Supplement 23 Jun 24 – Hold me now

Jun 23, 2024

“Bank of England decision “finely balanced” for 3 holds, probably including Governor, which mean it was a close run thing not to cut – August cut very much on” – Faisal Islam, BBC Economics editor, immediately following the rate announcement on Thursday this week.

Before we get started, there’s only 11 days to go to get a ticket for the Property Business Workshop on Thursday 4th July in London. We are nearly sold out!

This time Rod Turner and I are taking on: The fundamentals of property investment. Risk mitigation and control. Relevant investment metrics. Differing secured debt arrangements and loan structures – and – the biggie – Scaling your property portfolio/business – why, when and how?

Thursday 4th July, in a Central London location (Blackfriars). Let’s face it – there’s nothing else on that day apart from collecting on any bets you placed if you also had the inside info! There are tickets still available here:

Welcome to the Supplement, everyone. This week’s quote was well drilled, and was X’ed (is that right, really) out at Midday on the dot on Thursday when the decision hit the headlines. Some more inside info there, maybe.

We will – as always – get right into the Bank’s mindset and makeup in the deep dive, including what has looked obvious to me since well before the election was called. The tin foil hats went away as the idea that the Bank would capitulate to help out “their old mate Rishi” sailed off into the sunset. I called Q3 at the beginning of the year, and multiple times since, for the first rate cut – and I’m not right yet, but I’ve gone odds on.

Before that, of course, the macro – and before that, the state of the union (or at least the property market) – so, onwards!

Regular readers and listeners will know I’m a big fan of Chris Watkin, and his weekly UK Property Market Stats Show. Don’t miss an episode!

From the report on the week ending 16th June – prices on sales agreed remained at £350/ft.

Listings stayed 5% higher than the pre-pandemic market for the year to date.

Net sales were 13.5% better than the same week in 2023 (election, what election?), 4.8% higher than the 17/19 average, and 11.3% above the 2023 year-to-date.

The market will hit new highs when these figures get to completion in Q4 of this year, and many will be left scratching their heads as to “why it happened again” and why they got it so wrong. Can’t wait for the 2025 predictions, and we are only at the solstice!

To the macro feast, then. We had inflation – and all the associated – and you know I won’t resist a deep dive into that. We also had the Consumer Confidence figures and Retail Sales which fit together – the flash PMIs for June, which cannot go without comment – and a week never goes by without me tucking into the gilt and swap yields, as you know.

Wednesday’s inflation figures went, at a high level, just as I predicted – this wasn’t Nostradamus, although  backing the broader consensus to be correct usually makes me remind myself “a stopped clock is right twice a day”.

We need to get stuck in, though. The headline grabber is always CPI, and we hit that 2% target for the first time since July 2021. That felt good, and the less-well-informed thought that might influence the Bank of England, who, in reality, had made their minds up weeks and weeks ago. It didn’t (spoiler alert).

However – you know the detail is where it is at. Off we go:

CPIH – including owner occupiers’ housing costs (you see where this still needs improving!) was 2.8% down from 3%. Still – a much more realistic measure than CPI of the whole cost base for the general public. Month on month it was up 0.4%

CPI was down from 2.3% to 2%, and 0.3% up on the month.

Core CPIH (what gets stripped out here is not only food – which was down on the month – and energy – but also alcohol and tobacco) is still reading above 4% (4.2% to be precise) – down from 4.4%. Goods were down 1.3% but services up 5.9%, which is one of the figures still worrying the Bank (and me!)

Core CPI went from 3.9% to 3.5%, a healthy drop – CPI services were down to 5.7%, so CPIH services are still above those – and that >4% number really isn’t healthy nor is it falling quickly enough.

OOH – the owner-occupier housing inflation index – moved up to its new high in this cycle at 6.7% (the new highest figure in over 40 years). This is what the households are really seeing and that big number is pretty much all made up of the increased cost of housing for owner occupiers, primarily manifesting itself via higher mortgage payments. There’s still a runway for that to move upwards, and that is squeezing what households spend their money on – sure, it ignores tenants but we know that the cost of rent is going up for the same reasons as the cost of being an owner occupier.

