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The Monetary Squeeze Will Be Less Intense Than The Markets Fear

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Guest wrongmove

The monetary squeeze will be less intense than the markets fear

"IT HAS been a rude awakening for borrowers. Four years ago they were luxuriating in the lowest interest rates for almost half a century. A year ago rates were still unusually low: the Bank of England's base rate was 4.5%. But since then the bank has yanked it up to 5.75% and now the City is betting that it will reach 6.0% this autumn and, quite possibly, 6.25% by the end of the year. The lure of tighter money pushed sterling up to around $2.05 this week, a new 26-year high (see chart).

What lay behind these market moves was a setback on inflation. Since consumer-price inflation peaked earlier this year, at 3.1% in the 12 months to March, it has fallen quite sharply—to 2.8% in April and 2.5% in May. However, that downward progress towards the government's target of 2.0% slowed in June, when inflation fell to 2.4% rather than the 2.3% expected by the markets.

Indeed, the more the City delved into the numbers the less they liked the look of them. A turnaround in gas and electricity prices is continuing to pull down headline inflation. However, a core measure, which leaves out more volatile elements like energy and food, rose from 1.9% in May to 2.0% in June, its highest for ten years.

Other gauges of inflation also brought an unpalatable message. According to the longer established and broader index of retail prices, which includes owner-occupier housing costs, inflation actually rose from 4.3% in May to 4.4% in June. That reflected the impact of higher mortgage-interest payments; stripping these out, retail-price inflation remained unchanged at 3.3%.

It is easy to see why City dealers are putting their money on higher rates. On two occasions in the past year the bank caught them napping when it raised interest rates unexpectedly. But traders may be over-reacting this time. Labour-market figures released this week showed that earnings growth remains subdued.

Furthermore there are divided counsels on the bank's nine-strong monetary-policy committee. Minutes published on July 18th of the committee's meeting earlier this month, when it raised the base rate from 5.5% to 5.75%, revealed that three members wanted to keep rates unchanged. This minority pointed out that the bank's earlier rate rises had yet to work their way fully through to mortgage rates and the economy.

The base rate still looks set to reach 6.0% later this year. But that may be enough to do the trick, provided that sufficient evidence emerges that the economy and the housing market are starting to lose momentum. "

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In a letter sent to clients earlier this week, Bear Stearns admitted one of the funds was worth nothing, while the other has very little value left. The bank's shares have fallen 15pc so far this year.

So basically billions of dollars have just evaporated! BS can bail out one of the funds but they'll need outside help for the other. They tried to seize and sell the underlying collateral but it turned out to be worth way less than it was booked at.

If the CDO/CLO debt market collapses then nobody gets mortgages except at extortionate rates. We could see a complete de-coupling of base rates from mortgage rates; remember the 1970s when you had to "queue" six months for a mortgage?

Edited by Nationalist

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remember the 1970s when you had to "queue" six months for a mortgage?

Yep, remember it well. One of the lessons of history is that history has a knack of repeating itself.

I can remember having to save with a Building Society for 2 years or more - steady, regular savings, before you'd even get on the waiting list for a mortgage.

I might have my rose-tinted spectacles on but things were better then.

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The monetary squeeze will be less intense than the markets fear

"IT HAS been a rude awakening for borrowers. Four years ago they were luxuriating in the lowest interest rates for almost half a century. A year ago rates were still unusually low: the Bank of England's base rate was 4.5%. But since then the bank has yanked it up to 5.75% and now the City is betting that it will reach 6.0% this autumn and, quite possibly, 6.25% by the end of the year. The lure of tighter money pushed sterling up to around $2.05 this week, a new 26-year high (see chart).

What lay behind these market moves was a setback on inflation. Since consumer-price inflation peaked earlier this year, at 3.1% in the 12 months to March, it has fallen quite sharply—to 2.8% in April and 2.5% in May. However, that downward progress towards the government's target of 2.0% slowed in June, when inflation fell to 2.4% rather than the 2.3% expected by the markets.

Indeed, the more the City delved into the numbers the less they liked the look of them. A turnaround in gas and electricity prices is continuing to pull down headline inflation. However, a core measure, which leaves out more volatile elements like energy and food, rose from 1.9% in May to 2.0% in June, its highest for ten years.

Other gauges of inflation also brought an unpalatable message. According to the longer established and broader index of retail prices, which includes owner-occupier housing costs, inflation actually rose from 4.3% in May to 4.4% in June. That reflected the impact of higher mortgage-interest payments; stripping these out, retail-price inflation remained unchanged at 3.3%.

It is easy to see why City dealers are putting their money on higher rates. On two occasions in the past year the bank caught them napping when it raised interest rates unexpectedly. But traders may be over-reacting this time. Labour-market figures released this week showed that earnings growth remains subdued.

Furthermore there are divided counsels on the bank's nine-strong monetary-policy committee. Minutes published on July 18th of the committee's meeting earlier this month, when it raised the base rate from 5.5% to 5.75%, revealed that three members wanted to keep rates unchanged. This minority pointed out that the bank's earlier rate rises had yet to work their way fully through to mortgage rates and the economy.

The base rate still looks set to reach 6.0% later this year. But that may be enough to do the trick, provided that sufficient evidence emerges that the economy and the housing market are starting to lose momentum. "

And if the BOE drops interest rates when the economy slows - the pound will move down (probably sharply) and imports will get more expensive and, as we import a LOT more than we export, inflation will go up.

So we'll have a slowing economy and higher inflation. Stagflation I believe it is called. And people will demand higher wages and this will increase inflation even more and, before you know where we are, we're in the SH1T.

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Guest grumpy-old-man
And if the BOE drops interest rates when the economy slows - the pound will move down (probably sharply) and imports will get more expensive and, as we import a LOT more than we export, inflation will go up.

So we'll have a slowing economy and higher inflation. Stagflation I believe it is called. And people will demand higher wages and this will increase inflation even more and, before you know where we are, we're in the SH1T.

all the countries public service sectors are crying out for pay rises & more staffing & have been for some time. Yet the sectors seem to be cutting staffing & resources in a bid to balance the books, whilst giving out below real inflation pay rises.....we are fooked already, you just don't know it. :ph34r:

for example, the collection of the bins has been put back to 2 weeks in some areas, this is to keep the ready to strike binmen at bay for a while, without having to give them the required payrises. No doubt "carbon footprint" & will be mentioned in a report backing this 2 week bin change. <_<

Edited by grumpy-old-man

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