Claire Jones

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Inflation Report

The Bank of England’s Inflation Report is out on Wednesday, and with it the Monetary Policy Committee’s eagerly awaited forecast for inflation.

Claire Jones

Josef Ackermann better watch out the next time he visits the Eurotower.

It appears Mario Draghi, ECB president, hasn’t taken too kindly to comments made by Deutsche Bank chief executive last week.

Mr Ackermann told analysts last Thursday that Deutsche Bank had not taken part in the ECB’s first offering of three-year loans in December and was reluctant to be seen as needing help. This from the FT’s James Wilson in Frankfurt:

“The fact that we have never taken any money from the government has made us, from a reputational point of view, so attractive to so many clients in the world that we would be very reluctant to give that up,” [Mr Ackermann] told analysts.

The ECB has been keen to dispel any suggestion that a stigma is attached to participation in the auctions for three-year loans, the next of which to be held at the end of this month. And when quizzed on the topic at today’s presser, the usually unfazed Mr Draghi lashed out with the sort of rant that we had come to know and love from his predecessor.

Claire Jones

The European Central Bank’s governing council has left its benchmark rate unchanged at 1 per cent, as expected.

The deposit and lending rates remain at 0.25 per cent and 1.75 per cent respectively.

ECB president Mario Draghi’s press conference begins at 1.30pm UK time.

 

Claire Jones

The Bank of England’s Monetary Policy Committee has announced £50bn more in quantitative easing, taking the total size of the asset purchase programme to £325bn.

The amount is in line with the consensus view, though some analysts were unsure whether the MPC would back further asset purchases after some positive news on the economy in recent weeks.

 

Claire Jones

The pound, along with Britain’s fiscal retrenchment, are often cited as explanations for why yields on UK government debt now hover around record lows.

Some suggest another factor is at play: financial repression.

This sinister-sounding phrase describes the situation where government policy attempts to artificially lower interest rates with the specific aim of reducing their debt burden. Given that QE has done much to lower yields on UK government debt, some have tagged the policy with the financial repression label.

Regardless of whether or not this is the case (more on which later), Fathom, a consulting group made up of former Bank economists, today expressed doubts about whether such a policy – and for that matter gilt purchases – will do much to aid the UK recovery.

The Bank of England meets on Thursday with expectations running high that the MPC will announce a further large dose of quantitative easing. Even if they pass this month, which seems possible, this is likely to be only a temporary postponement. Whenever it comes, the next move will be another bout of “plain vanilla” QE, involving the purchase of £50-75bn of government bonds, and taking the overall Bank of England holdings to over one third of the total stock of gilts in issue.

Meanwhile, the Fed is still debating whether to increase its holdings of long dated securities, and if so whether to focus once again on government debt, or to re-open its purchases of mortgages. Any further QE would be contentious on the FOMC, but there is probably still a majority in favour.

Central bankers, unlike many others, have not lost faith in the efficacy of QE. The vast majority of them not only believe that additional asset purchases can further reduce long term bond yields at a time of zero short term interest rates, but also that this can increase real GDP growth, compared with what otherwise would have occurred. Are they right?

Most of the empirical evidence published since QE started in 2008 is on the side of optimism. Admittedly, a lot of it is published by the central banks themselves, who are scarcely the most independent source on this matter. But the weight of evidence is still impressive, and runs counter to those who believed from the start that QE would be a complete waste of time, if not worse.

First, there is little doubt that QE has significantly reduced the level of bond yields in the US and the UK, which is what it was primarily intended to do. The BIS reckons that the impact on the average bond yield across the curve has been fairly minor, amounting to about 25 basis points for each of the three doses of QE in the US, and to a total of only about 25 basis points for the much larger episode of QE in the UK in 2009/10. But two separate studies by the Bank of England (here and here) conclude that the impact of the UK action was about 100 basis points or more, and several other US studies suggest that the BIS estimates are on the low end of the range. The graph below shows how the yield curve has flattened markedly on both sides of the Atlantic since QE started:

 

The success of the central banks in reducing bond yields has come as a surprise to some economists, who believed that bonds and cash would be perfect substitutes when short rates hit zero. If that had been the case, then the central banks would not have been able to nudge bond yields downwards, no matter how much cash they had offered in exchange for them.

But in reality it turned out that bonds and cash were not perfect substitutes, so the central banks were able to raise bond prices (and cut yields). They needed to spend a considerable amount of extra cash to do this, but not the infinite amount which would be implied by perfect substitutability.

It is true that there is a lower limit to sustainable bond yields set by the Keynesian liquidity trap (explained in this earlier blog). Japanese experience suggests that this baseline is around 1.3 per cent, and the graph shows that the yields on maturities out to five years are already at or below these levels. So the central banks have now done all that they can do with QE in that part of the curve.

