John Redwood's Diary
Incisive and topical campaigns and commentary on today's issues and tomorrow's problems

Anyone submitting a comment to this site is giving their permission for it to be published here along with the name and identifiers they have submitted.

The moderator reserves the sole right to decide whether to publish or not.

Conservative economic policy

Yesterday  we heard the Chancellor defend his tax cuts and explain the need for more supply side measures.
He is right to want  to boost the growth rate, and right to fight the recession the Bank is  forecasting. He needs to make numerous changes in a wide range of sectors to boost the growth rate to his target and keep it there.
During  our years in the single market we accepted a major decline in home grown food, home energy production, home produced energy intensive manufactures from steel and glass to building materials and aluminium. Reversing  these trends has to start with supplying more energy,more affordable domestic gas, oil and electricity. Grant  regimes for farming, fishing, green energy and much else need reviewing to see what works and what is necessary.

I would be interested in your views on the Chancellors speech and economic  plan.

Now for some popular spending cuts

As government ministers are talking about some spending reductions let me repeat some of my proposals talked about on this blog. A fuller version of this should be the Daily Telegraph today.

1. Stop the small boat people trade which will save the big hotel costs and the need to build more social houses to house them

2. Stop funding Councils to put in aggressive anti vehicle traffic mismanagement measures on our main local roads

3. Stop making grants to farmers to turn farmland into wilderness

4. Tell the railways the government will not pay increasing subsidy levels for those little used train services that are not wanted by the travelling public. railways should concentrate on increasing use of more popular services.

5.Tell the Bank of England it must not for the next year sell bonds at a loss triggering Treasury/taxpayer reimbursement for their realised losses.

6. Refuse more borrowing to Councils wanting to acquire a property portfolio

7. Remove from the overseas aid list all governments with space programmes, nuclear weapon development or ownership, and abusers of human rights

8.Remove tv licence fee cases from the criminal courts to ease pressure on the justice system.

Cheap labour from abroad is not cheap for taxpayers

The government is right to discourage economic migrants coming in to keep wages low and fill low skilled jobs. A points based quota system can let us recruit talent and qualified people for higher paid roles. Whilst some firms and farms would like to have the benefit of more cheap labour we need to consider the strains this places on taxpayers. It also serves to keep low end wages down, hitting the incomes of those already settled here or born here in low paid jobs.

The EU once said that it costs a country about 250,000 Euros to provide all the capital it needs to welcome a new migrant. There is the cost of providing them with a home. There is the need for health capacity. If they have children we need extra school places. As numbers increase we need more transport capacity, more road space, more pipes and cables for utility supplies. It all comes to a big bill as we are all supported by huge sunk capital investment in an advanced country.

The best way of considering it is to see that if we invite in an additional 250,000 a year, each year we need to build the equivalent of an important new city to house them and support them. A new city costs many billions. Those are billions the employer of cheap labour does not have to take into account.

Rapid rates of inward migration also makes CO2 reduction much more difficult to achieve.

What will the OBR predict this time?

There are plenty of independent forecasts around for those interested. No government is exempt from scrutiny, criticism or alternative views and rightly  so. The problem is knowing if any of the independent forecasts are going to be right.

I understand why the government wanted the OBR to offer a new forecast when it has seen the spending plans and the growth measures of the new Ministers as well as the tax cuts.  As revenues, GDP and deficits are very sensitive to whether there is growth or not one needs to form a forecast with all three crucial elements of policy.

As I have pointed out in the past the OBR has in recent years been very wrong in its forecasts. It greatly exaggerated the deficits in the last two years when I queried its view when the budget occurred. Last year it overstated the central government deficit by £131bn which lay  behind Mr Sunak’s tax rises. They also wrongly said inflation would stay around 2% until 2025. This year I said I thought their £99bn deficit forecast would be too low, as it clearly will.

I hope any new forecast they make will try to improve on the last two years. I will continue to look at a range of external forecasts and interpret  them based on recent data and trends.

The Bank’s interest rate policy

I have set out before the issues surrounding the Bank of England’s powers . What is not in doubt is the Bank of England has the independent duty to set interest rates. There is political agreement by all main parties that they should have and do¬† have this power. There is usually no government or official opposition criticism of the way they use this power to show people it is independent.

