Comments: Bank may have squeezed enough

Do you think the MPC could be more effective if they increased to 0.5% the minimum rate change that they ever apply? Looking at interest rate history, most rate changes are in the same direction as their immediate predecessor, including all of the five rises within the last 12 months. This must surely bring into question the MPC's current approach. A larger minimum change might help MPC members to control inflation more actively, with any rate changes more likely to have a visible impact. 0.5% should still provide a sufficiently fine control to steer close to the 2% inflation target. Has any research been done on the effectiveness of applying two consecutive 0.25% changes as compared to a single 0.5% change?

Posted by Andy Carrott at July 29, 2007 10:57 PM

"June’s mortgage approvals softened significantly."

Whoops!

Posted by Sell Everything at July 30, 2007 09:56 AM

On Andy's point - yes, there is always a case for a "shock" announcement - of half a percentage point. I'm old enough to remember when the shocks were two percentage point hikes. You'll remember perhaps that the MPC gave brief consideration to a half-point hike recently. The system discourages it, however, in the sense that a half-point rise would imply that things had changed unexpectedly since the previous month, and that the Bank had lost control of things. Perhaps half-points would come into play if sterling suddenly started falling sharply.

On mortgage approvals, yes, the Bank's figures were stronger than it was reasonable to expect given the BBA data, but the latest three months was still the weakest since the third quarter of 2005. I'm happy to admit that the housing market has been stronger than I expected - but then again some people were predicting it would be crashing around our ears by now.

Posted by David Smith at July 31, 2007 08:46 PM

Like a certain someone who was predicting oil to be below $70 a barrel and cpi under 2% by about now-(ish)............!!

Posted by matt at July 31, 2007 11:01 PM

Oil yes, CPI no ---- but then I don't suppose you'd know the difference.

Posted by David Smith at July 31, 2007 11:10 PM

Hi David,

What's your take on Bloomberg saying that IR's should go up this next MPC meeting? To summarise:

Why the Bank should hike interest rates this week:

30.07.2007

...by John Stepek

1. Amid the panic last week, traders are clinging to one silver lining. At least, they think, the Bank of England won’t raise the base interest rate to 6% this month. Not now.... That doesn’t mean that it shouldn’t though… Most commentators are now expecting the Bank of England to hold interest rates this week....But if the Bank does hold rates, it’ll be a mistake.

2. There’s been a lot of vague talk of consumers and house prices showing signs of slowing down, but the reality is that most of this talk comes from companies and estate agents warning that people might slow down in the future....As for house prices, inflation still remains strong - with annual house price growth still in the high-single digits, according to most surveys. And lenders are still finding new ways to get people to take out bigger loans - the latest wheeze, judging from the amount of coverage its got in the papers recently - is to take out a foreign currency mortgage....Nobody mentions that this is probably the single most toxic form of the carry trade there is - borrowing money in a foreign currency to pay for your home...Anyway - back to the Bank. The point is, most commentators are expecting another rise to 6% this year - and if the current market turmoil hadn’t erupted, there’d be a lot more people looking for it to happen this Thursday.

3. And that’s the important point - inflation isn’t going away. Oil prices remain higher than anyone really expected them to be at this time last year. And meanwhile, food price inflation is becoming a real theme.

4. So while the credit markets may be collapsing, input costs are set to keep on rising. Those costs have to go somewhere – and shop price inflation is the most likely destination. So while the Bank may well pay more attention to the market’s current spasms when it meets on Wednesday and Thursday, it would be better for us all if it focused on its long-term game of catching up with and squashing inflation before it becomes any more entrenched.


Posted by pete balchin, Solicitor. at August 1, 2007 10:08 AM

That's not Bloomberg, that's somebody from Moneyweek writing on Bloomberg. And that is not a source I pay any attention to. As a simple point of fact, the surveys of analysts saying there would be no change in rates this week pre-dated the market turbulence.

Posted by David Smith at August 1, 2007 10:35 AM


Hi David,

And thanks for that, I did realise it was someone else after I had E Mailed , so sorry about that.

I can't quite help feeling they may and I stress may need to go up a further .5% - .75% before the year end and I should have thought that earlier would be better if as we fear, inflation is back and out of the bag...


Kind regards.......