We also know that the ratio of tenants with a landlord with a mortgage vs no mortgage is pretty much the same as the ratio of owner occupiers with no mortgage vs a mortgage. Some landlords without mortgages will still be putting rents up, of course, but it’s likely they are not being as aggressive with their rent increases.

OOH being at a record high also speaks as to why the average household is still very much feeling the cost of living squeeze – one of the bits that Rishi doesn’t understand.

CPI is up 34% since 2015 – CPIH is lagging behind at 32.7%, and OOH is up 25.3% – as a comparison. They are converging with their respective rates of change at the moment.

Food inflation down 0.3% month-on-month is the biggest positive of these figures in many ways, as food inflation has outpaced CPI (and all measures) over this recent period of inflation.

Regulars will know I like to look at the monthly figures and sometimes expand those into an annual figure or a more accurate real-time figure – looking back a year is arbitrary and sometimes things have changed dramatically (as they have in the UK I believe in the past 12 months).

Core CPI – month on month – for example: the last 6 months are now +0.6%, -0.9% (a typical January), +0.6%, +0.6%, +0.9% (!), +0.5%. So, May is the lowest of the non-January figures for 6 months, but is still way too high. From June ‘23 to Nov ‘23, we had only one reading at 0.5% and the rest below that, with a -0.3% in Nov ‘23 – those figures will be dropping out of the 12-month number, and unless core calms down rapidly, the headline figure will therefore go UP again.

Compare that to the past 6 months which annualises to 4.7% for Core – if you halved the January impact (as there’s only one January each year of course!) then you’d be looking at something close to 5%. You see this is still uncomfortably high on a more real-time measure – the only solace we can take is that we’ve moved down to 0.5% and that’s the best reading since last November, if we leave January out of that comparison.

Stating the obvious once more though – if we look at 0.5% and annualise THAT number (this is dangerous, taking one month’s figure, of course) then Core is 6.16%. I think high 4s looking backwards and 4 or just below looking forwards feels the most realistic, but having this discussion around 4% is not conducive to lower inflation. Remember – we WILL be able to swallow higher inflation, and as I often say I believe the Government would PREFER 3% to 2%, but it leaves us very fragile in the face of a shock and the frozen tax thresholds will certainly keep any feelgood factor for the workers somewhat at bay!

If we do the same exercise for CPI, since that’s the headline rate the Bank of England is tasked with managing – the last 6 months are +0.4%, -0.6% (Jan!), 0.6%, 0.6%, 0.3%, 0.3%. Remember this has bought energy back into the equation, and the price of energy cratered in April 2024 for households, and we STILL printed a +0.3.

The PMIs, my darling of real time metrics, suggested May was one of the calmest months for price increases for some time, but still saw a +0.3%. That 6-month CPI, annualised, would be 3.2%, which feels a lot more accurate than 2% does, in real time. I think 3.2% and calming isn’t a bad stab for the next 12 months, so over or under 3% is the line to be betting on, rather than over or under 2%.

Indeed – it is my own thought that the target SHOULD be 3% at the moment, although you would want to be wary of the effect this would have on bond markets – it would immediately devalue bonds, sending yields upwards – so this would have to be tapered and implemented gently. There would be a way, a way that no effort is being put into at the moment – very similar to the quantitative tightening situation, which I also want to spend some time talking about today.

If I just pick out a few of the 12-month components of note, before closing on inflation for this month (well, this week, maybe!):

Food +1.7% last 12 months, -0.3% month on month. Fantastic.

Alcohol and Tobacco +7.8% last 12 months

Clothing +3%

Health +6.3%

Education +4.5%

Restaurants and Hotels +5.8%

You can see where the pressure is, at the moment. Go down one level to the wage changes in those sectors (as I did last week) and you will see that wage rises have driven an awful lot of those rises. It’s where we go from here that will shape inflation significantly over the coming months and years.

