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Bad Timing at the Bank of England

Today the Bank of England reduced interest rates by 1.5%. I have no problem with that – I said to friends a month ago that October’s 0.5% cut should have been 2%, and I know I wasn’t the only finance professional saying that.

No, my problem is with the timing. Or rather, the slowness of it. Why didn’t they cut rates by 2% when it was clear there was going to be a recession, and quite a long one at that?

They were scared of causing a run on the Pound, that’s why. So they dropped rates by a little bit in a coordinated move with other National Banks around the world. Because the move was coordinated, the effect on the currency should have been very limited, but it wasn’t.

Trouble is, the FX markets saw the same data and they aren’t stupid. They could see that UK interest rates were too high and needed to come down, so the pound crashed in value just as if a 2% cut had been made there and then. The pound fell about 11% against the Swiss Franc even though the interest rate cuts were the same for both countries.

But, isn’t the sole job of the Bank to keep a lid on inflation? Yes, that’s what the rules say. But they haven’t exactly acted with any intelligence there either. They are supposed to keep inflation below 2% but it was over 5%. But let’s face it, the too high house price inflation that had been pushing money into the economy for too many years. Only the LibDems had suggested doing anything about this expanding bubble. The Bank and the Government ignored it.

I’m a bit of a fan of Vince Cable, the LibDem Treasury spokesman. He’d make a great Chancellor of the Exchequer. He suggests including a measure of house price inflation in the measure of inflation the Bank uses to set interest rates. That’s very logical, since the excess money that comes onto the market when people borrow against their houses to spend on consumer goods adds to inflationary pressures. It really should be measured so inflation can be attacked as early as possible.

More recently, the speculative rise in oil prices was practically the sole cause of the sudden inflation spike. It created extra costs throughout the world economy, but really wasn’t sustainable. Like an early stage virus that doesn’t itself survive because it kills its hosts, the oil price had to become more reasonable to survive at all. If it killed the economy, nobody would be buying oil and the dealers couldn’t have that.

Unfortunately, the way democracies work, the press control the politicians most of the time. Or rather, the politicians self-regulate through their fear of what the press might say about them. So are the seeds of disaster sown. Too much attention to the wrong sort of detail.

That isn’t the preserve of politicians though, the stockmarkets seem able to look at life through the narrowest of microscopes. No depth, no width, just a short sighted look at “now”. OK, they are supposed to project what is happening now about 6 months into the future, and they use the most precise of mathematical formulae to do this. Everything is computer modelled these days. They’ve forgotten how to think though.

When the interest rate cut arrived, they panicked. Markets fell around the world. Yet the FX markets did not, because the right decision had been made about the interest rate cuts. OK, the election of a Democrat in the US in the form of Barack Obama may have frightened them a bit, but it shouldn’t have done because stock markets have done better under Democrat Administrations than under Republican ones. Average market growth under Democrats has been 15.3% a year, 9.5% a year under the Republicans.

Of course, the losses made by the banks and others on sub-Prime investments the Credit Rating agencies were scared to downgrade has meant they feel rather like headless chickens right now. Without their “old” computer modelling and Credit Ratings, they oversell rather too easily. It’s a buyers market, but you have to have strong nerves and some spare cash to get into it. It’ll bounce back. Once traders learn about fundamentals again and stop making silly projections based on old data that is no longer relevant, anyway.

What all this tells me is that the leadership at the Bank of England is not really on the ball, they’re proving themselves to be weak ditherers unable to act soon enough to pre-empt negative economic effects. All they need is a little common sense, but as the Monetary Policy Committee which is the body that decides on rates is stuffed full of economists I suppose it is amazing they even reacted at all. It has been said that if you laid all the economists end to end around the world they still wouldn’t reach a conclusion. 😆 

What I also glean from this is that the stockmarkets, for all their technology and money have forgotten how to go with their gut instincts, and are just selling in knee jerks when something sub-optimal comes along, even if it was projected months ago. 

So, yes, a good decision to cut UK interest rates by so much, but still there is too much fear around. Fear by politicians, fear by market traders, fear by regulators.

Anyone would think change is a bad thing!

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