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The Politicalization of the Bank of England

Thursday, June 15th, 2017

QE and ZIRP have political consequences…

One week on from the General Election and the Bank of England meets to decide on interest rates.

The UK’s central bank, like the ECB, the Fed and the BofJ, are all independent of government control.  But that does not mean they are not political. Their  Quantitative Easing and (around) Zero Interest Rate Policy (ZIRP) have big political implications. 

Let me describe just two.  Firstly, QE means profligate politicians can spend spend spend with no consequences – voters can be bribed with spending.  And secondly that young voters in the UK may have voted for Corbyn because QE has made housing so unaffordable (renting or buying).

Lets look at the first implication.

Thanks to QE, the Bond Vigilante is dead.  These are the investors who protest at irresponsible monetary or fiscal policies considered inflationary or damaging to the credit worthiness of a country.   They would normally react by selling bonds (government debt) thereby driving up government borrowing costs (yields / interest rates). That normally brings politicians back to fiscal prudence.  If the electorates can’t or won’t do it, the bond markets will.   A government can only go on spending more than taxation raised, if they can find investors willing to lend them the difference… 

But thanks to QE this is not happening.  Central banks are ensuring that profligacy or fiscal irresponsibility is never held to account. The ultimate example of this is Japan which is technically bust with a government debt to GDP ratio of 250% (Greece is at 180%) yet can borrow for 10 years at an interest rate of 0.1% a year. 

The BofE currently owns £435bn worth of gilts and is still buying. By doing so it has ensured that bond investors did not take fright at Labour’s spending plans before the election.  Gilt yields barely moved on the result and the UK government can still borrow for 10 years at 1% interest rate a year. 

And yet the UK has very high levels of borrowing.  The UK debt to GDP ratio is at 90% – that is double the level from 1980 to 2008 when 45% was about the average.  It is also way above the EU’s Stability and Growth pact of 60% debt to GDP. 

The interest payments on this huge debt amount to around £1bn a week, thanks to the BofE’s QE and ZIRP.  (OBR estimates that  “Interest payments on the national debt are expected to cost £49.1 billion in 2016-17.”)

The following chart is the 10 year gilt yield going back to 1981, essentially the borrowing cost or interest rate for the UK government to borrow for 10 years on the bond markets. During the early 1980s, at one point it cost the UK government 15% interest rate a year to borrow.  That was due to high inflation rates but also the irresponsible spending of the governments of the 1970s that indebted the country and lead to the IMF loan in 1976.  

Then as inflation fell globally during the 1990s, borrowing costs fell further. And since 2008/9, QE and an almost Zero Interest rate policy (ZIRP) has caused government 10 yr borrowing costs to fall further from 5% interest rate a year to the current 1% now.

  
10yr gilt yield

But this chart is a notable reminder that if Corbyn’s policies were taking us back to the spending and inflationary times of the 1970s the bond markets are not pricing it in, despite him doing so well in the election last week.

It is not costing the UK government 15% a year to borrow.  And by the way if it did the interest bill a year would be unaffordable…   If it costs £49bn a year in total interest charges when the government can borrow at 1% a year, imagine what the interest rate bill would be at a 15% interest rate……..

QE is stopping markets pricing in the risk from profligate politicians. And that means that QE is also stopping the same politicians from being profligate in the first place.  Politicians can bribe voters with spending thanks to QE and ZIRP.  That benefits the policies of Labour.

Lets look at the second point – that QE may have lead the young to vote for Corbyn because housing has become so unaffordable (either renting or buying) due to QE.

The chart below shows the Bank of England’s base rates going back to the 1970s. 

uk base rates

It serves as a reminder of how extraordinary the current interest rates are.  Both being extraordinarily low, but also staying low for so long. 

And these record low interest rates are also heavily distorting asset prices  and how people behave and that has political consequences.

Let’s take the case of a relative of mine, retired with savings.  Now if interest rates had been more normal, say at the 5-6% of the 1990s, he would have left his savings in a bank. But he earns next to nothing on his savings and has done so for almost a decade now.  He doesn’t understand the stock market and doesn’t trust it and so has put his savings into property.  He has bought three buy to let houses.

And those are three houses that the younger generation could have bought for family homes.  Instead of which they are now renting from him and paying his mortgages.

And this is a direct result of QE.  QE distorts asset prices.  It drives investors out of bank savings and bonds into other higher yielding assets – shares and property for example.

There is a direct link from QE to higher stock markets and higher property prices.  And that means QE is political. 

I presented Money Box Live yesterday as usual, and had the Vice Chair of the NUS on.  She had been organising the campaign to get students to vote which has appeared to be so successful.  She said that it was not just the free tuition fees that had prompted so many to vote Labour, but also that housing was a huge issue. 

Unsurprisingly as the statistics are truly horrible. According to research from Savills 46% of 25 year olds owned their own homes 20 years ago, now it is only 20%
(http://www.itv.com/news/2016-12-22/home-ownership-among-young-adults-drops-dramatically-since-1996/ )
 
Sky News estimated that 66% of young adults voted whereas typically it has been much lower – around 40%.  And according to Lord Ashcroft’s polling data, 67% of those between the ages 18 and 24 voted for Labour.

So QE by driving house prices higher, may well have contributed to the huge young adult turn out for Labour.  The BofE’s actions are political.

I also find it odd when Mark Carney warns of the risk to the economy of over indebted consumers.  Its the BofE’s actions that cause consumers to take on debt.  Not just because interest rates are so low, so why bother saving.  But also the BofE has the various Funding for Lending schemes, encouraging banks to lend.  If the BofE’s actions are leading to over indebted consumers which are a risk to the economy, then raise interest rates to encourage savings or get rid of the schemes that encourage banks to lend in the first place…..

If its any consolation, its not just the BofE that is political.  As my cycling partner Ioan Smith founder of Semaphore Macro points out, the ECB’s demand for governments’ to reform their economics as a condition for buying their debt has compromised its independence.  However it is also difficult for the ECB to force any European country to reform with borrowing costs at these extremely low levels.   Monetary Policy is being used for fiscal policy – to allow governments’ to rack up huge debts without the normal consequence of rising interest rates. 

I am cycling the 54miles from London to Brighton this Sunday and getting up at 5am to do so (no lie in for me).  I am raising money for the British Heart Foundation is anyone cares to sponsor me..

click here to sponsor me…

 
 

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