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The Economist: Interest Rates

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I think we've already covered a lot of this, but it's always good to see it in print...

;)

Interest rates

They're heading up

May 11th 2006

From The Economist print edition

The Bank of England sends a signal

WHEN the cost of borrowing was lowered last August from 4.75% to 4.5%, the City confidently expected that more cuts would follow. Instead, rates have stayed stuck since then at 4.5%. This week it became clear that the next move will be up rather than down.

The Bank of England signalled tighter money in its quarterly Inflation Report, published on May 10th. Its new projections show that if rates were held at 4.5%, consumer-price inflation would stay above the government's 2% target over the next two years (see chart). However, if rates rose to 4.75% within the next year, as the market expects, inflation would return to the target in the spring of 2008. The Bank looks this far ahead when deciding monetary policy because it takes a couple of years for interest-rate changes to have their full impact on inflation.

Britain's economic prospects are now worse than the unusually benign outlook that the Bank painted in its last report three months ago. Then, on the basis of rates at 4.5%, it forecast a robust recovery in GDP growth with inflation virtually glued to the 2% target. Now, it is signalling not only that rates will have to rise but also that growth will be a bit slower and inflation higher over the next couple of years.

Adding to the bad news for borrowers, Mervyn King, governor of the Bank of England, warned homeowners that house prices still seemed “remarkably high” compared with benchmarks such as average earnings. The Bank would “look very carefully” at what was going on in the housing market, which had picked up more strongly than expected.

Despite the revival in housing, consumer spending is forecast to grow a little more slowly than in the Bank's February report, as higher energy costs squeeze budgets. The traded sector, however, will give a fillip to GDP growth thanks to the economic recovery in the euro area, which purchases half of Britain's exports. That will be a welcome step towards a better-balanced economy after a decade in which consumers have held sway while exporters have struggled. And although the growth forecast is a bit lower than it was three months ago, the Bank no longer thinks, as it did then, that the risks are tilted to the downside.

The Bank's main worry appears to be the persistent pressure on overall inflation from higher energy costs. With fuel bills at the pump and for the home surging, inflationary expectations are moving up. The Bank's own survey recently showed a sharp rise in the rate of inflation that the public expects a year on, from 2.2% last November to 2.7% in February.

Looking further ahead, another concern is that broad money (M4) is growing at an annual rate of 12%, having accelerated sharply over the past two years. The Bank estimates that this rate of growth is over three percentage points higher than is sustainable over the long term. The excessive monetary growth is a worry. As Mr King said on May 10th, “in the long run, if you have rapid broad-money growth, you are going to get inflation.”

For some time, inflation has tended to be lower and growth higher than the Bank has expected. But over the next two or three years, inflation may instead be higher and growth lower, as the economy adjusts to the shock of higher oil prices.

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no s**t. I could have told you that last year and you wouldn't have had to have pay me £3 a month :P

Looking further ahead, another concern is that broad money (M4) is growing at an annual rate of 12%, having accelerated sharply over the past two years. The Bank estimates that this rate of growth is over three percentage points higher than is sustainable over the long term. The excessive monetary growth is a worry. As Mr King said on May 10th, “in the long run, if you have rapid broad-money growth, you are going to get inflation.”

This is the key in my opinion. It is as sure as day will follow night. There is/was no room to cut interest rates anymore. Anyone with an ounce of intelligence would have realised that.

The housing market is dead. There is no more room for growth. Once people realise that there are no more capital gains to be had and that property is a burden (unless it is let successfully) it will be put on the market. That will drive prices down further. We have everything in place for a nice bear market in property. Anyone want to join the teddy bear's picnic or stay long property?

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Guest Bart of Darkness

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Can someone please tell me (as a financial idiot) WHY the M4 money supply is at 12% YOY? Is it the BoE extending credit, is it the internationals taking advantage of the carry trade, or what ?

I'd be really interested, not to mention instantly enlightened, if someone could clarify this point.

If it's the BoE extending 0% credit (money printing) then surely they are in control of it and can reduce it? There's lots of talk of the world's bankers devaluing their countries respective currencies... as I understand it, this is how its done.

Any takers on this most basic of points?

AF

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Can someone please tell me (as a financial idiot) WHY the M4 money supply is at 12% YOY? Is it the BoE extending credit, is it the internationals taking advantage of the carry trade, or what ?

I'd be really interested, not to mention instantly enlightened, if someone could clarify this point.

If it's the BoE extending 0% credit (money printing) then surely they are in control of it and can reduce it? There's lots of talk of the world's bankers devaluing their countries respective currencies... as I understand it, this is how its done.

Any takers on this most basic of points?

AF

I believe M4 is bank lending which the BOE can't control.

http://www.bankofengland.co.uk/statistics/...06/apr/m4SA.GIF

http://www.bankofengland.co.uk/statistics/...6/apr/LENSA.GIF

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I think they can .....

