A 7-year state of emergency….

Monday, 8th August 2016

In this issue of Money Truths….

  • Captain Carney fires the bazooka….
  • So what does it all mean?
  • A 7-year state of emergency….
  • The direction of travel….

Captain Carney fires the bazooka….

Three weeks ago the Bank of England’s Monetary Policy Committee considered it unnecessary to fiddle with the British economy. It wanted to wait-and-see before making a move.

Twenty-one days later that same committee felt it had waited and seen enough….

The bank’s forecasters had peered into the future and they didn’t like what they saw. They saw growth slowing to a standstill and the UK in recession. They saw 250,000 British workers about to lose their jobs. They saw house prices falling. They saw living standards falling. In short they saw the good ship Great Britain heading for the rocks.

Up on the bridge Captain Mark Carney and his crew made-ready to make the necessary adjustments….

On Thursday they pressed the buttons and pulled the levers that will guide the ship into calmer waters – at least that’s the hope….

Interest rates were cut for the first time in 7 years. The committee lopped off a quarter point. The new rate of 0.25% is the lowest ever. Never has money been worth so little.

The bank also recommitted to quantitative easing – printing money to buy bonds. It pledged to buy £60 billion in government bonds and also to buy up to £10 billion in corporate bonds over the next 18 months.

There will also be a new £100 billion funding scheme for banks which, in theory, will make it easier for them to pass on the cut in interest rates to consumers….

It’s quite a programme. In some quarters they are calling it a ‘bazooka’. In others a ‘sledgehammer’.

So what does it all mean?

That depends on who or what you are. Different things spell different outcomes for different folks….

Got a tracker mortgage? If so, you’ll benefit from a reduction in repayments.

Even many home-owners on standard variable rate mortgages will benefit. Santander UK and Barclays have already announced cuts to their standard variable rate – putting pressure on competitors to follow suit.

Fixed-rate mortgage holders won’t benefit though. Many people moved over to fixed rate deals in anticipation of an interest rate rise. That turns out to have been the wrong move….

If you’re a business, the reduced rate is good news. It will be cheaper to borrow money.

Work for a big company that offers a pension scheme? There could be trouble ahead. The interest rate cut serves to increase deficits. Which in turn can affect workers as business owners allocate money to the deficit rather than to wage rises.

Own shares? The interest rate cut is good news. The FTSE 1000 and the FTSE 250 both rose immediately after the Bank of England’s (BoE) announcement on Thursday. And with the BoE standing ready to do more in the future, market confidence and asset prices across the board have been bolstered – to some degree at least.

Do you have money on deposit? You get the dirty end of the stick. The banks will almost certainly pass the new rate on to you. The rewards of good husbandry – of working hard and saving for a rainy day – are not what they used to be. Money on deposit will earn next to nothing.

And the low interest rates serve to screw the banks to the floor too. Interest is where the bank’s profit comes from. With interest rates at miniscule levels, the banks are feeling the pinch. They are starting to look for ways of redressing the balance (which I’ll get to in a moment)….

A 7-year state of emergency….

There is no perfect world. In any economy there are winners and losers. Sometimes the chips fall your way. Other times they don’t.

There will be discomfort and pain for some. There will be casualties. But the important thing is that economy’s problems get solved in the round. That things return to ‘normal’. Right?

And that’s what the BoE’s latest interventions will do. Right? They will get things back to normal? They will solve the problems? Right?

I’m not so sure, compadre….

This latest round of BoE interventions is billed as a necessary antidote to the post-Brexit wobble.

Fingers are pointing at the people who voted Leave in the referendum. The vote produced shockwaves throughout Europe and nobody knows what is going to happen next.

Governments, people, businesses and markets are nervous. That’s affected confidence. Which has hurt the economy. Now the BoE has stepped in and applied sticking plaster so that the scratch can heal….

But the wound is a bit deeper than a surface scratch. It’s more of a gash. You can see right to the bone….

The post-Brexit wobble is just the latest twist in a story that has been running for the last 7 years – ever since the onset of the global financial crisis.

Don’t forget that when ground-floor interest rates of 0.5% were first imposed back in 2009 (cut from 5%), they were presented as an ‘emergency’ measure.

That interest rate of 0.5% – at the time the lowest in the BoE’s 322-year existence – was introduced as an ‘emergency’ rate. A return to normalcy was just around the corner…. when the immediate crisis had been averted….

Seven years later and the ground-floor interest rate is not only still with us, it has just been trimmed again. The emergency situation has never gone away. The immediate crisis of 2008/09 persists.

The truth is that 7-years of unprecedented low interest rates (along with all the quantitative easing) have not solved the problem of sluggish, almost stagnant, growth in the economy.

And nor is this latest round of remedial actions likely to get the job done. Mark Carney was clear on Thursday. He made his announcements but also warned British householders to expect a poorer future. He forecasted a rise in unemployment, rising inflation and falling house prices….

The direction of travel….

If Britain’s current economic ills are to be solved then growth is the key. Growth is the elixir that will get this ailing patient out of bed and back on the wheel.

Monetary policy is one tool that planners can use to try and stimulate that growth. And that’s what Thursday’s announcements were all about.

But low interest rates and printing money haven’t done the trick across the last 7 years. Maybe it’s time to try another tool. One option open to government is to run a more expansionary fiscal policy.

Now that George Osborne has been jettisoned, along with his economic programme of austerity, government might consider reducing taxes or pumping investment into infrastructural projects to stimulate economic growth.

But the new chancellor, Philip Hammond, has the reputation of cautious man. That may be a strength. Or it may be a weakness. Time will tell. But right now government spending plans are not expected to change until October at the earliest.

That leaves Mark Carney and the BoE out on stage alone for the time being. And with not much margin to work with if more stimulus is required.

An interest rate of 0.25% means money is cheap. Cheaper than it has ever been. The rate can’t go much lower without getting into negative territory – a twilight zone situation where banks pay customers to borrow and savers pay banks for the privilege of keeping money on deposit.

Mr. Carney has said he is opposed to negative interest rates. He might not go there. He might instead rely on more quantitative easing or on introducing ‘helicopter’ money in some way, shape or form.

But his commitment to positive interest rates is likely to be tested. Thursday’s rate drop will not stimulate the necessary growth. It is no more than a delaying tactic. The general direction of travel is down. We can expect to go further down still.

The banks are getting into position. Last week the Royal Bank of Scotland (in which the state is the majority shareholder) wrote to 1.3 million business customers and warned that the bank will consider imposing charges on credit balances if the BoE introduces a negative base rate of interest.

You can see it from the Royal Bank of Scotland’s point of view. They have to make a profit.

Other banks would almost certainly take the same stance.

And it wouldn’t just be businesses paying to keep money on deposit. It would be consumers too. People like you and I.

We live in interesting times. We are 7-years into an emergency situation and, I take no pleasure in saying it, there is worse yet to come. That’s a money truth….

I’ll be back with more on Friday.

All the best,

dave-gibson

Dave Gibson

Money Truths