However, that still leaves the rest of the yield curve, especially the part between 10 and 30 years, where there is plenty of scope for a further decline in yields. And, of course, the central banks could choose to buy mortgage debt, corporate debt, or other private securities, where spreads could be substantially reduced by official purchases.

Admittedly, any of these options would imply that the central bank balance sheets are taking on even more risk. But that is the whole point of the strategy. As the private sector attempts to restore its overall risk levels to the levels held before QE, they bid up the prices of other risk assets, like equities. The Bank of England study quoted earlier suggests that the immediate impact on UK equity prices may have been as much as 20 per cent.

That leaves the question of how the strategy affects the rest of the economy. The empirical evidence on this (which is well summarised in this Banca d’Italia overview) is also supportive of the policy, so far. Key research papers suggest that real GDP in the UK may have been boosted by about 1.5 per cent, while that in the US may have risen by 0.6-3.0 per cent, compared to what otherwise would have occurred. Inflation also rose, by more than 1 per cent, but again that was the deliberate intention of the central bank, not the reverse.

While encouraging, this evidence does not prove that future injections of QE will have the same benign effects, either in scale or even in direction. Much of the evidence seems to indicate that the first bout of QE had the most significant impact on bond yields, with subsequent bouts having far less bang for the buck. There are various reasons, including the increasing importance of the liquidity trap, and the waning impact of signalling effects about future central bank policy, that suggest this drop in efficacy may continue to be the case.

Nor should anyone feel entirely confident that the long term effects of QE on inflation are well understood. The historic correlations between the growth of central bank money and inflation in the long term are a cause for concern, as this earlier blog argued.

However, the growing consensus among central bankers is that their experiment with QE is still working. It was a shot in the dark, and a rather desperate one at that. But up to now it has had the desired effect, which is certainly a far better outcome than the alternative.

Ralph Atkins

The European Central Bank’s governing council has a lot to discuss at Thursday’s meeting. Interest rates may not attract the most attention: the ECB’s main rate is widely expected to remain at 1 per cent.

Since January’s council meeting, the “tentative signs of stabilisation in activity at low levels” spotted by Mario Draghi, president, have been confirmed in economic indicators, especially eurozone purchasing managers’ indices. The latest bank lending data and survey of credit standards were very weak – but perhaps no weaker than expected. Crucially, it was too early for the impact of the €489bn of three year loans injected into the eurozone financial system by the ECB in December to have been felt.

Moreover, there seems little reason for the ECB to adjust interest rates ahead of a second three year longer-term refinancing operation (Ltro) on February 29. Instead, attention at Mr Draghi’s press conference is likely to focus on two issues: Greece, and the latest relaxation of ECB collateral rules. 

Claire Jones

The Bank of England looks set to announce more money printing on Thursday, with £50bn the amount most analysts expect.

If the Monetary Policy Committee does go ahead and announce more QE, there is little doubt that it will buy nothing but gilts. However, it is less certain what sort of gilts the Bank would buy.

Over the past four months the Bank has bought around £5.1bn a week in gilts. The purchases have been spread out across the curve, with the Bank buying £1.7bn of gilts with maturities of between three and 10 years, £1.7bn with maturities of between 10 and 25 years, and the same amount with maturities of more than 25 years.

However, Sam Hill, UK fixed income strategist at RBC Capital Markets, believes that could change with the next round of asset purchases.

Claire Jones

So the Bank of England’s decision is out at noon on Thursday. More money printing is pretty much of a dead cert isn’t it?

More or less. Since the Bank’s November inflation report showed policymakers expect inflation to undershoot its 2 per cent target over the next few years, most analysts have viewed it as a case of when, not if, the monetary policy committee announces more quantitative easing.

But why has the Bank held fire in recent months if it already expects inflation to fall below target?

According to recent minutes of the MPC meetings, there are a few reasons.

First, some on the committee view the risks to inflation as more “finely balanced” than the forecast suggests, while others are not so concerned about below-target inflation as to view the need for more quantitative easing as particularly urgent.

There is also a technical factor. The Bank has expressed some doubt about whether the gilt market has the capacity to support further purchases, though external MPC member Ben Broadbent recently downplayed this as the reason to hold fire on announcing more QE.

Regardless of Mr Broadbent’s comments, with the purchases announced in October scheduled to end earlier this month, hopes have long been pinned on more QE at this week’s meeting.

That the February meeting coincides with the publication of the Bank’s inflation report the following week, further raises those hopes. The MPC’s decisions on further asset purchases have tended to coincide with the publication of the quarterly reports, when the forecasts for growth and inflation are updated and the Bank can state more clearly the case for further easing.

As a result, the Bank is more likely than not to announce more QE on Thursday. However, it is less of a dead cert now than was thought a few months ago.

Why’s that?

Things have turned out a little better than expected.

