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Rising inflation and slow growth render central banks powerless
The week's big news has centred on minutes released by the Bank of England and the Federal Reserve. Both paint a rather gloomy picture of the months ahead, with rising inflation and slowing growth dominating thinking among committee members on both sides of the Atlantic.
The Bank of England committee noted that the UK economy is slowing with GDP growth falling from 0.6% to 0.4% in Q1 2008. Industrial production also fell by 0.5% in March which was said to be "a weaker figure than that embodied in the original GDP estimate". There are equal concerns for the housing market, with house prices falling 1% in April. The growth in mortgage lending is likely to slow further with banks still not reaching "the end of their balance sheet adjustments" according to notes, or in simple terms the credit squeeze is likely to be with us for some time yet.
In the US, the Fed committee's statement noted that the outlook for economic activity had
weakened further; growth in consumer spending had slowed, and labor markets had softened. The outlook for the housing market was also bleak, the minutes also noted that financial markets remained under considerable stress, and that the tightening of credit conditions and the deepening of the housing contraction were likely to weigh on economic growth over the next few quarters.
The next policy meetings in Europe are due on the 5th of June and the committies are virtually certain to vote for a hold on base rates at 5% in the UK and 4% in Europe.Those controlling the purse strings around the world are currently paralysed by oil prices at record highs. Until inflationary pressures ease and the dollar strengthens they have little room for manoeuvre.
Extracts taken from the minutes of the BOE policy meeting released on the 21st May
On the UK economy...
"Even if money market conditions did improve further, lenders still had much to do to adjust their balance sheets to reflect a more realistic evaluation of risk. That meant credit availability was unlikely to improve in the short term."
"Further evidence had accumulated during the month that the UK economy was slowing.
According to the preliminary release, GDP growth had been 0.4% in 2008 Q1 compared with 0.6% in the previous quarter. More recent data suggested that industrial production had fallen by 0.5% on the month in March - a weaker figure than that embodied in the preliminary GDP estimate."
On the US Economy...
"Indicators of the United States economy had generally been less weak than financial market participants had expected."
"There had been no signs of a turnaround in the housing market, with foreclosures rising rapidly. And consumer confidence was fragile. The latest Senior Loan Officer survey from the Federal Reserve confirmed that banks had continued to tighten credit supply."
Oil Prices...
"According to the Bank's market contacts, speculative purchases did not seem to be the prime cause of the recent increases in the oil price. More fundamental demand and supply factors had probably been at the root of its steep rise during recent months, and there remained considerable uncertainty about the oil price outlook."
On the UK housing market...
"The housing market had weakened further. House prices had fallen by just over 1% in April, according to both the Nationwide and Halifax indices."
"Growth in mortgage lending was likely to slow further, as banks had not reached the end
of their balance sheet adjustment."
"Many existing homeowners had built up a sizeable amount of housing equity, but a weaker housing market and tighter credit conditions would make it harder to access this collateral to finance consumption."
On deciding to hold the base rate at 5%...
"In setting Bank Rate, the Committee continued to balance the upside and downside risks to inflation at this horizon. On the downside, a sharp slowing in the economy associated with weak growth of real disposable income and the tightening supply of credit could pull inflation below the target."
"The contraction of credit supply had been intensifying and, coupled with the erosion of real incomes, was likely to depress demand."
"The upside risk to the inflation outlook over the forecast period was that the period of above target inflation in the near term would, by affecting the expectations of those setting prices and wages, have a greater tendency to persist than had been assumed in the central projection. Reducing inflation from persistently high levels had in the past required prolonged periods of subdued economic growth."
"For most members, a reduction in Bank Rate this month would make it more difficult to keep inflation expectations in line with the target. CPI inflation was already at 3% and the Committee expected it to rise further in the near term. Although economic activity was likely to slow, the Committee had judged that some slowing in the growth rate of output was likely to be necessary for inflation to settle close to the target around two years ahead."
"For one member it was, however, particularly important to look through the short-term spike in inflation. The factors pushing inflation up - oil and other commodity prices - were beyond the MPC's control and, with pay growth remaining subdued, this period of above-target inflation would have little tendency to persist."
The Heat Is On
Just when the future was starting to look a little rosier, the UK was rocked by CPI figures of 3%, one percent above the target set by the treasury. This figure was higher than expected and a whisker below the level at which Mervyn King would need to write a letter explaining why.
This higher than expected increase from 2.5% shouldn't have come as much of a shock to anyone given that food prices are up 6.6% and energy 8.3% higher than a year ago. So what can the Bank of England do about it? Well nothing, it seems, as cutting interest rates further would exacerbate the inflation problem and raising the rate in the next meeting would only serve to plunge the country into a deep recession.
With all eyes on Crewe and Nantwich this week the government made a dramatic U-turn this week on the 10p tax rate ahead of a byelection which is taking on increasing importance. The Prime Minister has also been on a charm offensive, to bolster support for his battered party.
Looking elsewhere the 3-month libor rate the UK's key interbank lending rate has quietly increased, meaning looser lending conditions among banks are still firmly off the agenda.
This will of course feed down into the housing market via fewer mortgages being granted, which in turn will slow demand among those looking to buy property. This situation should at least benefit the rental sector with increasing numbers of people choosing to wait until the market recovers.
While it's been the hottest week of the year so far in the UK the economic gloom continues...
Breakfast with Brown
Will this be a full English breakfast or a continental? Whatever happens it will take more than a few extra rashers of bacon to force open the door to the coffers of high street banks.
There are signs that the banks are willing to pass on at least some of the of the recent interest rate cut to customers, however we are still a long way from seeing confidence return.
