Dissecting Aug 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 and today's meeting resulted in the rather predictable outcome of raising interest rates from 5% to 5.25%

This is the 14th increase in a row

Here's my analysis of the June 23 BoE MPC increase

Clearly this is causing  misery  to home owners, businesses and landlords.  However is this the right thing to do or is the BoE stupidity?

Let's dissect the minutes.

Firstly it states they have a plan - that plan is for the BoE interest rate to peak at 6% - so expect interest rate increases in October, December and February until we hit the magic 6% number.  They also state the average rate for 3 years (ie until 2026) will be 5.5% therefore another rate increase in October looks a safe bet. It looks like the era of low interest rates is definitely at an end.

It does beg the question when we had ultra low interest rates for 12 years and low inflation, whether there is a real correlation between interest rates and inflation?

Now lets look back at June 23 and their argument for increasing the rates from 4.5% to 5% was that "gilt yields have risen since May suggesting a rate increase of 5.5% in future"

Now gilt yields are government debt.  Unfortunately 25% of British public debt (ie government debt) is inflation linked so also unfortunately the cost of government borrowing has reached 100% of GDP. Even worse news is this debt is linked to the RPI inflation measure.  Each time the BoE increases interest rates it also has an increase effect on RPI.   Servicing this debt is now 10% of tax revenues. Surely this government should be doing something to control it's debt....

Now the August 23 MPC minutes does not make any mention at all of gilt yields.  Given this was a big issue 2 months ago yet nothing is mentioned in August.  How come?  BTW guilt yields are higher now than under the supposed disastrous  Kwasi Kwarteng mini budget - yield increases at the time were cited as "he crashed the economy" and peaked at 4.7%. So back in June 23 at the time of the last BoE MPC,  year guilt yields were averaging 4.6%.  Today they are 4.95% and have been as high as 5.5%.  

If high gilt yields is crashing the economy and it's not Rishi Sunak or Jeremy Hunt crashing the economy then who is crashing the economy?  The BoE?

Why was it such a big issue back in June ? It's got worse since then (or better depending upon your perspective) yet it's simply not mentioned. Strange?

So the next things the minutes mention is "The sterling effective exchange rate is around 4% higher than in the May Report".  It doesnt say whether this is a good or bad thing.  Personally I take a higher number as a good thing - it means imports are cheaper and therefore compensates for inflation on imported food. 

So let's look back over the last 10 years - the BoE must have thought the economy was in good shape 10 years ago as it didnt do much. Between 2014 and 2016 the effective exchange rate was around on average 87 and for June 23 it's 87.  OK that must be good news - in which case why raise interest rates?  

Next statement "Underlying quarterly GDP growth has been around 0.2% during the first half of this year".  Hmm . Not true.  The ONS number for Jan-Mar 23 was 0.1%.  April was 0.2% however growth in May 2023 fell to 0.1% which was a key input into the June 23 MPC decision. At best the average has been 0.1% 

The minutes go on to say "Bank staff expect a similar growth rate in the near term, reflecting more resilient household income and retail sales volumes, and most business surveys over recent months". 

Really?  The ONS numbers show growth is pretty weak. Again ONS data "Sales volumes rose by 0.8% in the three months to April 2023 when compared with the previous three months".  If you look at the data it shows that spending on fuel increased by 0.2% (not a surprise) and spending on food fell by 0.2% (ie people are looking for cheaper food or buying in bulk to reduce costs).   I wouldnt say the general public is busy spending like we are in a boom and the numbers certainly dont reflect this.

Next they say "The LFS unemployment rate rose to 4.0% in the three months to May".

Hmmm.  The BoE does like the LFS report (Labour Force Survey).  It's a report based on a sample of 57,876 people.  So let's look back to June 23 minutes and they cite the "trusty" LFS survey "LFS employment increased by 0.8% in the three months to April".  Yet here they are stating "The LFS unemployment rate rose to 4.0% in the three months to May".  So 1 month has made the difference from employment rising by 0.8% to falling by 4%. That looks pretty bad to me.  Averages are dangerous things...Clearly unemployment doesnt bother the BoE since an increase of 4% unemployment would be a reason to at least pause interest rate increases but they went ahead anyway.

Now I'm not keen on using the LFS survey as it's a pretty small sample of people.  Why not use the ONS data which measures the whole population? 

So what does the ONS have to say in the July 23 report ?

