May 12th, 2018
The Monetary Policy Committee voted to keep rates on hold this week. Given the latest data on GDP growth in the first quarter and the slowdown in inflation, the decision came as no surprise in the end.
Even so, markets reacted with a further fall in Sterling against the Dollar and the Euro.
So what can we make of monetary policy when real short rates are negative, ten year gilts offer a negative real return, with a bonus offer of significant capital loss to redemption?
Some comfort may be drawn from the Hitchhiker's Guide to the Galaxy. There is a theory therein, which states that if ever anyone discovers exactly what the Universe is for and why it is here, it will instantly disappear and be replaced by something even more bizarre and inexplicable.
I am beginning to feel the same way about monetary policy. If everyone discovers what current monetary policy is for and why it is in place, it will instantly disappear and be replaced by something else.
There is a further theory within the Hitchhiker's Guide - the Universe has already been replaced by something even more bizarre and inexplicable. This is probably more evident in monetary policy. Conventional monetary policy has already been replaced by something more bizarre and inexplicable. Alas poor Taylor rule, we knew him well.
What is this process of rate normalization, taking place as the economy recovers, that can be blown so easily off course by a bit of snow on the line and ice on construction sites in March?
The ONS suggest the Q1 GDP figures were weakened by the harsh weather and snow impacting on the construction sector. The phenomenon will not be reflected in the shape of recovery for the rest of the year as the Governor explains.
The Bank now expects growth of 1.4% (1.8%) this year, then modeled at 1.7% for the next three years. Inflation averaging 2.4% this year will return to target within two years. Interest rates are modeled (based on the path inferred by forward market rates) at 0.9% next year and 1.2% by 2021.
Forward guidance from the Governor may be dead. Some guidance is offered within "Hitchhikers' ... "the chances of finding out what’s really going on in the universe are so remote, the only thing to do is hang the sense of it and keep yourself occupied". So it is with monetary policy, the chances of finding out what's really going on are so remote, hang the sense of it and keep yourself occupied.
Mark Carney has one year left in the role. He is unlikely to take risks with the recovery during his tenure. The Bank is nervous, to say the least, about the impact of Brexit and any decision to leave the customs union. Further caution may prevail before the Governor makes his next career move.
In the meantime Hitchhiker's offers some insight into Quantitative Easing ...
“Since we decided a few weeks ago to adopt the leaf as legal tender, we have, of course, all become immensely rich.” Excellent ...
Beyond the Customs Union ...
Thanks for the feedback on the Customs Union piece last week. Economics should not be too complicated especially when it relates to matters of trade. My gravity trade model was further enhanced this week. Attraction based on size of country GDP was exchanged for size of country based on the level of imports. It is an obvious substitution.
Import dependencies vary from country to country. (Defined as the ratio of imports to GDP). The UK for example has an import dependency of 24%, China 15% and the USA 12%. The correlation between UK exports and size of country imports improves to 85% from 77% using GDP as the demand variable.
Size of country imports determines the pattern of UK trade. Distance also assists the process. Free to trade with countries around the world outside of the customs union will not improve the level of exports. As we explained last week. There are no new territories with which to trade. There are no real gains to be made from opportunities thought to be lost inside the customs union.
Theresa May continues to play the long game. The divisions within cabinet persist. The Prime Minister has set up two working groups to develop the options for the Customs Union deal. One team will work on the "Customs Partnership" deal, the other team will work on the "Max-Fac" proposal. The brief to "work towards a joint solution". Some chance. Robot wars would have a better chance of resolving the conflict peacefully.
Cabinet is like a troupe of late night drinkers, creating a cocktail with ingredients which do not exist, unavailable at the eleventh hour, with a barman who could never put it together, in a Brussels pub which has already called time.
Germany's EU commissioner Günther Oettinger, played down the chances of progress. "Madame May is weak. Boris Johnson has the same hairdo as Trump" he explained. Details of his own interpretation of the gravity trade model were omitted. "We can only hope that sensible citizens will put Madame May on the path to a clever Brexit".
Clever Brexit? It is a contradiction in terms. We return to The Hitchhiker's Guide to the Galaxy for the last word ... "It is a well known fact that those people who most want to rule people are those least suited to do it."
It must also be true those who would seek to determine the future pattern of UK international trade, in defiance of market forces, are particularly least suited to do it ... "ça va sans dire" ...
That's all for this week, Have a great week-end,
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