Dissecting June 23 Bank Of England Monetary Policy Committee Minutes

 The Bank Of England is hell bent on raising interest rates in a vague hope of controlling inflation.

The UK doesn't grow enough food to feed the population so we import 46% of the food we consume. Countries like France and Germany, where a large percentage of our food originates from, have high inflation so the UK is importing inflation - if we don't import it we will either starve or the scarcity of food will cause even more rampant food inflation.  It's far from clear how higher interest rates in the UK will curb France and Germany's inflation.

I personally have a deep concern we are about to enter a period of stagflation.  Stagflation is where there is high inflation, high or rising unemployment an low or negative growth (ie a recession).

Why am I concerned? 

April 2023 UK economic growth was 0.2% whilst growth in May 2023 fell to 0.1%.  We are getting very close to zero or negative growth.  If this is repeated for 2 quarters then we are in recession.

May 2023 inflation was recorded at 8.7%.  This was measured using the consumer price index (CPI) measure of inflation.  The Retail Price Index includes real-world costs such as mortgage interest payments,  rent etc.  Expect RPI inflation to rise rapidly as the BoE rate increases filter through.  In other words raising interest rates is also inflationary. 

UK wages have soared by 7.3% in the period Mar - May 2023.  In other words business costs have increased by 7.3% but economic output fell by 0.1%.

Unemployment rose to 4% in the three months to May 2023 increasing from 3.8% in the previous quarter.  In other words there were redundancies or people left paid employment.

So inflation is still high, unemployment is rising, domestic output is falling.  In the meantime the Bank of England is increasing costs for businesses and most of the population (and indeed government) by increasing borrowing costs.

Now if inflation is 8.7% per year and the economy was growing 8.7% then in reality it is standing still.  The UK growth is currently  0.1% x 12 = 1.2%.  In other words with inflation at 8.7% the economy is contracting.  If you use the Real Economic Growth Rate it strips out the effect of inflation.  The UK actually only grew 0.4% in 2022 whilst the Bank of England and government  preferred to use  the more politically acceptable ONS value of 4.1% growth. Now inflation in 2022  was 11.1% but the economy only grew 0.4% in real like-for-like terms.

The reality is we are pretty much in a recession in 2023.

There are no easy solutions to stagflation. Monetary policy can either try to reduce inflation (higher interest rates) or increase economic growth (cut interest rates).  Using only the lever of interest rates it is impossible to reduce inflation and stimulate growth to get out of the recession.  It is clear the Bank of England does not care if we enter a period of deep recession. 

So lets start the dissection the BoE minutes of the Monetary Policy committee published on the 22nd June 2023.

Firstly the committee decided to raise interest rates from 4.5% to 5.0%.  A jump of 0.5%. Previous increases were 0.25% so this is a clear signal that they want to get ahead of the curve and send a warning signal to all those nasty people that are causing this inflation.

The next statement of note is "gilt yields have risen since May suggesting a rate increase of 5.5% in future".  So what is this gilt yields?  This is the money  investors received  from holding government debt - think of it as the interest rate. The BoE have used the term gilts rather than bonds. Bonds are typically issued by companies and gilts refers to government debt.  

So in other words investors think the UK economy is in poor shape, the government is a bad risk  and therefore investors expect a higher interest rate because they are a bad risk.  Well it's not quite as simple as that. Many bonds or gilts have fixed commercial terms eg pay 2% per annum for a 25 year period.....Unfortunately 25% of British public debt (ie government debt) is inflation linked compared to most other countries where it is 10% of debt. In other words the cost of government borrowing (which has now reached 100% of GDP) has increased because of inflation being high. I can see why the BoE of wants to control inflation - their government masters are not happy that it's costing more to use the government credit card.

So the good old Bank of England thinks the man on the street and the businesses which create employment should suffer higher bank interest rates because the government has borrowed too much money and the government's credit card bill has got too big and our amazingly well run and clever government is  struggling to make the monthly minimum credit card payment. 

Shouldnt the emphasis of the BoE be to tell the government to cut costs and stop borrowing all this money?  Whatever happened to austerity? 

Just to put this into perspective.  Gilt rates (2 year gilts) rose from 3.19% to 4.96% in September 2022 in response to the "catastrophic" Liz Truss mini budget. In truth the gilt rise back then was more due to dodgy LDI derivatives poisoning  pension funds holdings than a response to the budget.  Unfortunately long periods of low interest rates creates bubbles and anomalies eg collapse of Silicon Valley bank.  I don't think the Bank of England wants to burst the UK governments debt bubble....Mr Bailey definitely wont get his knighthood if he did.

So what's the current 2 year gilt rate?  July 2023 it's around 5.2% so actually far worse than the Sept 22 mini budget.  Personally I think that says far more about the media bias as the current high gilt rate hasn't made news.