OK. That’s a lot on inflation. Enough, and onto the consumer confidence index, produced by GfK. This is more real-time – this is June’s number, generated between May 31 and June 14.

The summary – looking both backwards one year and forwards one year, consumers have a more favourable view. The print of -14 was ahead of consensus, and compares favourably to -17 last month, -19 in April, and -24 in June 2023. The negative nature of it is a tough framing, but it averages a negative number over a long period of time – the Brits are, perhaps, just bearish by their nature! The number was -49 in September 2022, after all.

One slightly disconcerting point from the past month was that the only positive figure – personal financial situation over the next 12 months – went from +7 to +4. Reality biting, or reflective of the election outcome perhaps? Or, a fuss about nothing. We will see. This will affect consumption, however.

It is interesting though, because although the survey shows less confidence over personal finances, it shows a dramatic increase in the hopes for the general economy over the next 12 months. From -17 to -11 in one month – and also the major purchase index looks as good as it has done for some time. So – do the people believe that Labour will be better for the overall economy but worse for them on a personal level? You can sympathise with that way of thinking, if you can put any partisan views aside, I’m sure.

The savings index has also come down markedly. Whether that’s less money in the pocket meaning less to save, or just monthly volatility – but the election announcement looks to have either snapped off and reversed a few trends, or exacerbated them – the figures are much more volatile than they were in recent months, and the obvious variable that has changed is the election announcement.

Nothing too damning for consumption, really, from this survey I don’t think. Less saving will help consumption, but more spending is inflationary (the rock, and the hard place). Let me repeat what I posted on a LinkedIn comment this week:

“Wages up 6%, spending DOWN 8% from a year ago (that’s nominal as well) and DOWN 10% from January 2020 (also nominal). That’s a BIG real terms consumption haircut – of course more is going on mortgages or rent for the 2/3rds of households that deal with them, although 70%ish of those on 5yr fixes and longer are not yet dealing with that pain.

There’s a sting in the tail but very little is over 6% over the past 12 months.”

Context is important – the question is when does it stop getting worse before it gets better, and my sense is that we are past that point. If it is “your month” for your rent to rocket, or your mortgage payment to go up massively, then it is your month – but the majority continue to creep forward since we have genuine real terms pay rises at the moment, whether you adjust for CPI, CPIH, Core, or whatever else!

Retail sales feeds well into this discussion. The backdrop is that we had an appalling April – for weather, and also on the basis that Easter was in March. May was always going to look better – but the May figures were well ahead of consensus, with a 1.3% rise year on year and a 2.9% rise month-on-month. The consensus was that sales would be down nearly 1% year on year, so +1.3% was a big bonus (although still behind inflation, of course).

The moral of the story is that consumption hasn’t cratered, but when you look at it in context:

Since 2019, volume of sales is down 1.5%. Value of sales is up nearly 19% (so, below almost everything else that inflation has battered). Volume of people is up around 3%, depending on whose figures you trust, with some estimates because figures tend to lag – so per capita volume is down closer to 5% than 1.5%. People are still buying less than they were pre-pandemic.

This does leave room for growth as wages repair, although frozen tax thresholds will suck disposable income from households of course. Of all of them, the personal allowance hurts the most and is the biggest percentage differentiator – but changing this causes a major tax gap. Tough times for those running the books for the nation!

So consumption HAS fallen, quite a lot, but the overall trend in the now isn’t clear. This is important because it is the cornerstone of Dr Swati Dhingra’s argument to cut rates. The noise around it means that in order to cross the floor, as it is known, the others likely need to find a different reason.

So – what ARE the other stories? Unemployment upwards – although I think that trend will calm. Economy slowing – that hasn’t been the case on recent PMIs, but here are June’s flash estimates:

Composite output (the aggregated index): 51.7, a 7-month low – down from 53 in May.

Services 51.2 – another 7-month low – down from 52.9 in May

Manufacturing 51.4 – a 23-month high – great news! Output is up at 54.2 for manufacturing, a 26-month high.

