The politicised role of the Bank of England has moved forward another stage and the dream of controlling inflation has been discarded in the cold light of day. We are set for continuing high inflation for the next 12 months.
The bank has, until now, concentrated on steering a steady course, avoiding rocking the boat above everything else. Thus we have had no changes in interest rates and no return to quantitative easing. That has not done anything to curb inflation, although it was the right thing to do politically.
As we have noted before, this policy has in practice meant a shifting away from the original purpose of letting the bank set interest rates, which was to keep the consumer price index within 1% of the 2% target. With inflation persisting above 3%, clearly the bank should have raised interest rates two years ago to comply with its mandate.
In the face of reality, the Bank of England, and in particular its Governor Mervyn King, has persisted in the fiction that inflation is about to start falling any day now. That perverse view has now reached the stage where the bank’s rate-setting monetary policy committee has actually considered lowering its base rate.
Considering that even King has admitted that CPI will top 5% before it starts to fall, and that the index did edge higher last month, it is painfully obvious that inflation remains intact. Yet this week the minutes of the MPC’s September meeting claimed in tortuous language that the risks to inflation have clearly increased to the downside, which in plain English means that the chances of inflation subsiding have improved.
There is even an implication that the rate of inflation could fall so quickly that it will drop below the 1% floor!
This is wishful thinking. It is now four years since the credit crunch started to overwhelm the global economy and despite a severe bout of recession in the U.K. since then, followed by lukewarm growth, we still see no signs of inflation coming under control. Banging on about inflation coming down merely provides a fig leaf to cover the bank’s embarrassment that it has abandoned its major criterion to serve the political expediency of trying to keep the economy going.
Rather than controlling inflation, the bank has taken a clear lurch towards more quantitative easing. First we had the bank’s quarterly report on Monday claiming that quantitative easing had been ‘economically significant’ or in other words it had boosted the economy, helping to end the recession and prevent a double dip.
This is a dubious argument, though it is impossible to prove or disprove it. We simply do not know what effect it had. However, given that almost all the £200 billion went in buying government debt rather than buying company bonds it is easier to argue that the programme was all about keeping the government’s borrowing costs down.
Undaunted, the bank’s chief economist Spencer Dale promptly weighed in with the hint that if the economy continued to deteriorate ‘some additional loosening of monetary policy might be needed’.
While that sounds rather vague and guarded, one should bear in mind that this is how the bank drops hints and the words were those of one of the more hawkish members of the MPC. While Chancellors tried to catch the market off guard when they set interest rates, the Bank of England prefers to give advance indication.
Now we have the minutes of the September MPC meeting suggesting that further stimulus to the economy will be needed. Given that the government is struggling to reduce the public sector deficit and will need to issue ever increasing amounts of gilts to cover the shortfall, it seems likely that any quantitative easing will take the same form as last time, that is mopping up government debt rather than giving the economy a genuine boost.
The effect will be further inflation just when we could do without it and quite possibly a further fall in the value of the pound, which is chronically weak against a euro that is bizarrely maintaining its value despite the troubles in Greece, Ireland, Spain, Portugal and most recently Italy. A weak pound will add to inflation by raising the price of imported goods.
Stock markets have given an unqualified thumbs down to hints of further quantitative easing both here and in the United States. Investors have chosen, not unreasonably, to concentrate on the negative connotations with the implication that things must be pretty bad if the Bank of England and the Fed are forced into further action.
However, I still feel that shares paying dividends are worth hanging onto. If we are to have more inflation then that will ultimately feed through into share price rises. Meanwhile, a wide range of blue chip companies offer yields of 5% plus. That allows for an awful lot of disappointment.
The Money section in the Sunday Times carries a table of changes to the FTSE 100 and the Halifax house price index over the past one, three, five and 10 years. It makes for interesting reading. Whichever timeframe you use, shares come out well when you take dividends into account. Except for the ten year period, which includes two years of the tech boom and bust bear market, shares performed better than house prices and even over ten years dividends kept pace with house prices.
Despite another attack of panic in the markets this week, I am remaining fully invested. At least the dividends will console me if share prices continue to fall and I can afford to hold on for the long term.