The next point in the MPC minutes is "the greater share of fixed-rate mortgages means that the full impact of the increase in Bank Rate to date will not be felt for some time".  That is true.  96% of  mortgages since 2019 were 3 year fixed rate.  In other words borrowers expected the long term trend to be interest rates increasing.  That also means it will take until 2026 until all these deals expire. 

Human behaviour can easily change. We don't need to be physically published to change behaviour - the mere threat of being punished with higher interest rates will be enough for people to change their behaviour. Clearly this is not something the BoE understands. Strange given economics is a social science effectively about human behaviour. 

The MPC justified the rate increase to 5% because "LFS employment increased by 0.8% in the three months to April".   This is a cryptic  reference to the Labour Force Survey. 

Here's the LFS Report Apil 2023

I challenge you to find any reference to 0.8% employment increase in there....

Now the LFS survey is not the whole population.  It's a sample of  57,876 people.  The ONS has unemployment data for the whole population. Indeed unemployment rose by 0.2% during the period but for some reason the MPC decided to use the more positive  LFS survey and ignore the other ONS data.  Maybe the ONS data didn't tell the story for their narrative for the actions the MPC wanted to take and hence was dismissed.

Personally I don't have a problem with unemployment falling (even though it didn't).  If your mortgage or rent has increased because the BoE increased interest rates and you don't want your home to be repossessed, what are you going to do?  Get a second job maybe? 

The next statement is "Average Weekly Earnings (AWE) increased to 7.6% in the three months to April, 0.5 percentage points above the expectation at the time of the May Report".  The MPC has interpreted this as pay rises or wage inflation. This might be true.  Since this is an average it also might be true that that the 0.2% of the working population that became unemployed in this period was also the lowest paid and that shifts the average up. It is also worth pointing out that the sample period is Feb, March and April and this decision was to increase interest rates was the 22nd June - nearly 2 months later.  Indeed the MPC raised interest rates on the 11th May 2023 which is closer to this data point.   The data is stale a clearly reacting to something which happened two months ago.

Assuming this is wage inflation, it's not good news. 

Anyway let's look at the ONS AWE data in more detail

It also happens to say "Growth in total and regular pay fell in real terms (adjusted for inflation) on the year in February to April 2023, by 2.0% for total pay and 1.3% for regular pay".

In other words, pay increases are not keeping up with inflation. What's this "total pay" and "regular pay"?  Well total pay includes things like bonuses.  In other words the bonuses being paid are smaller than 1 year ago.

It should also be pointed out that the National Minimum Wage increased on the 1st April 2023 from £9.18 to £10.18 and this increase will be reflected in these numbers and in fact will be worse for the period May-July.  This is an increase of 10.9%.  Now the minimum wage is set by government so in part they are responsible for some of this increase.  I accept that the lowest paid are probably most exposed to inflation and need this increase however I don't accept that salary averages are a good measure on which the MPC should make decisions.....

The ONS AWE data also neglects to mention that Public Sector pay also increased.  Admittedly by a more modest 5.6% however it should also be pointed out that a large percentage of public sector employees have defined benefit or final salary pensions.  These increase in line with inflation so this disguises the real increase they get. It also ignores that Public Sector employee contributions are woefully inadequate to cover the trust cost of the final salary pensions - in other words the taxpayer picks up the shortfall. There is not some magic pot to pay these generous pensions - it's paid for out of current taxation.  Companies have to declare pension liabilities.  Government don't. 

The cost of pensions for millions of public sector workers including civil servants, doctors and teachers rose by £116.7bn in the 2020-21 financial year. This takes the total to £2.3 trillion, but at the time UK GDP was just £2.1 trillion.  In other words the pension liability is bigger than the UK economy.

The Hutton report back in 2011 said that Public Sector pensions were affordable. I think not.....

To put this  annual increase (not total) of £116 Billion for cost or liability of public sector pensions into perspective, the whole cost of the NHS is £180 Billion.  The increase in pension costs just 1 year is nearly the cost of the NHS......

Back to the MPC minutes. It states "Services CPI inflation rose to 7.4% in May" compared to overall CPI was 8.7%.  Now the ONS AWE mentions that pay growth in services sector was 9.2%.  Of course the Bank of England did not mention this. In other words the services sector is not increasing it's prices as fast as it's salary costs are increasing and hence it's margins will be reduced which means lower or even no company taxes. Not sustainable.

It is far from clear that increasing interest rates was the right thing to do.  It is however clear the government is not reigning in spending - far from it is increasing spending. It is not solely up to the Bank of England to try and control inflation (or stagflation) - the government needs to get tough.  There needs to be some tough conversations about final salary pensions. Firstly doctors, nurses etc need to know the true cost and value of their employment package. They might elect to take a higher salary now in order to surrender the benefit.  New starters should be paid more and not be on final salary pensions - close entrance to the schemes.  Austerity 2.0 is needed.

Do they think we are stupid?