"Unemployment rate for March to May 2023 increased by 0.2 percentage points on the quarter to 4.0%.".  So at the last BoE MPC meeting the ONS data showed unemployment rising but they thought it was falling - ie pent up demand in the economy.  They are making pretty big decisions which hurt people on incorrect data. Why?

Why does the BoE NOT like the ONS employment data? 

Next they say "private sector regular pay growth increased to 7.7% in the three months to May".   OK this was pretty much baked into the June 23 MPC minutes - this isnt new information - they have already made a decision on this data.  Why the increase in August? 

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.

OK some good news in the BoE Minutes "CPI inflation fell from 8.7% in May to 7.9% in June" 

Hooray. Inflation is falling.

More good news "Within this, core goods and services CPI inflation were both lower than expected".

However let's just go back to the June 23 MPC minutes: "Services CPI inflation rose to 7.4% in May" compared to overall CPI was 8.7%.

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.

The care sector falls under the services sector and are large chunk of service sector employment.  Most carers are on minimum wage so wages will have increased in line with the National Minimum Wage so it's inevitable that service sector prices will have to rise.

Next the minutes waffle on about "modal inflation".  I tried googling it - all roads point back to the BoE.  I'm none the wiser what it is.  Come on guys - if you going to make things up to justify your decision, at least explain it and not bamboozle us. 

So in summary.  The minutes waffles on about stuff which they cite which is usually out-of-date and then ignore or dismiss and make the decision.

The decision should be a traceable process.  If raising interest rates (which is inflationary and will be reflected in RPI inflation stats) really is a measure to control inflation then at least be scientific about it.  

First rule I learnt at university.  Change one variable at a time and observe the effect on change.  The only variable they have is interest rates.  There is inherent system lag in the economy so changing this variable will take months or maybe years to filter through.  I am unclear whether some of the things they look at are actually metrics which are directly affected by interest rates.  Why not publish your model?  We can use this to make scientific educated judgements whether the BoE decisions are correct or just clutching at straws.

So one final word on the rate increase of 0.25%. Since the BoE pays interest to banks for holding reserves and the amount held in reserve is at least £325Bn, this 0.25% increase means private banks receive an additional £812Million per year in interest payments from the tax payer.  That's on top of the £16bn per year the tax payer gives the banks in interest.

Maybe the BoE should follow the EU central bank and stop paying interest on bank reserves? It would save the tax payer nearly £17Bn per year.

Else it must be  time for a windfall tax on bank profits.....Not something which I think should happen but public resentment is building against the establishment. 

One final word on inflation.  The BoE is looking at CPI inflation. The RPI inflation measure from the ONS includes mortgage costs. Given the BoE is trying to cause pain to people with mortgages it's no surprise they ignore RPI.

RPI is therefore increasing in-line with the BoE increases.  Good news for pensioners as the triple lock is based on RPI.  Bad news for tax payers as we will have to pay for the 10%+ pay rise increase in the state pension. Thankfully civil services pensions are linked to CPI not RPI.

Council Tax is linked to RPI so that unfortunately may increase by 10% putting yet more pressure on hard up home owners and tenants.

Now monetary policy (increasing interest rates) is not the only game in town to control inflation.  The government has a role with fiscal policy.  It could have decided not to increase the minimum wage by 10.9%.  It could decide not to increase the state pension by 10+%.  It could decide not to increase civil servant pensions by 10+%.  It could cut government expenditure eg cancel HS2 where costs are out of control.  The government decided to increase council home rents by 7% from April 23 - this doesn't affect CPI but does affect RPI yet Michael Gove wants rent controls for private renters (sounds like a Labour policy) so they can't increase by this level !!

Anyway the government is doing almost nothing to control fiscal policy in the fight against inflation.

The Conservatives are clearly incompetent (or paralysed) however I have even less faith in Labour - they will definitely open the fiscal money taps not close them.  We really need Austerity 2.0 to get the UK out of this stagflation period - persistent high inflation, very low growth....

So it looks like we are probably in for a protracted period of stagflation.  Don't expect a soft landing from all these interest rate hikes.  It takes time for these to ripple through the system yet the BoE is not waiting long enough for the hikes to have an impact.  I suspect something will break and then we will crash headlong into a long painful recession. The Business Confidence Index for the UK was 105 in January and has steadily fallen to 99.3 in June.  That means business are now pessimistic (less than 100) about the future.  

Its a bit like jumping off a tall skyscraper.  You can be falling for a long time and it doesn't kill you. It's only when you hit the ground  things get ugly.  These persistent rate hikes feel exactly like this.

Do they think we are stupid?