A busy week for the Bank of England

On Monday the Bank of England published a submission to the Treasury Select Committee on the first ten years of the Monetary Policy Committee. The bulk of the report is a backward looking assessment of the effectiveness of the MPC policy framework (which not surprisingly comes to some pretty favourable conclusions!). However, more interesting from a Prometheus perspective, the report also makes several observations which might shed light on the Committee’s future behaviour. By and large, these seem to support the view that the MPC is likely to err on the side of caution when it comes to inflation dangers over the coming months.

First, the submission notes that the short run trade-off between activity and inflation has been flattened by the forces of globalisation. This helps to explain why inflation has remained low in recent years, but some members of the MPC have previously warned that it might also mean that inflation will not fall as freely after a shock like the rise in oil prices. In other words, the MPC may need to slow the economy more sharply via tighter monetary policy to get inflation back to target.

Second, the submission concludes that at some point the current account deficit will need to close, which would probably require some depreciation of the real effective exchange rate. This supports the view that the pound has been fundamentally over valued for some time. Needless to say, a significant fall in the pound could pose an upside risk to inflation.

Third, the report reinforces the impression that the MPC has recently put increased emphasis on the money supply. It was felt that rapid monetary growth could have an upward impact on inflation expectations.

The one point which seems to go in the opposite direction is the Bank’s observation that the rise in the ratio of household debt to income should increase households’ sensitivity to rises in interest rates and could amplify the effects of shocks such as a fall in house prices. However, it concludes that the build up of debt has not yet had any significant effect on the economy.

Bottom line: Overall, one cannot draw any very strong conclusions from Monday’s submission. However, the report adds to the impression that the Committee still sees a number of general upside risks to the inflation outlook.

BoE MPC Minutes reveal more doves but confirms uncertainties

Today's release of the February MPC Minutes echoed last week's Inflation Report. The central bank is very uncertain about the path of inflation but feels that policy rates are approaching a peak.

Monetary policy members voted 7-2 to leave the Bank Rate unchanged at 5.25%. While the vote indicated there were fewer hawks compared with January, there remains a good chance of one more rate hike during the first half of this year. Regardless, overall monetary conditions have already tightened sufficiently to cool the economy. Since mid-2006, the central bank has hiked by 75 basis points, rate expectations have risen by 125 bps and the trade-weighted pound has appreciated modestly. Correspondingly, retail sales, housing indicators and inflation measures all appear to be peaking. Bottom line: the BoE is likely to hike once more (incidentally, this does not warrant an underweight position in gilts – see below).

How tight are UK liquidity conditions?

U.K. monetary conditions are modestly restrictive and should help cool the economy, benefiting bonds.

U.K. M4 money supply growth in January came in stronger than expected, ticking up to 13% year-over-year. While rapid money growth has been a source of angst for the BoE, it may not have provided an accurate picture of monetary conditions. Other measures of liquidity suggest that policy is slightly restrictive—for example, short-term interest rates are decisively above nominal GDP growth. Moreover, weakness is beginning to show in retail sales and the housing sector appears to have peaked, suggesting that recent monetary tightening is starting to bite. Bottom line: stay long/overweight gilts.

... and some good news for Gordon

January's UK public finances figures have given the Chancellor a timely boost ahead of next month's Budget. Public sector net borrowing (PSNB) came in at GBP10.3bn, just a bit above the consensus forecast of GBP10bn and last year's figure. However, some favourable revisions to previous months' data have left the cumulative PSNB for the year so far looking rather better, at GBP27.6bn vs. last year's equivalent figure of GBP31.3bn.  

Elsewhere, the provisional M4 figures for January show continued strength in the broad money supply, with a m/m rise of 0.9% pushing the yy rate back up from 12.8% to 13.0% and M4 lending growth rising more sharply from 13.4% to 14.6%. The rapid growth of money is one factor that will keep the MPC nervous about the inflation outlook even as CPI inflation itself falls back sharply with energy prices over the coming months (see above).

This all points to a full-year deficit of around GBP34bn, which would be about GBP3bn below Mr Brown's Pre-Budget Report forecast. Of course, things could still go wrong in the last 2 months of the year but, Bottom line: Tuesday's figures perhaps give the Chancellor some elbow room for a small giveaway in his last Budget – yippee!

And finally…………

A warning to all ladies who like to drag their husbands out shopping. This letter was ‘allegedly’ sent by Tesco's Head Office to a customer in Oxford:
 
Dear Mrs. Murray,

While we thank you for your valued custom and use of the Tesco Loyalty Card, the Manager of our store in Banbury has requested that we write to you concerning your husbands recent behaviour in his store.
 
Below is a list of offences over the past few months that have all been verified by our surveillance cameras:
 
1. June 15: Took 24 boxes of condoms and randomly put them in people's trolleys when they weren't looking.

2. July 2: Set all the alarm clocks in Housewares to go off at 5-minute intervals.

3. July 19: Walked up to an employee and told her in an official tone, “Code 3 in Housewares”..... and watched what happened.

4. August 14: Moved a 'CAUTION - WET FLOOR' sign to a carpeted area.

5. September 15: Set up a tent in the outdoor clothing department and told shoppers he'd invite them in if they would bring sausages and a
Calor gas stove.

6. September 23: When the Deputy Manager asked if she could help him, he began to cry and asked, "Why can't you people just leave me alone?"
 
7. October 4: Looked right into the security camera; used it as a mirror, picked his nose, and ate it.

8. November 10: While appearing to be choosing kitchen knives in the Housewares aisle asked an assistant if he knew where the
antidepressants were.

9. December 3: Darted around the store suspiciously, loudly humming the "Mission Impossible" theme.

10. December 6: In the Kitchenware aisle, practised the "Madonna look" using different size funnels.

11. December 18: Hid in a clothing rack and when people browsed, yelled "PICK ME!" "PICK ME!"
 
12. December 21: When an announcement came over the loud speaker, assumed the foetal position and screamed "NO! NO! It's those voices
again."
 
And; last, but not least:

14. December 23: Went into a fitting room, shut the door, waited a while; then yelled, very loudly, "There is no toilet paper in here."

Yours sincerely,

Charles Brown
Store Manager

Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.