Thursday, Mar 05, 2009
BoE cut as epected, plus details of asset purchase programme
Bank of England: Bank of England Reduces Bank Rate by 0.5 Percentage Points to 0.5% and Announces £75 Billion Asset Purchase Programme
he Bank of England’s Monetary Policy Committee today voted to reduce the official Bank Rate paid on commercial bank reserves by 0.5 percentage points to 0.5%, and to undertake a programme of asset purchases of £75 billion financed by the issuance of central bank reserves.
World activity continued to weaken, reflecting both depressed confidence and the persistent problems in international credit markets. In the United Kingdom, output dropped sharply in the fourth quarter of 2008. That reflected lower consumer spending, a further fall in business investment and a rapid run-down in stocks, in part offset by stronger net exports as the past depreciation of sterling began to take effect. Business surveys continue to point to a similar rate of contraction in the early part of this year.
24 Comments
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1. 51ck-6-51x said...
The presses are now on to the tune of £75bn.
2. mark said...
75billion wont buy much crap
3. mark said...
did anyone see and hear the ITV chief last night on the news, "He stated this was a cycle and he has been few a few cycles, but this was the worst he has ever known" financial cycles of course..lol
4. 51ck-6-51x said...
mark - this ain't a troubled asset purchase.
5. paul said...
Note the Bank of England has quoted the last inflation figure of 3.0% (down from erm ... 3.1%) to support the rate cut.
But of course, the BoE already has access to the newest February inflation report figures in advance. It will be interesting to see what they are. If CPI has gone up (as I suspect), it will be an embarrasment the MPC can do without tackling ... until the next rate decision where they will - of course have to hold.
How convenient.
6. 51ck-6-51x said...
good observation paul.
7. sold 2 rent 1 said...
mark,
"75billion wont buy much crap"
Correct but it will allow banks to lend out up to 1 trillion under fractional reserve rules. The lending will be to hedgies to buy commodities later this year. The end result will NOT be debts inflated away, but will result in more debt being created making the eventual crash much much worse.
8. Fingerbob69 said...
Every time I see or hear the term 'quantitative easing' I can't help but conjure up this mental image of a huge fat white banker's backside squatting over Britain... the faces of the whole population upturned in wide eyed horror ...as that sphyntal ring opens and let's loose an excremental deluge!
9. mountain goat said...
They don't know what they are doing. In the bond markets low interest rates mean high bond price. So dropping the interest rates pushes up the cost of debt. It likewise pushes up the cost of getting rid of debt taken on in the past.
"Iron Law of the Burden of Debt": The liquidation value of total debt doubles every time the rate of interest is halved. source
"If as a corporate treasurer you have sold a $1000, 30-year bond and the interest is halved next day, you could liquidate that debt only if you are willing to shell out a sum closer to $2000... Nobody will sell your bond back to you for $1000, because it yields twice as much as do the new issues of the same face value and same maturity." - source
As investor I will keep buying debt if I know interest rates will keep falling. But where do they fall after 0%?
Last night I saw a program of billions of sardines caught in the thin stream of cold water running up the coast of southern africa. The greatest assembly of predators on the planet showed up to finish them off.
10. 51ck-6-51x said...
mountain goat -
If one issues a bond one has borrowed money on some terms. If the bond is an FRN, then the coupons will probably go down [as the underlying rate, e.g. LIBOR will probably go down] and if it is fixed the coupons will stay the same. The company will therefore have the same or reduced servicing costs. If they are looking to repurchase the bonds they would not be able to do so for the $1000 in the first place, but you are right that the cost of the repurchase would also increase... but why would they repurchase? If you own a house on mortgage, and your monthly payments go down does that really give you an incentive to pay off the full amount? Now, if you are making money off of the finance rather than just owning an asset (i.e. you use the capital as investment), you have even less incentive to do so.
So how, exactly, is this even worthy of note? Or am I missing something fundamental?
11. mountain goat said...
51ck-6-51x - I thought it worthy of note because of the bigger picture which is financially unproductive. I will try answer your questions although I am struggling to understand. As you say for the individual with a mortgage if interest rates are low there is less incentive to pay off the debt. So indebtedness stays the same or even grows because low interest rates create an illusion of debt being easier to bare. As the ability to pay back monthly instalment falls with rising unemployment there will be more default and debt deflation. Exactly what financial authorities should be trying to avoid. So they should be creating incentives to pay down debt by raising interest rates.