Posted by Pete Balchin, Solicitor at August 1, 2007 06:22 PM

Dear Mr Belchin,
Q: Does Being a solicitor really qualify you to suggest rates should go over 6%? A: Yes it does.
Your guess is as good as most economists (ten out of the last three recessions and all that), David being no exception - he has got it wrong on rates for a while now. David dismisses Money Week commentators at his peril. They have correctly predicted the renewed oil price trend, the soft commodoties boom, the US sub-prime fall out, and they have, of late, been consistently better analysts of UK inflation and interest rates than him. (They might even be wittier, but I'm not sure about that now I've started to read some of his quips on this blog!)
Real interest rates have been low and monetary policy lax in the UK (and the world) for years now. Real interest rates are still too low in the UK, especially given GDP growth, money and credit growth, and the backdrop of an increasingly inflationary global environment. Sterling is holding things together, but that may not last.
I believe you are quite right: rates will top 6%, and a damn good thing for hard working saving brits as well.

Posted by T Gumbrell at August 1, 2007 08:05 PM

Dear Mr Belchin,
Q: Does Being a solicitor really qualify you to suggest rates should go over 6%? A: Yes it does.
Your guess is as good as most economists (ten out of the last three recessions and all that), David being no exception - he has got it wrong on rates for a while now. David dismisses Money Week commentators at his peril. They have correctly predicted the renewed oil price trend, the soft commodoties boom, the US sub-prime fall out, and they have, of late, been consistently better analysts of UK inflation and interest rates than him. (They might even be wittier, but I'm not sure about that now I've started to read some of his quips on this blog!)
Real interest rates have been low and monetary policy lax in the UK (and the world) for years now. Real interest rates are still too low in the UK, especially given GDP growth, money and credit growth, and the backdrop of an increasingly inflationary global environment. Sterling is holding things together, but that may not last.
I believe you are quite right: rates will top 6%, and a damn good thing for hard working saving brits as well.

Posted by T Gumbrell at August 1, 2007 08:05 PM

I certainly do know what consumer price index is... it's that nonsense inflation index, of (mostly) items non essential to living.

Posted by matt at August 1, 2007 08:31 PM

Well you've just proved you don't know what the CPI is, which doesn't surprise me. Food, energy and transport would be those non-essential items, I suppose.

As for Money Week, dog doesn't eat dog, and I'm sure it has its followers. I'm just not one of them. It gets some things right, and shouts about it, and gets as many badly wrong.

It is financial markets, of course, that have predicted 10 out of the last three recessions, not economists. I'd concede that I did not expect interest rates to go to where they are now, but neither did most people. Look at where the markets were in the summer of 2006. The membership of the MPC changed, and so did the Bank's reaction function. The dumb view on interest rates (inflation is up, time to panic) has proved to be the correct one. What matters though is the record, not just over one hiking cycle but over the long-term. In August 2006, when we had the first hike - which you may remember I said beforehand we should not be surprised by - I said after it that rates would rise to at least 5%. When they were hiked in January, I said 6% had become a distinct possibility. The dumb view is to say where you think rates should be. What I have to do is try and assess what the Bank will actually do. That means listening to them, privately and publicly. So in November the Bank told us that 5% should be enough but it has progressively raised its assessment of the necessary level of rates since. In the past, listening to the Bank, rather than wild commentary, was the best thing to do. This once, it hasn't been.

Posted by David Smith at August 1, 2007 09:31 PM

Hi David and thanks for returning although sometimes I think you must be despairing of the bloggers here (and I suppose I come to that!).

I know how you feel. The dismal science is very difficult to predict... I think in truth its even more difficult than the law and that is completely irrational based on what a judge thinks when you turn up in court and have spent 20000 getting there!

I still predict IR's at 6.5 % by year end and 7.5% by May next year...

Kind regards...

Posted by Pete Balchin, Solicitor at August 1, 2007 10:33 PM

Hi David,

...I guess that oil proces having climbed to 78.71 dollars last night, this compounds problems doesn't it?

Regards..

Posted by Pete Balchin, Solicitor at August 2, 2007 07:57 AM

From today's Telegraph: "Inflation fears have resurfaced after factory gate prices rose in July at the fastest rate in 15 years. Manufacturers shrugged off a strong pound and rising interest rates to push output prices to their highest level since records began in 1992.". And, from today's Times "Britain’s biggest mortgage lender today conceded that another interest rate rise was almost inevitable as it revealed that annual house price inflation rose by its largest amount for more than two years in July.".

It appears that there's too much heat in this economy doesn't it? 3% growth, house prices still climbing beyond all trend measures, input prices increasingly rapidly, output prices going the same way. In the background, M3 grows and global inflationary pressures increase.

Although its long-term record is untarnished, the Bank has failed to hit the 2% target for a year now. Irrespective of the real economy (and that's a big 'irrespective'), the Bank needs to hike at least once more just to show its mettle. Otherwise it may soon find its credentials (which were not hard, but easily won) under threat, and that in itself would raise the long term RI rate in the UK.

