The Bank of England gets it wrong again

This week we learned that one member of the Bank’s Monetary Committee wanted to put up interest rates last month. Mr Sentance was rightly concerned that inflation remains well above target, and dares to question the Bank’s orthodoxy that because there is such a large amount of spare capacity around that there should be no price increases to worry about. This site has been querying the whereabouts of all this spare capacity, and pointing to the inflationary threat, for many months.

Although Mr Sentance predictably lost his skirmish this month, he did some good. he reminded markets that the next move -whenever it is- in UK interest rates will be up. Coming in the same week that the government announced a substantial move towards lower borrowing, this was sufficient to put the pound up a bit more against the dollar, on top of its recent rise against the Euro.

Much of the current inflation has come from the big fall in the pound in the year or so prior to the Election. A rise in the pound will soon relieve inflationary pressures on imported commodities, raw materials and finished goods, and will likely be visible to us all at the petrol pumps.

Today the Bank decided to warn us all that banks are still weak thanks to the weakness of the Euro area in general and the threats to government bonds in particular. Their remedy is yet more cash and capital to be held by the banks. That is code for saying they want the banks to lend even less to the private sector, at a time when credit is already too scarce.

Think again, Bank. We need counter cyclical regulation of the banks. This is somewhere near the low of the cycle. That means allowing banks to lend more, not forcing them to lend less. The main banks have stronger balance sheets than in 2007-9, balance sheets strong enough to allow some more lending. UK banks are not too exposed to Greek debt. Behind the scenes the Bank should be working with other European authorities to ensure no EU state does renege on its debts. The Regulators made the commercial banks buy loads of state bonds. They should now help ensure the banks are not damaged by doing as they were told to do.

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25 Comments

  1. Ian Jones
    Posted June 25, 2010 at 8:55 am | Permalink

    The extra capital for banks is to cover the losses they will be forced to take when Greece, Spain and Portugal default. We are not out of the woods yet.

    • lola
      Posted June 26, 2010 at 7:32 am | Permalink

      Quite. And I heard that the banks are being allowed to value the bonds of greece spain and portugal at face value rather than market value to help their capitalisation.

  2. waramess
    Posted June 25, 2010 at 8:58 am | Permalink

    How about forcing Government to borrow less. Pie in the sky?

    How about making a start by de-nationalising the National Health system? Too revolutionary?

    So was the denationalisation of water companies, electricity companies, mines and steel making before some revolutionary actually achieved it

    • Stuart Fairney
      Posted June 25, 2010 at 4:21 pm | Permalink

      Yes indeed, and despite the utter cowardice on display from the various front benches, it could be very easily achieved given the fundamental seperate-ness of the various hospitals and GP surgeries.

      If the hospitals were all private and achieving the survival rates of the USA not the dismal NHS no-choice, expensive failure we have now, would there really be a hue and cry to nationalise them? Clearly not and so the failure to act on this monster which will destroy our finances and our very freedom (as we are impoverished) gets ever worse.

      • Conrad Jones
        Posted June 26, 2010 at 5:36 pm | Permalink

        I think I understand what you are saying, it would be nice to have genuine choice – if you have a bad experience with one Hospital you can say "Well at least I can try that other Hospital up the road".

        Are you saying that if we had the American System in the UK we would have a much better Health System though?

        50% of the American Population is either underinsured or not covered adequately to cover medical costs.

        From Wikipedia: "A 2001 study in five states found that medical debt contributed to 62% of all personal bankruptcies. Since then, health costs and the numbers of uninsured and underinsured have increased." And that was 2001.

        I beleive we could afford this type of system if Housing Costs weren't so overinflated. But then how do we afford a good pension as well. I like to pay my way too, I like to vote with my feet,.

      • APL
        Posted June 27, 2010 at 8:36 am | Permalink

        Stuart Fairney: "..expensive failure we have now, would there really be a hue and cry to nationalise them?"

        Alas, I think there would.

        Just look at the private education system. The Labour government started to encroach on the freedom of action of the private schools.

  3. Duyfken
    Posted June 25, 2010 at 10:30 am | Permalink

    Is there not a need for the membership of the MPC to be revised by the Chancellor asap? Unfortunately two external members (Posen, Miles), are appointed for terms into 2012, but it seems the BoE members also are getting it wrong with the consistency you suggest. Perhaps the MPC should be a candidate for the chop but can we depend on just Mr King and his colleagues for proper and enlightened decision-making?

  4. StrongholdBarricades
    Posted June 25, 2010 at 10:53 am | Permalink

    Instead of viewing it as "less lending"

    Why can't policies influence where the money is lent?

