Of UK bank rate, Swervin' Mervyn and the future...

[Martinghoul]

A spontaneous discussion erupted on another thread about the future of UK rates and other such lofty subjects. In order to stop polluting the original thread, I thought I'd create a separate one that would allow us all (residents and evil tax evaders alike) to have a bit of a discussion.

The basic question is simply what happens to the bank rate over the medium term, where "medium" is defined in line with the various Central Banks to mean arnd 2 - 3 years.

Not sure if it be useful for me to try to establish a bit of a context, in terms of the current economic situation in the UK. Pls let me know if a summary would be of use.

 

[mikmo]

In the other thread I mentioned that I felt the curve seemed too steep given the fragility of the economic recovery, I feel rates will have to be held down for quite some time to ensure we have a real recovery in place before rates can be raised.

Further to that I was thinking about where we see the curve, say 1 Year out. It's currently at 1.125%.

I'm at home and not sure where I can find futures online but this seems to suggest I'd be economically indifferent if I borrowed at floating for 1 Year (currently 3M LIBOR is 0.77, highest rate since August 2009) or fixed at 1.125% for 1 Year. From this we can very roughly imply that 3M LIBOR in 1 Years time will be c.1.50.

To me it seems so unlikely we'll see rates double over the coming 12 months. We've been stumbling along in a very low rate enviroment since the early 2009. Even given this the improvement in the economy has been fairly muted. Factor in the demand drag doubling rates would have and I think we'd back in trouble very quickly. Think about peoples increased mortgages payments, resulting defaults, business borrowing dropping etc.

Apologies for the very rough calculations!!

 

[HowardCohodas]

Are not interest rates set by the central bank in the UK to a significant extent determined by what happens with other country's interest rate decisions? If any one central bank is out of line, I would think it would trigger huge cash flows seeking higher rates.

 

[Martinghoul]

If only things were so simple, Howard... While it's certainly true that the MPC looks at the global situation when making monetary policy decisions, rates in other economies arnd the world are just one of the many inputs into the process.

 

[HowardCohodas]

If only things were so simple, Howard... While it's certainly true that the MPC looks at the global situation when making monetary policy decisions, rates in other economies arnd the world are just one of the many inputs into the process.

I'm good with that. I'm just wondering if rates in other countries are a first order or second order effect on the the interest rate setting decision.

 

[montmorencyt2w]

One commentator recently was suggesting that Osborne is hoping (or betting) that King will "keep his nerve" and hold down rates into the foreseeable future.


Personally, I can see stagflation being on the cards.


As for global versus domestic concerns, I would think that the BoE will not want to be too much out of step with the Fed, at least, more so than the other central banks.

 

[breadman]

interest rates are to low in England but they will not raise them until the market forces them to. King and his chums seem to think their is loads of spare capacity so inflation is not a problem as it will come back down one day. King and Bean have said as long as the average worker in the uk is only getting pay rises of around 2% inflation is not a problem, they do not care that prices are going up 4 to 6 % a year.

Inflation is when to much money is chasing to few goods, driving up the prices of these goods. What we have now is rising prices because we have low interest rates with a low value currency.

 

[mikmo]

I'm good with that. I'm just wondering if rates in other countries are a first order or second order effect on the the interest rate setting decision.

Hmmm... I think it's going to depend on the situation.

At the moment sovereign debt is the big issue, so it's in all countries interest to keep their rates low in an attempt to devalue their currency and reduce their relative debt.

So i'd say on a purely fiscal basis we'd like to be out of step (lower) than other countries but the politics of currency wars etc doesn't allow for that. So the compromise we seem to have is that the major countries have agreed to roughly act together in rate setting. So for the moment even more than usual you'd expect the major countries rate setting to track each other at least roughly.

 

[Martinghoul]

Let me offer this nice, relatively recent piece by Macro Man as evidence for the prosecution, i.e. those of the view that the BoE is hopelessly behind the curve:
Mervynflation

 

[DashRiprock]

http://www.youtube.com/watch?v=KJh0pDMnL8M&feature=player_embedded

 

[meanreversion]

I recall clearly when VAT was cut from 17.5% to 15%, this led to a fall in inflation (obviously) which was then in itself used as a reason to cut interest rates (this is circular, a bit like typing =E5-1 into cell E5 in Excel).

Presumably the reverse argument will not be used with VAT going to 20%, which makes the original argument "disingenuous".

By the way, does anyone recall how during the time of deflation, it was never quite as negative as predicted? Similarly, the numbers are now always higher than predicted.

 

[Black Swan]

Let me offer this nice, relatively recent piece by Macro Man :-0 as evidence for the prosecution, i.e. those of the view that the BoE is hopelessly behind the curve:

He's great on Zero Hedge that lad..

 

[meanreversion]

Presumably Merv's pension pot is a good £5mio and index linked? He's a little indifferent to inflation, n'est-ce pas?

 

[montmorencyt2w]

I recall clearly when VAT was cut from 17.5% to 15%, this led to a fall in inflation (obviously) which was then in itself used as a reason to cut interest rates (this is circular, a bit like typing =E5-1 into cell E5 in Excel).

Presumably the reverse argument will not be used with VAT going to 20%, which makes the original argument "disingenuous".

Interesting point. I am not an economist, but in my view increases in prices due to VAT are not inflationary in the true sense, although they contribute to CPI and RPI. In reality, they tend to reduce the disposable income (or "money supply" in a very informal sense) of the consumer, and so could be regarded is deflationary in the longer term.

By the way, does anyone recall how during the time of deflation, it was never quite as negative as predicted? Similarly, the numbers are now always higher than predicted.

What are you referring to by "the time of deflation"? I'm not sure that I remember any.
Oh ok, sorry, yes, I remember. Yes, very brief and very small, IIRC.
(probably why I couldn't remember it).

 

[montmorencyt2w]

Presumably Merv's pension pot is a good £5mio and index linked? He's a little indifferent to inflation, n'est-ce pas?

He's "comfortable" with it, I'll bet.

 

[meanreversion]

What are you referring to by "the time of deflation"? I'm not sure that I remember any.
Oh ok, sorry, yes, I remember. Yes, very brief and very small, IIRC.
(probably why I couldn't remember it).

Come on, it lasted for at least two weeks.. you don't remember??

 

[Lodian1019]

interest rates are to low in England.

England is only one part of the country, you do understand this right?

Lodian

 

[meanreversion]

That's overly pedantic/patronising.

 

[new_trader]

If only things were so simple, Howard... While it's certainly true that the MPC looks at the global situation when making monetary policy decisions, rates in other economies arnd the world are just one of the many inputs into the process.

I though it would mostly depend on whether you subscribe to the Keynesian or Austrian school of economics.

 

[Pazienza]

England is only one part of the country, you do understand this right?

Lodian

The only one part that's a net contributor.