... with tighter economic policy,

i.e., if you want to slow down M4 it's time to raise interest rates.

Let's keep our eye on bond yields tomorrow to see where the market thinks we're heading.

It looks very much like we're heading for stagflation (or hyperstagflation :o ).

Therefore, we must have been on the edge of deflation back in 2001.

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Therefore, we must have been on the edge of deflation back in 2001.

IIRC that was indeed a fear at the time, which concerned me that house prices might fall.

Since Warren Buffet and the Duke of Westminster weren't selling off any of their portfolos then I decided not to either. [/TTRTR Mode] :rolleyes:

Edited by JohnG

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Since Warren Buffet and the Duke of Westminster weren't selling off any of their portfolos then I decided not to either

Please BEAR in mind, neither have mortgages. :D

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IIRC that was indeed a fear at the time, which concerned me that house prices might fall, but then since Warren Buffet and the Duke of Westminster weren't selling off any of their portfolos then I decided not to either

Well it looks like deflation was on the cards. After a huge amount of central bank stimulus and money printing we're still not seeing an awful lot of GDP growth.

The correct thing to spot at the time was that the US would not allow deflation to occur and would prefer the inflationary option. Therefore, IR would be going down and gold and equities would undergo huge growth in $ terms.

However, we're now back at a crux after all this monetary stimulation. The question is where do we go from here? That is the question investors are asking themselves.

On the one hand, can central banks afford to tighten monetary policy at this time to deal with inflation in a stagnant economy and risk everything grinding to a halt and an unavoidable spiral into deflation? That would require one action from investors.

On the other hand, will central banks keep interest rates artificially low, continue to print money, prop up the huge equity bubbles that have formed and risk it all collapsing in a chaotic fashion? This would tend to suggest another strategy is needed.

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...continue to print money...

There, you said it. As I understand this to be equivalent to 0% (or near enough) credit supplied by central banks, where does this money go? If M4 is to do with bank lending, what's the connection between banks and the central banks of the various countries? Surely if 0% credit extended to banks from the central banks is a mechanism by which inflation can be created and the currency devalued, WHY WOULD THEY DO THIS ?

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Hi,

Au contraire mon vieux. This has been THE active topic of discontention between the UK treasury and, well, the rest of the world over the past few years (reminds me a bit of that episode of black adder where Tom Baker, the legless sea captain, says to Edmund that the need for a ship crew on a voyage was a matter of contention. All the other captains say you do need a crew, I say you don't, his reply). Particularly with the head of the European Central Bank, Mr Issing, and Gordy. The inflation targeting policy that NuLabour hijacked (but didn't fully implement) from the Tory treasury in the early ninetees dispensed with broad money (M3, M4 now) targeting via interest rates and instead used M0 narrow money and headline inflation (inflation that the government compile and modify themselves....humm.....).

For various reasons, this was considered better, partly due to some problems with broad money targeting that became quite unreliable, especially around the time of ERM. However, the key point is that the relationship between M4 and inflation can be proved to exist across history and nations from the discovery of Inca Gold 500 years ago in the spanish empire to the modern day US economy. Broad money goes up, a year or three later, inflation goes up. Always happens. That is why the ECB, FeD and BoJ have been raising central bank lending rates in the recent past to head off present and future inflation, they believe M4 is important and that preventative raising of rates will ward off a lot of future problems now, M4 targeting is an active - albeit secondary - plank of monetary policy. The Treasury under Gordy have been smug to say that broad money matters not and is too crude, as long as M0 is controlled and inflation is held. (Even if that inflation level is politically doctored).

The BoE has now seen broad money rising and - surprise, surprise, something we have known for 500+ years - inflation is rising. Infact, worse than that, the extra liquidity and signals from the rate cut last year, that Mervin was against - has done nothing to assist personal indebtedness, industry or trade and has squarley gone into house price speculation, further underpinning general inflation within the economy. (Even Bootle in the Telegraph today was spouting off about inflation locked into the UK economy ;) )

Boomer

Edited by boom_and_bust

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Can someone please tell me (as a financial idiot) WHY the M4 money supply is at 12% YOY? Is it the BoE extending credit, is it the internationals taking advantage of the carry trade, or what ?

I'd be really interested, not to mention instantly enlightened, if someone could clarify this point.

If it's the BoE extending 0% credit (money printing) then surely they are in control of it and can reduce it? There's lots of talk of the world's bankers devaluing their countries respective currencies... as I understand it, this is how its done.

Any takers on this most basic of points?

AF

Because people (the public) are borrowing more money, and the government is selling more gilts. And thus is money created.

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Has anyone got a graph of M4 extending back before 2000 ?

Hi,

Go to the Bank of England website, they have the figures going back in the stats. section for download as spreadsheets. M4 used to be called M3.

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  • 342 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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