This morning's meeting will take place in Downing Street as a result of growing concern for the UK economy. While the prime minister has rejected any suggestion that this is a crisis meeting, it is evident that the economy is on the slide. Brown will be anxious to avoid following America into a property market crisis with plunging house prices spreading into other sectors of the economy including jobs.
He will need to ensure that banks have no more skeletons hidden in their closets and urge them to loosen their purse strings by repairing shattered confidence. The importance of this meeting cannot be understated as the solution to recovery from the slowdown rests on a loosening of credit conditions.
Recently nationalised Northern Rock will be among those banks he will need to convince. With those alarming queues around the block still fresh in the memory, the bank still have their standard variable rate under review even after April's base rate cut.
Will he succeed in convincing them? Has the recent base rate reduction been successful in restoring confidence?
What do you think? have your say
Credit crunch brings good news for students
As I write this, the Bank of England has yet to make their decision on the UK base rate. The only way as predicted on this site is down owing to the impact of the credit crunch; however, whether or not the decision is to cut or hold, it will at least help debt laden students.
We are all about to suffer the fallout from what is turning out to be one of the worst financial storms since the 1930s and there is little in the way of good news to lighten the gloom. However it turns out that with base rates odds on to fall today, students will be reaping the benefit. The introduction of student loans has been the curse of many students forced to graduate with a minimum £12,000 mill stone hanging around their neck. Debt is a depressing reality for many in the UK particularly graduates who are forced to choose between getting on the housing ladder and paying off their loans.
The silver lining, if there is one, for graduates now is that in times like these it can actually be the poorer members of society who stand to benefit.
The student loan tracks the base rate; therefore each successive cut will go some way to lightening the load. It has to be said they'll still struggle to afford a property with average starting salaries for many graduates currently at £13,000, but with a house price crash looming; maybe there is further good news on the horizon...
What do you think? have your say
How many Base Rate cuts will it take to restore banks' confidence?
A typical mortgage now costs £216 more a year than it did just three weeks ago. The recent rate cut and rumours of a further rate cut, have so far failed to have any effect on bringing mortgage rates down, on the contrary, they are actually rising - and fast...
Once again it is the average homebuyer who will be absorbing the fallout from the credit crunch, itself caused by Banks' irresponsible lending in the first place. Those who have chosen to borrow beyond their means are not to blame, houseprices have risen so high in the past decade that first-time buyers have been prepared to borrow more than 4 times their salary just to buy a decent sized home. The availability of mortgages at these levels has been a disaster waiting to happen, banks desperate to gain a greater slice of the mortgage market pie have actively encouraged irresponsible lending. For such large sums of money restrictions were incredibly relaxed.
So now with fixed rate deals coming to an end, those people will need to find new products, yet they will find there options becoming more and more limited. With banks now withdrawing some mortgage products and upping their new fixed rate deals, many will face a hard time meeting payments. This will be very damaging for the housing market, making a crash a virtual certainty.
It is deplorable that banks that banks could potentially profit from their own recklessness.
Availability of credit is one of the key drivers of a healthy property market, yet the banks are choosing to up rates and withdraw products even though the BOE is cutting the base rate in an attempt to rescue the situation, a trend which is certain to continue. When will the banks realize that the sector of the market they are squeezing the most happens to be the most dynamic? There are people who think correction is a good thing, but try telling that to the people losing their homes this year.
The banks have now turned their attention to the long neglected area of saving to try and bring some stability to the industry, yet with the base rate falling this will become even less attractive to savers. We may yet see the same aggressive base rate cuts seen in the US in the next 12 months before banks loosen their grip. Watch this space...
What do you think? have your say
Bank of England base rate policy
A recipe for disaster?
After a particularly turbulent there are signs of the dust settling over in the US after successive cuts in base interest rates. It remains to be seen whether successive base rate cuts will help the US economy in 2008, with the spectre of inflation looming large on the horizon and house prices still in freefall. The question is should the UK follow the US into base rate cuts to kick start the slowing economy and combat the threat of falling house prices?
The BOE pursued a policy of raising interest rates last year in response to house price inflation reaching unsustainable levels. This policy has worked, but there are signs now that the policy may have worked a little too well. The brakes are now firmly jammed on the housing market, it is steadily grinding to a halt and there is the very real prospect prices sliding into reverse. House prices have fallen to their lowest level of increase since the mid 1990s.
Of course no-one could have predicted how deep the current credit crisis would be last summer, but there is now the very real prospect that those interest rate rises last year have bitten back. The twin impact of the credit crunch is widely reported on - mortgage applications are down and first time buyers are unable to capitalise on cheaper housing with the disappearance of 100% mortgages impacting heavily. But what about the effect of those high interest rates? This made mortgages more expensive to begin with which made people less inclined to re-mortgage.
The expectation now is for another cut in the base rate in April, however it will be some time before this has any effect on the housing market with the spread between the Libor (the rate banks lend to eachother) and the base rate having widened. This is passed onto customers in the form of higher interest rates on their mortgages. The Nationwide for example have just added 0.6% to their fixed rate and tracker mortgages. A further cut is unlikely to have any real effect on the housing market ailing housing market.
An interest rate cut in April will also raise the prospect of inflation with consumers already hit by the rising price of food and fuel which has risen significantly more than the current measure of inflation. People will be less inclined to go out and buy non essential items with the cost of daily necessities growing ever higher and the prospect of their homes falling in value.
Wage growth is likely to slow too with the very real prospect of a recession on the horizon. In the 1990s recession companies will be less willing to negotiate higher salaries with their employees in difficult market conditions.
A cut in the base rate will do little repair the damage and could make things worse at this stage. The best decision would be to hold rates and wait for the current financial storm to blow itself out, the last thing we need in the UK now is an increase in inflation.
What do you think? have your say