In a democracy there should however be proper debate about how this aspect of economic policy is conducted, and there are plenty of external commentators who express views and provide free advice to the Bank. The last two weeks have been mainly about the level of interest rates needed in the UK to control the inflation that has been allowed to develop. The important statement came on Thursday of last week from the MPC of the Bank when they told us they were going to start selling bonds out of their portfolio. The purpose of this is to lower the price of bonds and to increase longer term interest rates. The bonds after all had been bought to do the opposite, to raise their price and cut rates. The accompanying statements and forecast were interpreted by the market as meaning there were substantial short and longer term rate rises to come, which triggered a progressive sell off of bonds.This was on top of a global sell off triggered in the USA by the Federal Reserve Board who also signalled higher US rates and a large selling programme of US bonds which hit UK and European bonds too.

Some market participants criticised a couple of the measures in  the Financial Statement on the Friday but the main focus of the gilt market remained on rates and bond prices. The markets had not been unsettled by the very expensive one off help for business and household energy bills announced a week ago Wednesday.  The selling pressures in the market accelerated during the following week, reaching a crescendo on Wednesday.

The Bank then produced a statement which said it was changing policy dramatically to launch a new round of Quantitative easing with  buying of longer bonds because they had come to see long interest rates were too high. This was argued on financial stability grounds. Many pension funds have geared positions in gilts, and were finding it difficult to raise money to pay the extra calls on their geared derivatives. Bond prices on Wednesday were wildly volatile on news of Bank intentions. Nothing changed on Wednesday concerning tax cuts to affect prices .It should be clear to  anyone the extreme volatility on Wednesday was about the Bank’s interest rate policy, not a delayed response to the Financial statement.

The Bank’s statement went on to say the bond buying would end after two weeks and then sales of bonds would resume, and interest rates generally would rise. It seems that the part of the Bank that rightly worries about financial stability wants a different policy to the Monetary Policy Committee. I hope the Bank will think through what level of rates they think necessary to bring inflation down to the targets they now forecast they will hit, to give greater clarity. If it allows markets again to think it wants higher  longer term rates it will create a nasty slump and balloon the very government deficit being argued about.I doubt the Bank can resume bond sales anytime soon without forcing rates too high.

Of course the Bank needs to do enough to bring inflation down. Its own forecasts say it has. It needs to tell us more about how it judges the rates needed to do this. The obvious way would be a money target like the Chinese who have low inflation. Money and credit excess last year could have warned them they were too loose and getting inflation wrong. Money and credit now points to falling inflation as it is tight in real terms.

Bonds and mortgages

The Bank of England¬† yesterday after a bruising few days for them in the bond market decided that they needed to stop selling bonds, driving prices down, and do something to try to rally them. That is good news at last. The Bank’s selling came on top of the bond rout brought on by the US Central Banks interest rate rising policy, and their own sales policy of government bonds. If the Central Banks themselves think bonds are too dear and should be brought down in price, others will agree with them.

Bonds are parts of the debt the UK government has borrowed from pension funds, insurance companies and others. They are the government promises to repay the money they borrowed. They can be sold on by the people and institutions that first lent the money to the government, so they do not have to wait for the repayment date of the loan. If the prices of the bond fall then the rate of interest you get on it goes up, and if the price rises interest rates go down. If you bought a bond where the government promised to pay just 1% interest but interest rates meanwhile had gone up to 2% then you would sell the money you lent to the government for less so the next person receiving the interest on the bond would get a 2% return on his investment. How much the bond falls by depends on when the government is going to repay the full amount anyway.

The biggest buyer of these bonds in recent years has been the Bank itself since Labour introduced the policy of the Bank buying up state debt, continued by the Coalition and the Conservatives. At its peak the Bank owned £875bn of government debt. It rightly stopped buying up more of it last year, as the policy was proving inflationary. More recently it said it would start selling some of the bonds it owns. It said it wanted to shrink its balance sheet, swollen by the large amount of bonds it owns as an asset. They started selling very recently just as global bond markets led by the USA took another nose dive on interest rate rises announced by many Central Banks and in anticipation of more rises to come. The addition of Bank of England selling  implied that they wanted to see the bonds go down in value and  added to the general selling pressures on UK bonds.

Yesterday the Bank acknowledged that selling now with bonds so¬† much lower in price would not be good idea. They did not, however, say they would end the sales programme unless and until bonds had picked up substantially. That was a pity, as the value of these bonds matters to families with mortgages and businesses with longer term borrowings. All the time the Bank says it will sell¬† as the largest potential seller it can spook the market. The Bank’s wish to shrink its balance sheet has ironically been achieved in the last few weeks by the fall in the value of the bonds it holds. Crystalizing the loss makes no sense.

