On Friday evening we got quite a significant policy speech from the Bank of England. This is partly because of its structure as of the 9 members of the Monetary Policy Committee some 5 of them are “insiders” under the patronage of the Governor. So if the operate as a pack which they usually do they can overrule the 4 external members in theory. In practice we have a situation where Governor Bailey has suggested he may soon be considering interest-rate cuts and we already have one external member ( Swati Dhingra) voting for them.

So when the “markets and banking” Deputy Governor Dave ( Sir David to his friends) stood up to speak in Washington there was interest. Not least as to how he got there as the Bank of England is a committed climate change warrior?

Our climate objective is to play a leading role, through our policies and operations, in ensuring the financial system and the Bank of England itself are resilient to the risks from climate change and in understanding its macroeconomic implications. Where there is alignment with the Bank’s objectives and legal framework, it acts to support the transition to a net-zero emissions economy.

Of course they do not mean for themselves they mean for plebs like us.Although as the “markets man” Dave will this afternoon be again demonstrating how he bought the UK bond market at the top as the Bank of England charged into the market like a headless chicken and is now selling at the bottom. Another £800 million will be sold this afternoon and the price will be lower due to the rises in US bond yields.

Inflation 

Although he does not put it in such words the speech highlights another failure by Dave.

Throughout much of 2023 I was worried that the UK was an outlier among advanced economies, diverging in terms of inflation performance and the degree of persistence.

There is particular significance in this as the speech was given at the Peterson Institute headed by Adam Posen who was regularly quoted in the mainstream media saying this. Unfortunately neither Dave nor the MSM bothered to check that Mr,Posen left the Bank of England because his inflation forecasts went very wrong. Those who were aware of that would not be surprised by this.

But over the last few months I have become more confident in the evidence that risks to persistence in domestic inflation pressures are receding, helped by improved inflation
dynamics.

Actually I had been making the point all along with particular reference to weak and at times declining numbers for the money supply. But I can agree that Dave deserves a large slice of humble pie.

.But we should travel with a high degree of humility, given
the ongoing uncertainties and complexities we face in forecasting inflation.

What Next?

The crucial moment in the speech came here.

.For me the balance of domestic risks to the outlook for UK inflation, relative to the February MPR forecasts, is now tilted to the downside, with a scenario where inflation stays close to the 2% target over the whole forecast period at least as likely.

So with inflation forecasted to be close to 2% then an interest-rate of 5.25% is 3.25% over that. Putting it another way if you wish to bear down on inflation the rule of thumb is that you put interest-rates 2% above it. So we have an upper tier for future UK Bank Rate of 4% to 4.25% and remember that if you are on target you do not really need  to near down on inflation so minds will shift to an interest-rate beginning with a 3. There are consequences from such thinking but let us stay for the moment with the speech.

In case you are wondering why the thoughts of Adam Posen has disappeared from the MSM this is pretty devastating.

This leaves the UK as less of an outlier and more of a laggard in terms of recent inflation performance, and one that is now catching up quickly.

He gets to my points above here.

The MPC’s assessment of the risks emphasised three key indicators of persistence: labour market tightness, private sector wages and services inflation. Trends in these indicators have also played an important part in the MPC’s decision to hold Bank Rate at 5.25% since last August, alongside communications which have stressed the
need for monetary policy to remain restrictive for an extended period of time, in order to
slow the economy and bring inflation sustainably back to the 2% target.

The next bit is really rather basic and we have been on the case for around a year now but for devotees of the Adam Posen line it has come as a surprise.

 This divergence was broad based but also in part reflected the timing of UK energy interventions relative to those across Europe which prolonged the impact of high energy
prices on UK inflation.

Also he confesses that I was right all along and that the wages growth they were concentrating on was a lagging and not a leading indicator.

More recently, I’ve started to focus more on
shorter-term expectations given the closer correspondence to headline inflation and importantly their significance in our understanding of wage dynamics.

You might have thought that basic competence would mean a policymaker had spent quite a lot of time thinking about and looking at wage dynamics but apparently not Dave. He has been singing along with Diana Ross.

Upside down
Boy, you turn me
Inside out
And round and round

Now the real world has not changed simply Dave’s perception of it with wages now following rather than leading.

But there is also analytical evidence that services inflation has been determined to a
greater extent by the energy prices shock

Or if you prefer what has been my point all along. In terms of the detail we get it here.

For example, by estimating the effect using the
most recent data and exploiting the cross-country differences in energy prices my former
MPC colleague Jan Vlieghe finds energy prices to be more important in driving services.

Actually there is something worse for the Bank off England which has previously been ignoring its own research.

And the Bank’s neural network model for services inflation, one of the recently developed cross-check modelling approaches the MPC deploys, also finds a significant role for energy prices.

Comment

This speech sets out a road for UK Bank Rate to decline to 4% and in reality to have a big figure beginning with 3. The problem with that comes from the market response as the “markets” man put the skids under the UK Pound £ as it fell below US $1.24. Someone needs to tell Dave that foreign exchange markets do not observe civil service hours.

One area of concern is how the “markets” man has no market experience at all.

Before joining the Bank, Dave was Chief Economic Adviser to the Treasury and Head of the Government Economic Service from 2007 – 2017……….Previous to that he held a number of civil service roles including leading the Treasury work advising on whether the UK should join the Euro.

If I was intervening in markets on such a grand scale I would want someone experienced and battle-hardened.

This is part of two basic themes at the Bank of England where HM Treasury has in effect taken it back. Three of the four Deputy Governors are alumni of HM Treasury. Also how did we get to having four Deputy Governors as we have seen clear inflation in this area? This is also how they claim to have taken only small pay rises as they get promoted and this more pay instead.

Let me leave you with a final point. If they now believe inflation will be on target why are they still racking up large losses by selling UK bonds via QT? One for the markets man I think….

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