If the Bank of England does not raise interest-rates in response to 4% inflation when will it do so?

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by Shaun Richards

This morning has seen something of a different event but it has given us an insight into the thoughts of the Bank of England. This is because QuickBooks arranged an “Ask the Expert” session with Michael Saunders of the Bank of England on YouTube. Let us pick up on his replies. We can start via Live Squawk on his view of the economy.

BoE’s Saunders: Level Of GDP Now Probably Fairly Close To Pre-Pandemic Levels

If we look around there are some signals hinting in that direction such as the reports that traffic has returned to what were previously regarded as normal levels. In terms of forecasting performance this means that the Bank of England has been behind events as this from the February Monetary Report shows.

GDP is projected to reach its 2019 Q4 level by 2022 Q1.

In fact that itself was an upwards revision.

such that the economic impact of Covid fades somewhat more rapidly than previously projected.

Whilst the path of Covid-19 and the economic effects have been at times unpredictable it is also true that they have been consistently too low in their estimates. This matters because they have set policy for that as I will come to.

Inflation

Here the questions seemed to anticipate what is coming tomorrow as the Treasury Select Committee in Parliament.

MPs are likely to explore the BoE’s forecast that inflation will rise to 4%, and the Monetary Policy Committee’s continued expanding of quantitative easing.

Here is his morning’s answer.

BOE’S SAUNDERS: INFLATION HAS INCREASED MORE QUICKLY THAN PLANNED. ( @FinancialJuice)

It is hard not to have a wry smile at that as we remind ourselves if their prediction in February.

As those effects drop out of the annual
calculation over the rest of 2021, and recent rises in energy prices feed through to petrol and utility prices, inflation is
projected to rise sharply towards the target.

Actually they have a small window of respite as last month in something of a head fake the CPI annual rate was reported at 2%.Those seeing it as a change of trend are about to get a shock over the next couple of months. The RPI gave a much better signal by only dipping marginally to 3.8% but that will be ignored by the Bank of England.

There was a confession that inflation is about to surge again.

 I’m concerned that continuing to buy assets while CPI is at 4% may lead medium-term inflation expectations to rise. ( @FinancialJuice)

However we did get an attempt to distract us by moving from the reality above to something of a fantasy world at the end. He is focusing on inflation expectations for two reasons. The first is that they tend to be lower than inflation.

Market gauge of long-term eurozone inflation expectations rises to highest since Feb 2018 at over 1.76% ( @PriapusIQ)

Whereas Euro area inflation is 3%. Why is this so? It is easy really markets have no idea and we are often dealing with markets where central banks intervene with their bond purchases either explicitly as in the US ( buying TIPs) or indirectly like the Bank of England does via its own QE. The second is that they are in the future and provide another excuse for not acting now.

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We did get the word “transitory” thrown into the mic as well as this.

The United Kingdom will not deal with a long-term inflation issue. ( @FinancialJuice )

I presume he does not mean they will just ignore it as that is much to close to the truth!

House Prices

Completely ignored – as it is by the CPI inflation measure- was this from the Halifax earlier.

Average house prices climbed again in August, with the cost of a property increasing by 0.7% or £1,789.
Back-to-back monthly price gains have now pushed the cost of a typical home to a record of £262,954,
topping the previous high (£261,642) recorded in May this year.

So another rise to a new record which is on what is the largest purchase many of his audience will or have already made. So any sensible inflation measure simply should not ignore this in my opinion.

However, compared to June 2020, when the housing market began to reopen from the first lockdown,
prices remain more than £23,600 higher (or +9.9%).

As importantly whilst there is an obvious bias here the Halifax thinks it will continue.

We believe structural factors have driven record levels of buyer activity – such as the demand for more
space amid greater home working. These trends look set to persist and the price gains made since the
start of the pandemic are unlikely to be reversed once the remaining tax break comes to an end later this
month.

Policy Response

We already know that Michael Saunders voted to stop QE bond purchases at £830 billion. What else would he do? Via FXStreet.

“Should ease off the accelerator rather than apply brakes.”

So this is a confirmation of what he voted for. But we did get some views on official interest-rates or Bank Rate.

“Maybe right to think of rates going up in next year or so, depending on economic conditions.”

That is hardly convincing and even that vague effort is undermined by this.

“If bank rate does rise in next year or so, it would be relatively limited.”

So it would go from 0.1% to 0.2%? I am not being as silly as it might seem because their previous move was a cut of 0.15%. So let us say back up to 0.25%. But frankly what use would that be against inflation at 4%?

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More questions are begged because as he does not intend to do much, how will it change this?

“This could cause a more severe monetary policy response later.”

As well as what would he consider to be a “severe” response?

Comment

We learn quite a bit I think from what are the throwaway lines. For example he defined the 2% inflation target with the output objective which means that inflation was always going to be allowed to overshoot. This raises another problem which is that whilst the UK economy has recovered pretty strongly we are now in more stormy waters. We were always worried about the impact of the end of the furlough schemes and this will happen as overseas worries are in play as well. For example the New York Fed has bot done this because the numbers were going to rise.

The uncertainty around the pandemic and the consequent volatility in the data have posed a number of challenges to the Nowcast model. Therefore, we have decided to suspend the publication of the Nowcast while we continue to work on methodological improvements to better address these challenges.

It was 3.8% annualised and thus was about to take a dive from that. So inflation before there and here seem set to be ignored by the Fed and Bank of England until we get to stage 4.

It’s too late now

Or as I put it on the 6th of August.

What we learn from that is they have no intention of making even modest rises in interest-rates. The plan looks to be to dither so much that by then the next downturn will have arrived.

Is it arriving now?

Switching to Michael Saunders he did at least vote to stop the QE bond purchases. But they carry on as there will be another £1.15 billion this afternoon. The effect of this and all the credit easing is being felt in the mortgage market.

 

Quoted mortgage rates falling rapidly across all loan-to-value (LTV) ratios. Rates on two year fixed rate: at 75% LTV & below are at record lows, above 75% LTV still higher than pre-pandemic but falling quickly. ( Neal Hudson).

I pointed out in this week’s podcast that the Bank of England chose a 1% interest-rate as a level for reducing QE because it has no intention of getting there. Let me add that there are now roads ahead where it does not raise at all.

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