A licence to print money

Well no, actually. The amount of paper cash wont actually rise from the current c. £40bn mark after the MPC’s decisions to embark on quantitative easing .

The money created instead will be flooded into high street and commercial banks in an attempt to get them lending once again – “back at 2007 levels” if you believe our PM. Which you shouldn’t.

Essentially, in spite of what some on the MPC have argued – that the transition mechanism of monetary policy is broken – they today decided that inflation in Britain will soon fall below 2 per cent. It may even go negative.  So:

Accordingly, the Committee also resolved to undertake further monetary actions, with the aim of boosting the supply of money and credit and thus raising the rate of growth of nominal spending to a level consistent with meeting the inflation target in the medium term.

Interest rate decision: the choices

Tomorrow the MPC will announce that Alastair Darling has given permission to the governor of the Bank of England, Mervyn King to begin quantitative easing. The Bank’s purchase of government gilts and assets is designed to increase liquidity and, ultimately, increase lending.

Firstly, this wont work. The only thing printing money is likely to achieve is an immediate devaluation of the currency and, with no significant exporting sector, is unlikely to act as a fiscal stimulus. But more on that tomorrow.

For tonight, let’s look at the three options available to the MPC re: interest rates.

1. 0.5 per cent cut

Expected by almost everyone. In spite of David Blanchflower’s assertion that the “transition mechanism of monetary policy is broken” the Bank is likely to continue easing central credit conditions in a bid to encourage lending.

Sterling is dead. Long live sterling

There’s an often quoted episode from the later days of the Weimar Republic.  A man walks into a cafe and orders a coffee. He drinks it and orders another one. The coffees are priced on the menu at 10million marks. The bill comes. It is 25million marks. When the man queries his bill the waiter replies, “Sir, if you wanted to save money, you should have ordered them at the same time.” This is an extreme caricature of what was very real hyperinflation.

Since the start of the week, when Blue Monday saw billions of pounds wiped of the share value of our very own bank, the value of the pound has fallen at its fastest since 1985. One English pound now buys you 1.3793 dollars, or, put another way, almost 40 per cent less than this time 18 months ago.

Concerns are being raised in global currency markets that Britain is in real danger of being declared bankrupt. Whispers are already getting louder that Britain could lose its AAA rating allowing it borrow swathes of cheap money in the short term. Several renowned voices are already way above whisper quiet.

These economists may have a point. The  potential liabilities incurred from a full blown nationalisation of RBS (which now looks near-inevitable) and further stake raising in Lloyds TSB/HBOS are twice our entire GDP. That’s £4,200,000,000,000.

The pound is set to plummet. But will Mervin King’s insinuated ‘qualitative easing’ (that’s flooding the market with cash to you and I) stop its slide? How, I find myself asking, can a currency undermined by excessive borrowing be allayed by more borrowing?

There are a few death-knell measures at troubled treasuries’ disposal. Cut interest rates to 0 per cent? Merv quietly admitted last night that this is on the way. In America, it’s already in place. Print more money? Don’t rule it out. Buy treasury bonds? Who wants them? Besides, taking Japan as the most recent model, such a measure is no guarantee of success.

The government is today considering all these most drastic measures in a bid to stave off deflation. It should be worried about hyperinflation. Michael K. Salemi, Professor of Economics at the University of North Carolina:

[Hyperinflation] occurs when the monetary and fiscal authorities of a nation regularly issue large quantities of money to pay for a large stream of government expenditures.

Remind you of anything? Large quantities of our money and ‘regular’ monetary tinkering – such as rate cuts – can skew a currency and ultimately devalue it further.

David B. Smith from the IEA reckons that recent interest rate cuts already “could fuel rapid inflation in the future.” With further monetary measures, the treasury “may have amplified the inflation cycle”. See.

So don’t get worried about the falling pound. You might see an awful lot of them around soon.

Hate to say I told you so…

Yesterday it was Ben Bernanke who tacitly handed over control of the global economy after the Federal Reserve’s base lending rates hit rock bottom – zero percent.

Today, Britain’s counterpart, Mervyn King, has admitted that he and the institution he represents – the Bank of England – no longer have control over inflation.