In terms of government debt and bonds, making it more expensive makes it less liquid. If as you say one won't want to repurchase bonds to liquidate the debt (because they have become expensive), why would anyone else want to purchase the debt either. i.e. low interest rates reduce liquidity and marketability of the debt product. When more debt needs to be sold but the market can't see anymore benefit because IR can't drop any further this will be critical, and brought to mind the narrowing trap I described.
Thanks for challenging my thinking, I probably still don't understand this clearly enough. Intuitively I feel that interest rates should be going up to encourage those with capital to lend money. Instead the opposite is happening, and this is unsustainable if there isn't a sharp rebound in the economic situation. So as long as we have this slow slide into recession the strains grow to the point when a water-shed moment happens in the bond market. Low interest rates are leading us right into this very dangerous situation I believe. So instead of a severe recession we are going to face something worse, where the financial system stops working at all.
12. Ticktock said...
"75billion wont buy much crap"
I don't know. I reckon I could buy a hole lot of crap with £75 billion.
13. landofconfusion said...
"Intuitively I feel that interest rates should be going up to encourage those with capital to lend money."
Ostensibly they are trying to encourage inflation by cutting interest rates. High interest rates destroy money faster -> deflationary, which is why raising them is used to reduce overall inflation.
It seems to me that they are trying to encourage lending based on the premise that low rates makes loans more affordable but they fail in that the economy is now in reverse and banks don't want any more black holes in their balance sheets. This is also why QE will not improve the situation - banks will just horde the money.
QE will also (in theory) encourage people to send more because of the low return on their savings but again this is a trap because in the current situation most people will realise that paying down their debts and having a cash cushion is a prudent strategy.
Another problem with QE is that it devalues the currency leading to higher "imported" inflation. The BoE and other central banks seem to be trying to avoid this by cutting rates in concert but I'm not sure how long this will go on for given the different specific problems within each country.
14. landofconfusion said...
Oh, and as for the bond markets, a low rate of interest makes bonds (especially 'Junk' bonds) less attractive and therefore harder for companies to raise capital. If the risk is high but the rewards low why should I invest?
15. 51ck-6-51x said...
mountain goat -
I don't think your understanding is particularly bad... I don't think many, if any, people have a truly great understanding (I certainly don't, I think my understanding is fair, but not great).
I think that lowering rates does usually encourage borrowing (at least short term borrowing), but at present there seems to be little demand for borrowing anyway, so making the load more bearable may be the Right Thing.
You observe that there will be less deleveraging as rates decrease, which may also help stem the problems we see currently - and may even encourage the slower payment of debt which would soften the blow.
Certainly your observation that the BoE seems to be expecting a fairly sharp recovery would seem accurate. This is also confirmed as a sensible opinion by comments made by Capital Economics' Jonathan Loynes.
Furthermore, if interest rates were put up it could really hurt companies which are already struggling to keep up with repayments on (or are refinancing) debts which were taken out for the right reasons in the first place - and if companies go down, the economy follows and we get a deflationary spiral. (I personally would like high rates without adverse affects on the economy!)
16. 51ck-6-51x said...
landofconfusion -
Is that good, bad or a bit of both? We don't want to encourage certain risk taking right now, but we don't want to discourage new business... hmm.
17. timmy t said...
MG & 666 - your debate highlights how debt really is like a drug. In the early days you can deal with it and as long as you don't overdo it you should be OK. But this country really got hooked. Excess availability of the drug caused us to become addicted - to the extent that we now need more to prevent a complete breakdown. But more of the same is being pumped into the system. It will keep us going for longer but will ensure we die in the end! We needed a good dose of Cold Turkey about 4 or 5 years ago to get us off the habit.
This is why on the one hand I can see the rationale for QE. On the other,I can see how it guarantees this all ends in tears.
18. 51ck-6-51x said...
timmy t -
Yes, I agree. And, like drugs, the answer, I think, is liberalisation not regulation. Drugs should be legal and credit should be traded in a truly free market (not a state controlled one).
I think Milton Freidman was spot on with these quotes (amongst others):
"I'm in favor of legalizing drugs. According to my values system, if people want to kill themselves, they have every right to do so. Most of the harm that comes from drugs is because they are illegal."
"If you put the federal government in charge of the Sahara Desert, in 5 years there'd be a shortage of sand."
"The problem of social organization is how to set up an arrangement under which greed will do the least harm, capitalism is that kind of a system."
"There's no such thing as a free lunch." [Although I do know of a sandwich shop with a flawed system ;p]
19. landofconfusion said...
