at December 11, 2007 10:15 AM

One-month sterling rates have risen back over 6.7% now. So much for the interest rate cut!

Posted by: Top Cat at December 12, 2007 12:01 AM

As I say, I don't think we'll really know until we get beyond the year-end. You'll remember that the Bank originally said in August that it could only influence the overnight rate, which has come down. I'd concede, however, that it has been trying unsuccessfully to influence other rates.

Posted by: David Smith at December 12, 2007 11:12 AM

As I said, Libor has again gone up, but a much more interesting thing has happenned today...

It seems the central banks have finally realised how badly they have been messing this up. Today's actions say to me that the central banks really do not want to cut rates, and even if they do it won't effect the front end, and the problem area, of the the curve. By today's combined actions I suspect they are hopeing to not have to cut rates much more. Only time will tell how effective these measures will be, but to my eyes it seems to be just what the markets have been screaming for since August!

The buffoons have finally swung into the correct course of action...

Posted by: James Trouble at December 12, 2007 03:00 PM
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