These interest rates matter. There are 2,5, 10, 20,30 year rates and others in between. If the 10 year or 20 year bond rate goes up so bank lending for people to buy homes will also go up, as will the cost to business of a longer term loan to invest in their company. Mortgage holders and businesses do not want their Central Bank actively intervening in the markets to drive these interest rates higher. The Bank should believe its own forecasts which show inflation tumbling next year. High energy prices and dearer mortgages are already taking too much demand out of the economy. Thank you Bank for at least a temporary pause to your driving the mortgage rates up.

An answer to the green lobbyists

I am receiving several copies of a lobbying letter condemning fracking in particular and the new government’s approach to energy and the road to net zero. The general complaint is we should not extract any more fossil fuel at home, run down our oil and gas industry quickly and¬† accelerate renewable electricity.

I disagree with these emails. Let me begin by explaining they are wrong in their own terms. Substituting imported gas for home produced gas  increases the amount of CO 2 produced globally. LNG in particular requires substantial energy use to liquefy, transport and convert back the gas compared to pipeline gas from the North Sea. Importing energy intensive products similarly entails more global CO 2 whilst cutting U.K. output of energy intensive products. The net zero movement must look at global impact, not just national generation. Every extra amount of home produced gas  eases the global shortage a little, and cuts the overall output of CO2 by saving on LNG volumes.

The pressure to go faster with expanding renewable electricity comes up against the inconvenient  fact that most U.K. people heat their homes and water with gas or other fossil fuels, and most drive petrol or diesel vehicles. All the time this is true we need fossil fuels to live.  If we accelerated the rate of converting our vehicle fleet to electric it would raise CO2 output from the scrappage processing and from  the manufacture of  new electric vehicles. You need to drive a lot more miles than most car owners  to make the switch favourable on CO2 accounting instead of running your older vehicle for its full useful life. The CO 2 accounting for replacing good functioning gas boilers with electric heat pumps is also problematic. Anyway governments cannot make people rip out their gas boilers or replace their cars, especially at a time of income squeeze when most cannot afford to do so.

Meanwhile government has a duty to ensure there is sufficient energy at affordable prices to keep us warm, provide necessary supplies and buttress jobs at home.  On any analysis the next few years will see the need for plenty of gas, whether from home or foreign sources and whether used to make things here or imported things from overseas. Indeed if we import more from places like China and Germany more will be made with coal based power, producing more emissions than using  gas.  The greens say there will be new jobs making wind turbines. There will not be enough to offset the big hit to jobs if we fail to keep enough sensibly priced hydrocarbons for the period of transition. The West is already too dependent on China and her satellites for raw materials and products required in wind farm and battery production. We also need to consider the environmental impact of mining the materials and handling the waste from battery and other electrical products.

We all believe in an independent Central Bank

The independence of the Bank of England is widely asserted and almost universally applauded. Let me begin before I am condemned for views I do  not hold, by saying  I do support the Bank of England continuing to have the important independent power to fix and change short term interest rates by setting an official influential Base rate. The wider problem is money policy (anti inflation policy) is about  much more than just fixing the short term official rate. In most of the other areas that matter the Bank is not independent.

The obvious point which no-one else ever seems to make in the debate concerns the main thrust of money policy since 2008. The decisions to create a lot of money to buy up government bonds have always been joint between Chancellor and Bank. This was set up by the Labour government and continued under the Coalition and Conservative governments. The Treasury not only agrees and signs off the policy but also offers a full guarantee to the Bank against losses on the bonds bought. Presumably Chancellors as well as Governors have therefore taken this task seriously, as the Treasury runs the risks. When interest rates are around zero money policy is driven by decisions on how much to print and how many bonds to buy. Why did the Bank do so much for so long last year?¬† Why didn’t they have target interest rate levels for longer term borrowings to guide their interventions? Why didn’t they monitor and comment on the explosion of money growth their bond buying generated?

These decisions have had a big impact in setting longer term interest rates at artificially low levels, which in turn leads to lower borrowing costs for property, business and other users. This has fuelled asset price inflation for more than a decade until this year when the underlying bond buying stopped.  The Bank did not worry about asset inflation.

It is also the case that Gordon Brown when he wrongly said he was making the Bank of England independent took away crucial powers it used to have to regulate the commercial banks. The  main UK clearing banks determine many of the details of how much credit is advanced, to whom. They decide how many loans to make. Regulation of these activities including warning them about running too much individual balance sheet risk rests with a different Regulator. Pre Gordon Brown the Bank directly and daily influenced clearing bank balance sheets and lending positions.