The latest round of surveys based on the opinions of purchasing managers, on which the Bank keeps a reasonably close eye, have been favourable; the latest reading for services activity, which according to the Office for National Statistics makes up more than 76 per cent of economic output, was above expectations.

This suggests that the contraction in the UK economy towards the end of last year is set to be short-lived. To boot, the US economy is holding up well, and the European Central Bank’s bumper offering of three-year loans in December appears to have tempered fears that the financial system is teetering. For now, anyway.

And some on the MPC remain concerned about whether or not inflation will dip below target. Despite the recent fall in inflation being in line with what the Bank expected in November, some believe that pay and price rises could keep inflation above 2 per cent in the medium term. Paul Tucker, one the Bank’s deputy governors, has also said that he sees no reason why the Bank would not tolerate below target inflation for a period.

However, there is little evidence yet of wages and retail prices spiralling, the economy shrank in the fourth quarter, and confidence remains fragile. Sir Mervyn King, the governor of the Bank, indicated late last month that he supports more QE. And what the governor says usually goes.

So how much this time?

Unsurprisingly, the estimates have declined of late.

Most analysts had originally pencilled in £75bn. Some now expect nothing, or as little as £25bn. But £50bn is now seen as the most likely amount. That would take the total stock of asset purchases to £325bn.

What will the Bank buy?

Gilts, gilts and more gilts. Despite pleas to the contrary, most policymakers are adamant that the Bank should stick to buying UK government debt. None of the MPC has suggested otherwise of late.

In terms of the timescale, the Bank has been buying about £5.1bn in gilts a week in recent months. Given the fears over market capacity it’s unlikely that it will up the amount, though it could lower it.

Will it work?

If you believe the Bank, then yes.

The Bank’s research into the effectiveness of the first £200bn of QE shows that, by depressing gilt yields by 100 basis points, the first round boosted growth by between 1.5 and 2 per cent, and inflation by 0.75 and 1.5 per cent.

Not all are as convinced as the Bank, however. Research by the Bank for International Settlements, the influential “central bankers’ bank”, suggested that the first round of QE had little more than a quarter of the impact on gilt yields than the Bank estimated.

The Bank’s view also clashes with that of the BIS research in that the MPC expects similar bang per buck, so to speak, from this round of quantitative easing. The BIS research states that further asset purchases won’t have as great an effect as the first round.

Who’s right?

Who knows. When it comes to QE, there is little historical precedent, with only the Bank of Japan experimenting with the policy before the current crisis. Besides, given that it’s impossible to know what would have happened without QE, estimating the impact asset purchases have had on the UK economy is more art than science.

But, while the BIS might be influential in central banking circles, what ultimately matters for policy is what the Bank thinks.

So, if the MPC does plump for more QE on Thursday, will that be it?

Most analysts think not. They expect more in May, and perhaps the autumn too. Estimates of the eventual size of the Bank’s asset purchases differ widely, however.

 

Claire Jones

Our week ahead email helps you track the most important events in central banking. To see all of our emails and alerts visit www.ft.com/nbe

Bank of England, ECB decisions

The Bank of England’s Monetary Policy Committee and the European Central Bank’s governing council will set policy for the coming month on Thursday.

The Bank is expected to announce further quantitative easing after finishing the £75bn-worth of purchases announced in October.

Analysts are wavering, however, on whether the Bank will opt for £50bn or £75bn in additional asset purchases.

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The Money Supply team

Chris Giles Chris Giles has been the economics editor of the Financial Times since 2004. Based in London, he writes about international economic trends and the British economy. Before reporting economics for the Financial Times, he wrote editorials for the paper, reported for the BBC, worked as a regulator of the broadcasting industry and undertook research for the Institute for Fiscal Studies. RSS

Ralph Atkins, Frankfurt bureau chief, has been writing about European economics and politics for the Financial Times for more than 20 years following an economics degree from Cambridge. He has been watching the European Central Bank and eurozone economies since 2004. He has previously worked in London, Bonn, Berlin, Jerusalem and Brussels. RSS

Robin Harding is the FT's US economics editor, based in Washington. Prior to this, he was based in Tokyo, covering the Bank of Japan and Japan's technology sector, and in London as an economics leader writer. Robin studied economics at Cambridge and has a masters in economics from Hitotsubashi University, where he was a Monbusho scholar. Before joining the FT, Robin worked in asset management and banking. RSS

Claire Jones is Money Supply economics team writer, based in London. Before joining the Financial Times, she was the editor of the Central Banking journal and CentralBanking.com. Claire studied philosophy and economics at the London School of Economics. RSS

James Politi is US economics and trade correspondent for the Financial Times, based in Washington DC. He joined the Washington bureau in January 2008 following four and a half years as US deals correspondent covering M&A and private equity. James Politi joined the FT in London in 2000 with an MSc at the London School of Economics, and undergraduate degrees from Georgetown University and the University of Florence. RSS

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