Comments: Hawkish MPC on the brink of another hike

LIBOR futures are now firmly pricing in 6.0% base rates by Christmas.

Posted by Minh at June 20, 2007 10:32 AM

Poor Mervy. It's the second time he's been outvoted.

Posted by Werewolves at June 20, 2007 02:19 PM

Dear David,
In contrast to previous minutes, the current ones provide a lengthy discussion of M4 (points 14, 15, and 16).
In my view, the money effects on inflation are statistically significant but negligible. So there is an issue, but it is rather exaggerated.
Many thanks.

Posted by Costas Milas at June 20, 2007 03:45 PM

I note the BOE report mentions that the very large increase in money supply doesn't matter, if this is a result of portfolio preferences - I take that to mean the money created is going into Assets, which would not directly affect the path of inflation as they do not affect GDP directly.

Of course, this would imply that v - the velocity of money - i.e. money supply to GDP activity - would decline further as asset prices and this money increase will not show up in GDP.

The implication for inflation, P = M + V - Y, would thus be tame for the time being.

Interestingly, The report mentions that evidence of lending standards on the ground, indicates credit, loans to income multiples - is too loose and needs tightening.

Posted by J Law at June 20, 2007 10:12 PM

Given that data since the previous MPC meeting has been on the soft side especially average earnings and CPI, and housing beginning to show signs of having peaked, it may not be a given that they will get the 5 votes necessary to hike in July. Why would any of the 5 who voted no change in June, vote for a hike when the data since then has been weaker and would it not follow that they would want to wait atleast till Aug to see one more month's of data before making a decision?

Posted by Sal at June 21, 2007 03:14 AM

I think you can deduce that a July rise is likely by looking at some of the comments in the minutes about the views of the members who voted for a hold. They all seem to agree that at least 1 more rise is needed, they just disagree about the timing. July is now looking very likely, and if it doesn't come in July then it will certainly come in August.

There's a great piece on bloomberg today about the role of central banks in steering the global economy, it begins:

"Granddad Benny, is it true that central bankers used to believe they could steer the global economy with quarter-point twitches in overnight rates?"

Full article: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aNdzlfjZPuxM

Posted by Minh at June 21, 2007 10:58 AM

Rates may peak soon to offset consumer spending dropping.
Retail sales have been dropping on non-essentails, as essential goods and services have been rising in price while wage growth is subdued (leading to dropping inflation?)

I seem to recall Mervin was encouraging businesses on the 11th to add more capacity - more jobs - he seemed to indicate there would be plenty more labour, or at least wages are not likely to grow much.

This tallies with a token rate rise or two, but not enough to curb business investment, which is also a major feature of Browns Budget.

Posted by J Law at June 21, 2007 10:57 PM

I remember getting pretty short shrift late last year when I predicted rates could touch 6% by the end of this year. Oh well. I'm not going to say it though.

I remain convinced that the benign conditions of the 'great stability' are under considerable threat and that we've mis-read the counter-inflationary inflluence of China.

I've said before and I'll say again that most of the benefits of cheap goods from China have already been factored in and the benefits realised. Factory gate prices are unlikely to drop further. If the Chinese economy can continue to expand (and I maintain that there's a narrower skilled labour and managerial bottleneck than people generally factor in) then it will simply push up raw materials and energy prices as companies compete for the basics. Chinese production costs will rise pretty sharply over the next three or four years.

As for Minh's reference to the Bloomberg piece; saw it, read it - silly conclusion - global bubble implodes 2008 world uses Yuan as global currency by 2025.... nah.

If the global economy implodes then China will suffer - it's markets will shrink and jobs will go. China's rural hinterland is already experiencing considerable unrest - largely because it remains poor as the rest of the country prospers - a sharp downturn would transfer that unrest to the cities. China is worse placed than almost any other country to deal with a downturn. It's huge and almost ungovernable in good times with Beijing and Provincial governments often at odds and pulling in different directions.

Even if they hold it together through a downturn China won't be in such great shape afterwards and with such great transparent institutions that the rest of the world would want to use the Yuan as a global currency - that's simply scaremongering from a Bloomberg columnist who should know better.

Arguably the biggest issue in world politics and economics today (aside from climate change and maintaining economic stability) is how will China cope with a serious economic shock - or even with a sharp rise in aspirations amongst its middle and skilled working classes.

Chris Patten says HK is a lone example of a liberal non-democracy. That's pretty much what China aspires to - economic liberalism, political one dimensionism. Well look at the scale of popular protest in Hong Kong. Just imagine that replicated in half a dozen major Chinese cities.....

And no I'm not going to predict the outcome - but if it happens I'll be on the edge of my seat watching

Posted by Jonathan at June 23, 2007 02:56 AM

Some well-argued points. I can't remember that you got short shrift on 6%, but I hope you made some money on your interest rate bet. The mistake some of us made, with hindsight, was to take guidance from the Bank itself. It was fairly clear after August that this wouldn't be a one-off, but by November the Bank was indicating, in its inflation report, than 5% probably would be enough. Not long after that we had the January surprise and the rest is history.

On China, which I've recently been looking at in some detail in my book The Dragon and the Elephant, I take a different view. There are growing pains and strains at the moment, as you'd expect in an economy expanding by 11%. But I think the China effect has a long way to go, for two reasons:

1. The upward effect China exerts on food and commodity prices will always be smaller, in its impact, than the downward effect it exerts through goods prices.

2. As long as China continues to gain market share, which everybody expects it to do, there will be a China effect - a shift from higher cost to lower cost production.

A simple illustration. Suppose Chinese unit costs are a fifth of those in the UK. Chinese costs rise by 15%, UK costs by 5%. The absolute gap between the UK and China has still grown

But I do accept your point that China would struggle with a serious economic shock - that is one of the messages of the book. After nearly 30 years in which GDP growth has averaged 9.5% a year, even a modest downturn would lead to severe political strains.

Posted by David Smith at June 23, 2007 05:13 PM

I'm not sure I totally understand the reasoning behind your first point ("The upward effect China exerts on food and commodity prices will always be smaller, in its impact, than the downward effect it exerts through goods prices").

Would you care to expand? Thanks

Posted by Sell Everything at June 24, 2007 09:35 PM

Yes, sure. Commodity costs are only a small element in final prices - even for food. What's being happening to food prices in the UK over the past 12-18 months is mainly a rebuilding of margins, not a commodity price effect.

Posted by David Smith at June 24, 2007 09:54 PM

David - I see your point. But there's also a question about timing. Most of the gain from lower Chinese labour costs will be felt in a short space of time. In fact, I think we've already experienced a large bulk of it. In contrast, the upward influence on scare commodities will be felt over longer periods.

Also, I'll just point out that, since the start of 2006, the IMF's global food commodity price index is up a cumulative 16%. 'Food' in the CPI is up 6%. It looks difficult to deny that most of this is cost push.

I don't think we've 'mis-read' the disinflationary influence from China, as Jonathan suggests, just exaggerated it.

Posted by Sell Everything at June 25, 2007 11:42 AM
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