You can see the direction of travel here. Services have slowed dramatically in a couple of months.

As always though we need to go a level down before we write the UK economy off. The survey did show the slowdown being partly driven by a pause in client spending decisions during the election period. We would need a broader analysis of previous elections to see if that held true in general.

Worse news contained deeper in the detail, though. After a significant slowdown in inflation in the May PMI reports, which hasn’t really fed to particularly low month-on-month inflation as reported above, June saw much higher transport costs thanks to “severe global shipping constraints”. Producers raised prices at the sharpest rate since May 2023.

Customer demand for services was up; manufacturers are expecting continued demand increases; there was also a dip in foreign demand for our manufactured goods.

Employment overall – sounds quite weak. Sideways, is the best interpretation of the report.

The resultant GDP output from this flash survey would be 0.1% quarterly – however, I wouldn’t read too much into that because of the election uncertainty impacts here. Reserve judgement until next month, but the economy certainly isn’t roaring forward. The Chief Business Economist at S&P Global who produce the PMIs has a fair turn of phrase:

“In short, while a slowdown in economic growth may prove temporary, should businesses react positively to the policies announced by any new government, the stubbornness of underlying inflationary pressures above the Bank of England’s target still looks somewhat engrained.”

OK – just to close the macro with the yields, then. We had a sideways week here, as well. Opened at 3.947% and closed at 3.941%. It doesn’t come a lot closer than that. It was largely dull as ditchwater, a solid trading week for the bonds – but there was a brief breakout above 4% again on Monday, and a trip down to test 3.85% (yes please) on Friday before coming all the way back for the close when the PMIs were released with that data inside.

3.95% still feels too high to me, but not miles too high. The Thursday close was 3.908% and the swaps closed Thursday at 3.823%, the same reverse margin that we’ve been seeing for months now. This is good news, and should see some more headlines about rates being clipped over the coming weeks, although lenders may also be deferring decisions until after the election. Mortgage rates with no arrangement fees, for limited companies, sub 6%, should persist for a while yet. Overall I think the yields are still on the way down, slowly, but there are suggestions of some inflation gremlins in the PMIs that have me a little concerned!

The Bank will, of course, have seen half of this (the PMIs were out on Friday) – and didn’t have lots more to go on than their last meeting, to be honest. I was quoting 95% certainty of a rate hold – and predicted last week that one more would cross the floor, and we would see a 6-3 vote to hold – but that didn’t come to pass. They did hold, but held at 7-2 in the voting, in an exact mirror image of the last MPC meeting.

I had already discussed that the realistic response to the election was not to cut rates. It looks too political for an independent central bank. Either way, I don’t think they were really leaning towards the cut anyway. Also – don’t miss the nuance that the Deputy Governor for Monetary Policy has now done his last meeting, and so will be replaced by former Treasury advisor to Jeremy Hunt, Claire Lombardelli, next meeting (first week of August). My own tin foil hat theory that she was sent in to get rates down is also now up in flames thanks to the earlier-than-expected election call, of course. Still – she is now the one that Andrew Bailey will listen most closely to – and there is no real information at the moment as to whether she will be particularly hawkish or dovish. We will find out!

What are the most important parts that the Bank pulled out of the data:

Inflation at 2% – of course. They still believe this will rise towards the end of the year – and without a consumption collapse, it will.

GDP stronger than expected but business surveys indicating a much slower growth rate of around 0.25% per year (on June’s PMI, that sounds right, but will there be a post-election flurry of confidence?)

Unemployment is difficult to trust, loosening but tight by historical standards – they’ve wheeled out this rhetoric for at least 9 months now. My personal view is that the pace of job losses has slowed right down and we are likely near our top unemployment figure for the year – but in reality, economic inactivity is a much bigger problem (although that’s not the Bank’s remit, of course).