    Surely if less money went into the homes market for mortgages, but the cash value of loans to business was maintained or improved we would get a double benefit: a net reduction in house price inflation whilst also helping businesses to grow.

    The lower house price inflation might also see greater movement within the housing sector and a much more moveable workforce.

    • Conrad Jones
      Posted June 26, 2010 at 6:12 pm | Permalink

      Absolutely agree. We've effectively Nationalised some Banks but have no say in where the Money goes. Some of our Taxes (quite a large amount) is still going into the back pockets of private individuals who work for the Banks. Yes – they've got smaller bonuses – but their fixed salaries have been dramatically increased. Currency that should be lent to Private Businesses has suffered more than the Mortgage industry. In effect – we have a Banking System which is slowly driving us into a Socialist (Communist) State by starving private business of capital. Don't forget that Banks also make hefty profits by "Lending" Governments currency to fight Wars.
      Abraham Lincoln Inflated the American money supply with the 'Greenback' banknote to pay for the Civil War which was mainly about controlling the Southern States Agricultural economy than about civil rights or slavery.
      The Banks have invested heavily in Property which they do not intend to see reduce in value. They do not have any real incentive to invest in private enterprise which would create wealth and jobs in the private sector. just look at the proportions of Manufacturing Loans to Mortgage Loans. 3% (Manufacturing Loans) to 75% (Mortgage Debt).

  5. StevenL
    Posted June 25, 2010 at 11:15 am | Permalink

    I read in the Telegraph that Mr 'I'm puzzled about the gold price' Bernanke wants to print another $2.6 trillion over the pond.

  6. Sally C.
    Posted June 25, 2010 at 11:39 am | Permalink

    The B of E is facing a dilemma. As we know, lax lending standards at the banks and artificially low interest rates, courtesy of the B of E, has led tens of thousands of families to rack up unprecedented quantities of credit card debt, overdrafts and unsecured loans over the last ten years.

    In today's Daily Mail, Steven Law, president of R3, an insolvency practitioner, said: ‘We stand on the brink of a personal insolvency crisis that will take years to work through the system. We know there are nearly a million people out there who are struggling with their debt.'

    So what is the B of E to do? Keeping interest rates at the current record low levels encourages people to take on more debt This is especially true of homeowners who can access quite cheap money in the form of a mortgage. If the Bank was to raise interest rates an awful lot of people and businesses could go bankrupt. So the B of E and the rest of us are holding our collective breath, hoping that the new government's economic policies will encourage new businesses to set up and employ a lot of people.

  7. Javelin
    Posted June 25, 2010 at 12:38 pm | Permalink

    As risk of sounding boring I'll repeat my experience of trying to save £100,000 in HSBC.

    I walked into HSBC and said "I have £100,000 can you tell me how I can put it into your bank for 6 months at a low interest rate in a savings account."

    The answer was that HSBC don't do a savings account and the only way I can save money at 0.1% is by putting £500 a month into a current account with a saving account attached.

    Complete madness. How did we get here? Basically the bank wants you to open a current account and pay for it OR run up overdrafts on it.

    But HSBC does NOT want you to deposit money in them. How can George Osborne sleep at night knowing the culture of or sfatest banks is to prioritise current accounts over savings accounts.

    Mandatory savings accounts should be a MUST in any new banking legislation. It may seem obvious but that's how crazy our banking system has become. We need to go back to basics.

    • Acorn
      Posted June 25, 2010 at 5:27 pm | Permalink

      Assume you don't have an account at that bank, I do. It was offering 6 month deposits, at about base plus 2%, to its clients who have IMA (Investment Management Accounts) with them. This is not investment advice and if I say anymore it will be an advert for that bank's trust company.

    • libertarian
      Posted June 25, 2010 at 10:06 pm | Permalink

      Why not just put your money in a building society

  8. Andrew gately
    Posted June 25, 2010 at 1:51 pm | Permalink

    I think that you should be governor of the Bank of England John. Your calls and understanding of the situation have been far better than Mervyn "moral Hazard" King.

  9. Ex Liverpool Rioter
    Posted June 25, 2010 at 2:45 pm | Permalink

    John
    UK PLC IS House prices………………..nothing more, just bloody house prices. Now that "Ozzy" has that neo-lib drip Will Hutton on board (personal comment excluded -ed) there is NO WAY they do ANYTHING to stop the UK Ponzi-house scam!

    Sadly, the only way we will get back to a true productive cap is IF we allow the MASSIVE over priced house to fall………in the end it will…..Roll on a run on the £ !