51ck-6-51x,
We appear to be stuck between a rock and a hard place. I too want higher interest rates but not massive country-wide defaults. The problem is that low rates don't necessarily translate into higher lending. If the economy is in a really bad shape then who do you lend to? And even if they are currently solvent what if their customers are or become unable to raise capital? Clearly the best way to avoid this is not to get into it in the first place but...
Another thing, as was posted in an earlier article, we import most of our food and this is leading to double-digit percentage increases in food costs. My favorite cheap liquor for example has gone up 33% since Nov 07 and it's very likely that this "imported" inflation will (eventually) not just affect food. If we were a single, contained system with just one currency then yes, I can see how QE might work but we have partners who have less debt than us and stronger currencies.
If we were net exporters then QE might just get us out of this mess but as a nation reliant on net imports and with a heavy reliance on a crippled services sector I really don't see how.
Also what happens if or more likely when the Eurozone/US/China emerges before us?
20. 51ck-6-51x said...
landofconfusion said "The problem is that low rates don't necessarily translate into higher lending" -
Not necessarily a problem now. The lack of lending that is talked about is that of the shadow banking system and is not really the kind of lending we need to have right now (lending for speculative gearing). Banks themselves seem to be lending to businesses, maybe not quite as readily as before (and there was certainly a period of fear which affected necessary restructuring, but I believe that is gone now).
Imported inflation is a concern, but a weak currency will also boost exports and inflation expectation is a driver there - and we export financial services, which may actually end up being a good thing! (how perverse)
What do you mean by emerge? I think there will be massive problems in the Eurozone.
21. troy said...
666 said ""The problem of social organization is how to set up an arrangement under which greed will do the least harm, capitalism is that kind of a system."
~~~~
not all would agree of course :-
To explain our view, we believe that a monetary system simply designed to make the trade in goods, ideas and services easier, is not in itself harmful and does not create massive inequalities in wealth distribution.
Instead we believe the problems lie in the economic practices of Usury and Fractional Reserve Banking as these are the harmful triggers. The greediness in which money is being initially created, has the tendency to filter down into the rest of society.
The majority, who then find themselves with a fraction of the worlds wealth, and proportionate power and influence, naturally may then find it difficult to see the world as a fair place, and so may choose to survive by the rules that society seems to be run by, rather than by a preferred set of rules which are more caring and thoughtful. XAT3/4
22. troy said...
same source
"We interact with each other along the tracks of thought we have inherited. Our politics, economics, how we manage the environment, our education, social perceptions, our moral values, diets, and how we treat our friends or strangers in the street are all expressions of the thought systems we have adopted as our own.
Most of our thought systems are obviously necessary and beneficial, and may be applied well at any time within our world; others however are only useful during specific periods and when these ideas are enforced and promoted beyond their sell-by date, real problems can occur.
All of the world's power structures depend on people's co-operation to stand. We all together make them possible. While it remains true that we support injustice by not objecting to it,1 surely this implies we could withdraw our support at any time.
23. landofconfusion said...
"20. 51ck-6-51x said...
landofconfusion said "The problem is that low rates don't necessarily translate into higher lending" -
Not necessarily a problem now. The lack of lending that is talked about is that of the shadow banking system and is not really the kind of lending we need to have right now (lending for speculative gearing)."
From what I've heard a lot of businesses are laying off staff and even going bust because banks won't lend to them. And all that's without even mentioning the penal rates some firms are having to pay even if they do get the cash.
"Imported inflation is a concern, but a weak currency will also boost exports"
From what a friend who used to work in manufacturing has told me our manufacturing base has pretty much gone and in any case we will still need to import the raw materials to manufacture what we export. In fact the only advantage we have is cheap labour and the Chinese will almost certainly see that off.
"we export financial services, which may actually end up being a good thing!"
At the moment I don't see how. Much of the money from financial services seems to of been obtained though risky practices, the same risky practices which caused this mess in the first place and which will most likely be banned. I also wouldn't expect a recovery from that sector for quite a while.
"What do you mean by emerge? I think there will be massive problems in the Eurozone."
Oh I agree and it might well break up. But then on the other hand it might not. Who knows? All I know is that our debt situation is worse, we have nowhere near as competitive manufacturing base and our educational standards are slipping. In fact the only thing going for us is (as previously mentioned) our cheap labour but that's hardly a big deal.
24. 51ck-6-51x said...
troy -
No, not all would agree with anything.
The world is not a fair place, whatever systems of power we decided to put in place, but yes any such system requires support from society itself.
- Friedman also said, "Underlying most arguments against the free market is a lack of belief in freedom itself."