Services inflation isn’t falling as quickly as they thought in the previous meeting (which is strange – they seemed to struggle to model a massive increase in minimum wage feeding through into higher services prices – I really don’t know why). The past month has been a good result but the month-on-month services inflation is deep in the ONS reports, which is silly given that it makes up basically half of all inflation! Sometimes I think that people are just too scared to challenge the establishment – I suspect this is why I have never tried to work there. I’d last 6 months tops, because I’d be too disruptive and ask too many difficult questions. Consultant-only material, me!

There’s a reminder that the 2% target is medium-term – 3 years. There’s no update on the last report (because the full reports only happen quarterly – I don’t know why) – but the 3 year number was 1.6% last time out. It may not have changed much, because again inflation has looked more persistent than the Bank forecasts.

Then there’s a veiled ending to their summary in the minutes. Best repeated verbatim:

“As part of the August forecast round, members of the Committee will consider all of the information available and how this affects the assessment that the risks from inflation persistence are receding. On that basis, the Committee will keep under review for how long the Bank Rate should be maintained at its current level.”

That’s been interpreted as “we are cutting in August” or at very least – the door is wide open for an August cut. It’s the most dovish statement thus far in this cycle for sure. It also says (to me) that “we don’t do that much on these meetings in between the full reports” which is a bit frustrating for those waiting for a cut, of course.

My specific technical feelings are that inflation is still more entrenched in the system that anyone is willing to talk about or realise. HOWEVER – I live in the real world, and in the real world I know that a cut is important for business and for consumers, to show some hope. That hope will then be dashed, assuming August is a cut, when we get to September’s meeting and that’s a hold – because some will assume the start of cuts will mean regular cuts. The preferred path by the Bank is much more likely to be quarterly or even 6-monthly cuts, and not down to a particularly low level. I’m convinced this is the correct thing to do, all else being equal, but you can’t just set a strategy here and follow it without tweaking. The data is varying and difficult, and needs to take into account fiscal policy changes that will be coming after the election as well, of course.

I still do feel much more positive than many of the commentators about the UK growth rate though – some are still maintaining 0.5% for this year (which is just lazy, or not looking at the real time data, frankly) – even 0.25% per quarter (which I feel is too low) is a shade over 1% for the year, and slightly more than double these bearish forecasts. NIESR’s 0.5% for Q2 now looks too enthusiastic though, and 0.4% will be closer to the mark – however, 0.6% Q1 0.4% Q2 0.25% Q3 0.25% Q4 would still be 1.5%+ for the year, treble the bearish forecasts – and it is doable!

The Bank does note the changes since the last meeting, in terms of oil moving back upwards in price, continued shipping disruptions (as have fed through into the PMIs now), and international inflation coming in slightly less hot than expected (as far as CPI and core is concerned) – although those downside misses were very marginal indeed, or non-existent!

They note a stronger sterling (which gives further room for cuts, or at least for divergence from the US bond yields if there is yet more inflation stuck in that system, as I think there is). They also note a very steady and sustainable credit growth, which has to be a positive.

The Bank also makes the argument that the strong H1 for 2024, well above their forecasts, balances a weaker than expected 2023 H2. That’s true, but doesn’t change the fact that their previous reports from 2024 all KNEW what had happened in H2 2023 and didn’t amend their models accordingly!

They also note house prices and housing investment moving upwards in Q1, suggesting that the market is coping with the higher rates (which seems true – and don’t forget how much lower the current rates are than the high points of 7% or so, and even the resi stock mortgages for owner occupiers was drawing at an AVERAGE rate of 5.34% in November 2023 – the high point of the cycle, as the Lettuce worked her way through the system even though she was long gone.

That rate is now back down to 4.74% and whilst still a dramatic increase on the halcyon days, that 60 basis points of repair is significant and should hopefully persist downwards, slowly.

The Bank quotes household consumption up by 0.2% in 2024 Q1, which is likely ideal in the current circumstances (they can’t say things like that, but I can). We could always do with more growth, but we do want to put this inflation fire out once and for all, and runaway consumption wouldn’t be helpful at this stage. The change in major purchase attitudes (although – as always – we need more data) will be interesting to note in the Consumer Confidence figures next month.