If Alastair Darling expects a letter from Merv to explain what the Dickens is going on with the Consumer Price Index, he’ll be disappointed. Merv has sovereign stamped his last letter on inflation for a while; he is suspending predictions during this period of “shocks and disturbances”.

Inflation is still persisting in spite of an eight percent fall in oil prices compared with October. But this will fall – of course it will as people spend less.

Mervyn King has recently come in for criticism due to what was perceived as dallying. If interest rates should now be at 2 percent, why were they at 5 two months ago? The answer is simple: ignorance is bliss.

It grates me as much as the next man whenever I hear Mr. Darling’s woefully optimistic predictions, but they have some merit. People who here that the economy is fine will be slightly more inclined to spend and, in turn stimulate growth (or at least stave off shrinkage).

Once you tell people that we are in serious trouble, they, for some reason, trust you. They stop spending on the anticipation that prices will fall further and deflation becomes a self-fulfilling prophecy. They must think you’ve got an economics degree or something.

Bernanke’s big backfire

In the past few hours, the US Federal Reserve – the body in control of more money than any other on the face of the earth – has announced base interest rates of “between zero and 0.25 per cent“. This is not only unprecedented: this was, until recent weeks, utterly unthinkable.

Think for one moment what this means. If a bank borrows $1m, it will have to pay back, at most, $1,002,500 over the period of the loan. This is free money.

The aggressive action from Ben Bernanke and co comes two weeks after the Bank of England cut its base rate of lending to an all time low of 2 per cent. And still people are calling for more.

Interest rate cuts are resorted to when an economy is threatened with deflation. A source working in the currency market reckons that even such cheap money will not stimulate the economy in the short-term. Customers, both retail and wholesale, simply cannot afford any more debt.

“Interest rates are better in punitive terms, for choking off inflation. They’re less effective at producing inflation from thin air,” he said.

There is a further problem. If, by some fluke or miracle, Gordon Brown actually manages to borrow Britain out of a deep and prolonged recession, and the economy starts to recover, what’s going to happen to the pound with such unsustainably low rates of interest?

David B. Smith from the Institute for Economic Affairs, said: “The danger is now we are getting into over-steering territory. Extreme interest movements risk destabilising the economy.” He’d probably know a thing or two.

Concerted and co-ordinated rate cuts are a deliberately decisive attempt to stimulate economic growth by making bank lending and inter-bank lending enticingly cheap. What is the best case scenario, should this manage to magic up confidence?

The liquidity returns to an over leveraged market – a market now with increased levels of liability from these goliath lenders of last resort. This would, in turn, eventually lead to banks ceasing lending once again as currency spirals, unencumbered by interest rates. It wouldn’t be pretty.

With such a slashing of rates, the Fed has also driven itself to the end of the road. There is nowhere left for US rates to go, no space in which to react to the effects of monetary movements, such as, I don’t know, interest rate cuts.

So will Mr. Bernanke’s all-on-red gamble work? Probably, and hopefully, not.

Is the Bank of England punishing the prudent?

Voltaire (1694 -1779) was a mere glint in his Father's eye when the Bank of England set base rates at 2 percent

The Bank of England has never had a lower base rate of interest. Not once, in over 300 years, has the Bank offered money more cheaply.

For an institution that predates the birth of Voltaire, the Bank’s decision to shave another 1 percent off base rates is historic. The last time interest rates were this low, Winston Churchill was still prime minister.

What does this mean for you? That depends on who you are.

If you have a tracker mortgage (that moves with the BoE’s base rate), then you’ll have more money in your paycheck at the end of the month. You’ll get additional breathing space to go with that being prepared by the government should things turn out poorly.

(That said, many tracker mortgage providers have ‘floors’ that are activated if the base rate falls through it. Which it has. For example, Nationwide’s tracker floor is at 2.75%, so many customers wont see too much of a pass on.)

If you want a new mortgage, it might take a little longer for banks to start offering money at previous levels. But a little creepiness from Mandy should sort that.

If, however, you’re one of those increasingly rare breed – known as ‘savers’ – this rate cut is most unwelcome. People who have worked hard and put money aside for this torrentially rainy day will have found their income cut by more than half over the past month.