In practice the independent Central Bank, 100% owned by the state, answers directly to Parliament. The Treasury Committee makes the Governor attend and defend his actions on a regular basis. Parliament  changed the legislative controls and requirements on the Bank when Labour took over and when the Coalition took over. Labour changed the inflation target when in office. I think it is right that the Bank should be held accountable for its actions through Parliamentary scrutiny and through media questioning of policy and results. There needs to be more consideration of why inflation is so far above target, and more analyses of past recessions when Bank tightness was part of the problem.

It remains a mystery how the Monetary Policy Committee thinks it can control inflation without monitoring and commenting on the amount of money in  circulation or the speed at which it is used from bank accounts. Real money supply is now contracting. Money policy has lurched from far too loose to tight. I agree with the Bank who now forecast inflation will tumble next year. There is no need for them to be selling bonds at big losses to make things worse.

Inflation and debts

The recent  decision by the Bank to raise interest rates by another 0.5% to 2.25% has done enough to slow the inflation the Bank had allowed to build over the last year. According to the Bank’s own forecasts inflation will now subside to the 2% target over the next two years as the economy slows and as world commodity prices and energy prices come under control, whether from market forces or government intervention. The danger is the Bank will do too much by way of rate rises, withdrawing too much money and credit from the system, creating a nasty recession. Their own estimates already show the UK in recession as we enter next year on their current policy.

           The Bank of England carried on creating money and buying up bonds for too long and on too vast a scale last year. An inflation was well set  by early 2022 when the Russian invasion of Ukraine disrupted energy markets and added to the inflationary pressures with a surge in gas and electricity prices. Whilst this energy price shock had as its first impact a boost to inflation, if left untreated it would also bring about a recession. Large sums are removed from people and companies to pay the sky high bills, with much of that money sent abroad to pay foreign suppliers and pay the elevated energy supply tax bills of foreign governments. None of this money remains in the UK to pay wages and buy goods.  It created a nasty double problem for both the Bank and the government.

           The Bank was right to correct its past monetary excesses. It had  bought too many bonds to keep the longer term interest rates too low for too long. In the process it allowed a bubble in the money supply to develop. At first the excess money simply created an inflation in the prices of the bonds the Bank bought and in shares and properties which the sellers of those bonds bought with the proceeds. It then started to seep out into the world of consumption, bidding up the costs and prices of a wider range of goods and services. This is now being adjusted sharply by a major change of money policy and by the inflation robber coming in the night to depress the real incomes of all energy buyers.

             The Bank needs to be careful from here. The government is providing considerable assistance to people and companies through the energy support measures  and through reversing or cancelling inherited and future  tax increases. These are needed and are not in themselves inflationary if borrowed through issuing new debt to savers. The much tighter money will slow the economy, and as the Fed brakes  the US economy violently so there will be reduced price pressures from global commodity prices, from international transport rates and from internationally traded goods. Nor need we worry unduly about the level of UK debt. At an official 96% of our national income it is way below Japan, and  below Italy, the USA and various other advanced countries. As a substantial proportion of the debt is owned by the Bank of England and all is repayable in local currency the state should be able to roll over the bonds as they fall due without too much problem. The official figures and commentary spreads alarm about the current high level of debt interest. This is a distortion of the position. The cash sums the state has to pay to cover the interest bill on the debt are at quite modest levels because so much of the debt has been financed at the very low interest rates or recent years. Of the £8.2bn of stated interest in August only £3.5bn were cash payments. The rest is the increased eventual repayment cost of the indexed debt, which will simply be refinanced  when it falls due.

            Of course I would like borrowing to fall and the budget to move closer to balance. The truth is there are no options to let that happen easily. Were the government to refuse to offset some of the energy damage we would have a deeper and longer recession. That would mean much less revenue and more costs from higher levels of benefit expenditure to compensate people for loss of some or all of their work incomes. If the government seeks to stop the recession then that entails in the first instance borrowing more to allow the tax cuts and subsidies to sustain more activity. The second round effects should mean the state borrows less if it stops a recession now than if it opted for  austerity and a longer recession. The government needs to get more people off benefit into work, find ways of working smarter in crucial public services, and cutting out things the state does  not need to do in order to control public spending . Getting a better grip on numbers of  illegal and low paid economic migrants would also make a welcome saving.

Consider the environment – Think before you printThe contents of this email are confidential to the intended recipient and may not be disclosed. Although it is believed that this email and any attachments are virus free, it is the responsibility of the recipient to confirm this.You are advised that urgent, time-sensitive communications should not be sent by email. We hereby give you notice that a delivery receipt does not constitute acknowledgement or receipt by the intended recipient(s).