    Mike

  10. Simon2
    Posted June 25, 2010 at 6:07 pm | Permalink

    The Bank certainly did get it wrong again, keeping rates at 0.5% for so long given inflation and other economic indicators will go down in history as a complete joke.

  11. Steve Tierney
    Posted June 26, 2010 at 1:35 am | Permalink

    While you are, no doubt, absolutely correct – there will be a lot of people breathing a sigh of relief. All this "the recession is over" nonsense isn't actually true for many – and an increase in interest rates will mean higher payments for those of us with loans and mortgages linked to the base rate. Just now – that's going to make things really tough for many, many people. So While I share your overall view – I can't say i'm as concerned about what they've done as I might be….

  12. Lindsay McDougall
    Posted June 26, 2010 at 5:36 am | Permalink

    The Chancellor appoints the Govenor of the Bank of England and the MPC. It is open to him to do something about this situation.

  13. A.Sedgwick
    Posted June 26, 2010 at 9:58 am | Permalink

    Somewhat off message but everyone who read your blog needs to have their lack of faith in local government efficiency confirmed by reading Saturday's Daily Mail article : "The Great Inertia Sector: A whistleblower's account of council work where staff pull six-month sickies"

    Read more: http://www.dailymail.co.uk/news/article-1289702/P

  14. Steve
    Posted June 26, 2010 at 3:26 pm | Permalink

    I've said it many times before on this blog, and will repeat it again: Mervyn King is a (words left out which query his judgement) who failed to foresee the looming disaster, who supported all the wrong policies before the crisis struck in 2008, and who has since failed to distinguish himself by showing any more spine than a tadpole in the face of his masters in Whitehall. Now he keeps on telling us that the seemingly never-ending inflationary "spike" (RPI 5%++) is nothing to worry about, leaving that dirty work to Charlie Bean. King is (unflattering description given)with an opinion of his own abilities that was only exceeded by Gordon Brown's (and look where that landed us!). He must be sacked forthwith, with no compensation and a public enquiry into his and the then-MPC's failure to foresee the crisis and the hundreds of billions of pounds that it has cost us, as well as all their pitiful policy misjudgements which were well documented and discussed here at the time. Until King is removed the BoE will have no international credibility whatever.

    MERVYN KING MUST GO!!!!!

  15. Mark
    Posted June 26, 2010 at 4:10 pm | Permalink

    You refer in passing to the BoE Stability report. I find the charts from Chapter 2 tell the key points of the story.

    2.1: 56% of banks' assets are in the UK, just 17% in Europe.
    2.3: Foreign holdings of UK government debt are low relative to GDP, unlike in Euroland.
    2.4: Italy, France, Greece and Germany have much lower levels of household debt relative to GDP, while we are at ~100% along with Ireland and Portugal
    2.8: Tier 1 capital is not a current problem for British banks, who could afford to consider writing down more loans equivalent to another 3% of assets per annum
    2.12 The bubble in UK commercial property has been allowed to unwind with prices falling 40% from peak to trough (unstated: the house price bubble remains close to peak)
    2.13 Bank lending in the UK is dominated by mortgages (~70%) and lending for commercial property Industry only gets about 10% of the total (excluding financial services)
    2.15 Mortgagors are being heavily subsidised
    Chart C US house prices have been allowed to correct relative to incomes
    2.17 Over 20% of mortgages are at negative equity risk when UK house prices do fall (5% already there)

    Then the real frightener: Chart 4.15, which shows the rollover financing that major banks will need (well, actually it excludes "secret" loans from the BoE under the Credit Guarantee Scheme, as a footnote reveals). Over £750bn by the end of 2012. How much of that will be added to national debt in the next banking crisis?

  16. Conrad Jones
    Posted June 26, 2010 at 6:29 pm | Permalink

    "Inflation remains well above target". I suspect that Inflation is well below target as without it – how will the UK pay off it's debts? Interest rates will be held artificially low by the Bank of England to help the Government. If interest rates go up now – the Budget will be thrown off course – even capsize, as we could no longer afford the repayments on the UK Debt. This is a fantastic position of power and authority that the Banks hold on all of us and not just the Government. They were responsible for the Financial Crisis but if we punish them for it – then they will either starve the economy of currency and create the next Great Depression or put interest rates up and do much the same thing. President Andrew Jackson had a similar battle with Nicolas Biddle (President of the Bank of The United States) in the 1830s.

  17. christina sarginson
    Posted June 27, 2010 at 11:33 am | Permalink

    I think that very few people trust banks anymore, I heard a story on the news yesterday which said that a bank was going to charge more for an individual for an unapproved overdraft than to an individual for an approved overdraft, this is maddness what is the world of banking coming too?

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    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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