Where's your fighting spirit David? Get behind the UK's savers, support the sanctity of our money, stop defending the fools that borrowed more than they could afford to repay. These quarter points are nonsense. We need a good solid half point market shocker straight to 6.25%. That would stop us from having to go higher, reward savers, dioscourage credit bingers, restore the Bank's credibility, and you never know, might even help out the FTBs. It would also probably ensure that RPIX sank below its old 3% target, and CPI below 2%.

Posted by T Gumbrell at August 2, 2007 09:53 AM

On dear. Ever come across the notion of lags in monetary policy? I can understand why some people are clamouring for higher rates for their own vested interests but the role of the Bank is to strike the right balance. The RPIX target, for information, was 2.5%.

Actually, the biggest shock value the Bank could achieve would be by hiking to 6% today rather than leaving it until the autumn. Not that I'm advocating it.

Posted by David Smith at August 2, 2007 10:34 AM

T Gumbrell ,
"the Bank has failed to hit the 2% target for a year now... the Bank needs to hike at least once more just to show its mettle... We need a good solid half point market shocker"

Don't forget that it's thought interest rate changes take about two years to have their maximum effect on CPI - interest rates are set based on where inflation is expected to be in the future. To make a half point 'shocker' would not only look like panic, but may also not be in our best interests in terms of controlling inflation. The last thing we need if monetary overkill. A big recession and possible deflation is an awful lot harder to control than slight over-inflation (just look at the situation in Japan from the early 90s till very recently).

Posted by Ed B, Software Engineer at August 2, 2007 10:43 AM

My undertstanding is that it normally takes upto 18 months for the effects of rate changes to be FULLY realised. This doesn't mean that changes have no effect in the intervening period. Effects are gradual and cumulative, depend on transmission mechanisms, and come to full fruition after the lag.

In any event, I believe that rates need to rise for the now, and for the future. We can surely discern the form of growing global inflationary pressures, and we know that there is rapid growth in money and credit. Rates need to increase further to counter these future events, at the same time as helping the Bank to bring CPI under control in the pre-18 month period.

Vested Interests? - there is no greater and more powerful vested interest than the overstretched, over-indebted UK consumer. It is the (over) consideration given to this VI that perturbs the MPC from showing its teeth. It is common sense turned on its head. The authorities have sent a signal to the people: do not save, borrow. We are uniterest in savers, but will protect debtors at all costs.

Ed B - It is the very laxity of monetary policy since 2001 that has allowed this economy to bubble-up to such an extent that you fear that it could collapse into a Japan-like deflationary spiral (your fear not mine). Are you saying that we might be 25 or 50 basis points away from a depression? I disagree, I think that real inflation is rampant in the UK, and that even the CPI will come under increasing pressure over the next two years.

I repeat my point that failure to act in any event is too big a gamble for the Bank to take. It's reputation was easily won in a low inflation global economy. The real test is just beginning. To secure its reputation it needs to get ahead of the curve. Lat time I looked the curve said 6.25.

Posted by T Gumbrell at August 2, 2007 11:39 AM

Well I'm afraid that's no more coherent. We've had part of the effect of the first three rate hikes, and none at all from the last two. Some effects are showing through - there has been a decisive slowdown in consumer credit and, though the evidence is mixed, in spending and the housing market. The art of monetary policy is to judge when the dosage is sufficient, not keep adding to it until the evidence is clear, by which time you'll almost certainly have done too much. Ed understands this point rather well.

Posted by David Smith at August 2, 2007 12:43 PM

For reasons stated, I still tend to disagree about your outlook for rates, but understand and defer to your contention about lag times. Of course the weighting you give the various variables in your forecast is critical - I know there have been previous discussions on this site about money supply growth for eg.

David, on a broader level, do you think that CPI inflation targetting is the right monetary policy framework for the UK? I haven't spotted any of your musings on the issue. It seems to have worked impressively in benign times, but we do have some issues with asset prices, personal debt, and don't seem to be saving very much anymore. Sometimes it feels like things are out of kilter. We're in so much debt that many (Ed B for eg) think the economy is vulnerable to a Japanese style deflationary meltdown. I don't think so, but the UK certainly seems to exhibit some worrying imbalances (economic and socio-economic), some of which might be attributable to the monetary policy framework.

I would be fascinated to know your thoughts.

Posted by t gumbrell at August 2, 2007 02:26 PM

To paraphrase Churchill, inflation targeting isn't perfect but it has worked better than any other variation of monetary policy we have tried in the UK for very many decades.I wouldn't, though, have changed from RPIX to CPI, as I've said many times.

Posted by David Smith at August 2, 2007 04:55 PM
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