It wasn’t widely reported, but a landmark event took place in UK monetary policy last week. Perhaps it would be more accurate to say, the truth was finally admitted.
Mark Carney was appearing before the Treasury Select Committee and he confirmed that the £375B worth of gilts the Bank of England bought as part of the QE program would not in fact be sold back to the market as previously claimed. This is shattering stuff; it means the fig-leaf which separated the BoE from the Bank of Zimbabwe is now gone. They are both monetise debt, they just differ in degree.
Carney went on to play Nostradamus by claiming he expects rates to rise to about 3% in the next three years. Quite why anyone takes BoE economic forecasts seriously any more escapes me. Their record is unimpressive. Perhaps what he was actually expressing was an aspiration rather than a prediction.
Now it’s true, the Monetary Policy Committee can set rates at any level they want regardless of relevance, but I wonder if the long-dormant inflationary dragon might make a fool of Carney.
Quantitative Easing didn’t cause much in the way of inflation*contrary to my expectations. To some extent this was because policy makers were pushing on a string. The demand for consumer credit was neutered and banks just used the QE cash to repair their balance sheets or buy gilts as above. It also held up UK house prices and set a fire under stocks as investors chased dividend yields.
But this money hasn’t substantially gone away. If you printed a trillion pounds in cash then buried it in your back garden, it would have no impact on inflation. The impact would come when you start spending (and therefore circulating it to increase the money supply).
So what does the future hold? Like everyone else on the planet, I don’t know, but the combination of current economics and future politics leads me to believe the following: the BoE will tolerate higher inflation as banks start to loan again. They may well tolerate a negative real interest rate for years to come. This is because the national debt simply isn’t payable, so they will erode it with inflation crypto-tax.
House prices will probably zoom on for a while, certainly until 2015. No-one will want to rock the boat in an election year, and the way you get the floating voters to give you their loyalty is to convince ‘em they are rich by means of rising house prices. And I suspect there will be some momentum in this. But sooner or later around 2016/7 there must be another serious correction as inflation is well and truly out of control and beyond even Carney’s capacity to ignore. At this point, interest rates have to go close to real terms parity. Even rates as low as six or seven** percent would slaughter lots of recent highly leveraged buyers and rates may need to be higher than that. This beats the hell out of UK property prices, bank balance sheets, companies etc
This period will be very ugly indeed and I think we might see some full on financial repression and possibly civil disorder. So don’t keep much cash in the bank because I think Ed Balls might just help himself “in the national interest, to protect the most vulnerable, because of the actions of greedy bankers” etc
As ever, this is not financial advice, make your own decisions yadda, yadda.
* Except insofar as we probably would have experienced deflation which debtors fear, but is good for the rest of us because it just means falling prices, i.e. things getting cheaper.
** Contrary to Radio 5’s assertions, we have not seen the end of high interest rates. I recall building society interest rates of 17% in the early 1980’s The normally quite sane, if curmudgeonly financial guy went on to rail about bitcoins because they are not backed by anything (true) unlike the pound (sic) What the fuck is the pound backed by? Fiat currency much? It is paper with pictures of dead guys on it, nothing more. It is simply more widely accepted at the moment.