There are questions that need answering. How does the government hope to wean us off debt culture when the central bank is ramming virtually free money into our hands? Why should people who took out mortgages they knew were too expensive profit when prudent savers are set to lose out?

The City has welcomed the Bank’s decision. The government will now position itself as the party of financial fairness by pushing banks to keep lending. And we will probably now spend slightly more over Christmas than we had planned.

Was it Voltaire who said,

Everything’s fine today, that is our illusion?

Interest rate decision – how low will they go?

The Bank of England is today charged with the arduous task of staving off a deep and prolonged recession by cutting interest rates.

With the slump in oil, food and house prices threatening a damaging spiral of deflation, the Bank, it is agreed, must act quickly and act decisively.

So how low will interest rates go?

Larry Elliott isn’t sitting on the fence or anything, but he reckons the cut will be between 1 and 1.5 percent.

The Time’s Gary Duncan says that two thirds of City analysts are betting on a 1 per cent cut. And if there’s one thing that City analysts know how to do, it’s bet.

$1.48 to the pound is not yet a crisis, according to the Telegraph. Another halving of interest rates should precipitate that.

While we’re on the pound, the Independent’s Jeremy Warner argues that it has been too high recently. Interest rate cuts should go some way to addressing the balance.

The FT reports that bumper rate cuts have already begun in Sweden. They’ve only gone and cut 175 points, making even the most radical City analyst look a little soft.

Bloomberg have solved it. It’s definitely going to be 1 percent. You heard it there first…

But the markets are not so sure, according to City AM.

Short of cash? Have some more cheap debt

Do the banks have any moral obligation to hand on the Bank of England’s base rate cut?

The Nationwide, HBOS, the RBS/NatWest group and our own Northern Rock have announced that they will pass on the full cut of 1.5% to its lenders in December. It seems Darling’s enticements of “coffee and bacon rolls” sufficiently appeased/threatened bank chairmen to help out borrowers and small business owners.

Admittedly, this will help many homeowners struggling to meet their mortgage repayments. It will also help businessmen borrow at more competitive rates. But a cut in the Bank of England’s base rate wont help the banks themselves.

Because banks don’t tend to borrow from the Bank of England, they borrow from other banks. The Libor, although on the way down, is still far higher than 3%. Any liquidity that the Treasury had hoped the Bank of England’s violent rate slashing would produce will not materialise until the rate of lending between banks dips further.

Governmental and retail pressure has seen banks capitulate in their refusal to alter rates offered to customers. Such political posturing epitomises the mess that part nationalisation has produced for all concerned parties. As preference shareholders in the big commercial banks, the Government (and, by extension, us) should like them to make a quick profit and pay us back. But they won’t make a quick profit by lending at unrealistically low rates.

Furthermore, if the easy availability of debt and mortgages the public couldn’t afford were what got us into this pickle, does anyone really expect more cheap lending to help? People on the high street – the same people who will struggle to make their repayments, who may have to close their businesses – need get used to spending and borrowing less.

The banks are trying to save themselves. But in doing so, they just might be teaching us all a valuable fiscal lesson.

Watching with interest

The Bank of England has slashed interest rates by 1.5%, the largest cut since 1981. The new rate of three percent is the lowest since Elvis Presley sang “Heartbreak Hotel”. This is unprecedented territory.

It is the kind of radical action financial experts and small business managers were calling for, but it will amount to little if banks don’t pass on the saving to their customers. Stock markets are clearly unconvinced.

“I think it’s essential that the banks do pass on the benefit of lower interest rates to people and to businesses,” said Alistair Darling, before admitting there was absolutely nothing he could do to make them.

It appears the Bank can’t win. Were it to err on the side of caution (as it has recently,) critics would be quick to point out the measure’s insufficiency. It may now have done too much, too late.

People will panic. If such drastic action cannot persuade lenders to start borrowing at sustainable rates, then what can? Banks’ reluctance shows that they see the profound gravity of the UK’s economy. And the shopper on the street soon will too.

Christmas may well plaster over the gaps in people’s bank accounts. Credit cards will be festively maxed, money woes will be put off until for a less jolly month, and  January will bite. People will then realise just how much trouble we’ve got ourselves in. By then it might be too late.