Business investment was also up 0.9% in Q1 – these indicators all seem to point to a lack of need to cut rates, to be honest, but I am betting on the message that they want to send, combined with the fact that 6-12 months is the period we are looking over, not what happened last quarter.

Around 40% of wage settlements take place in April – but their expectation of just over 5% annual wage growth for Q2 always looked silly, and still does in the face of the fact that it has hardly come down at all from the 6% level it has been at for months.

Here’s where you really get into the meat, though, and have to read between the lines and try to be objective. First:

“There continued to be a range of views among these members about the extent of accumulated evidence that was likely to be needed to warrant a change in Bank Rate, and the degree to which incremental information was leading them to update materially their assessment of inflation persistence.”

I’d expect that. It is hard. Really hard. There are very few times when all the ducks are in a row, and everything points in the right direction. It is, really, educated guesswork to an extent. You’d also expect there to be a difference of opinion, which the Bank works hard to drive, and talks about (unlike the Federal Reserve where they pretend everyone agrees, when they definitely don’t).

Then we have:

“For some members within this group, the return of headline inflation to 2%, while welcome, was not necessarily indicative of the required sustained return to target. Continued high levels of, and upside news to, services inflation supported the view that second-round effects would maintain persistent upward pressure on underlying inflation. Wage growth had continued to exceed model-based estimates. Indicators of domestic demand were stronger than had been expected, and the risks to the outlook for activity were skewed to the upside. For these members, more evidence of diminishing inflation persistence was needed before reducing the degree of monetary policy restrictiveness.”

That’s your hawks, right there. Mann, Haskel, Greene (maybe, or partially). They want more data. The risk is staying too high for too long. They know this, but they balance the risks of course in their decisions.

THEN we have:

“For other members within this group, the upside news in services price inflation relative to the May Report did not alter significantly the disinflationary trajectory that the economy was on. This view was supported by evidence that the recent strength in services inflation included regulated and indexed components of the basket, and volatile components. The impact of the increase in the NLW (National Living Wage) this April on aggregate pay growth was unlikely to be as large in future. Such factors would not push up medium-term inflation. For these members, the policy decision at this meeting was finely balanced. “

That’s just about where I am (or at least where I am closer to). I straddle the two positions but lean towards this one for more pragmatic reasons as I’ve laid out. The country needs a break, and a signal. The impact WON’T be as large as in future – my preference would be to lay that out as “This is NOT a wage-price spiral, AT THE MOMENT. The reason it isn’t is that people are catching up with inflation, and not, ultimately, finding themselves with more money in their pocket at the start, middle, or end of the month”. That’s harder to evidence (although possible) and is not an “institutional” view of course, it is more of a street-smart view. Andy Haldane would have agreed with this, I’d like to think, when he was the chief economist!

This group (which I suspect to contain Bailey, Broadbent (leaving – but expect Lombardelli to have the same view), Breeden and Pill) almost sounds like they know things are on the way down and are ready to cut. This is in line with an August cut, IF I’ve got this right.

Then the doves:

“Two members preferred a 0.25 percentage point reduction in Bank Rate at this meeting. For these members, Bank Rate needed to become less restrictive now to enable a smooth and gradual transition in the policy stance, and to account for lags in transmission. CPI inflation had been on a firm downward trajectory for some time and had returned to the 2% target in May. It was forecast to stay close to 2% in the short term, consistent with the further easing in the labour market, forward-looking indicators of inflation and pass-through, and continued falls in inflation expectations. Given the subdued outlook for demand, the risks to inflation remaining sustainably at the target in the medium term were to the downside.”

The downside risks I struggle to see, but then I could have some blindness at this stage! The gremlins are still in the machine, and real terms pay rises are helping to bridge consumption gaps – or, in other language, consumption has ALREADY fallen. Significantly, in real terms. It should repair and be repairing, from here, not falling.

Where I can agree is the lag in transmission, for sure. These guys see inflation staying closer to 2 than 3, whereas I am at a shade over 3, simply based on the most recent 3 and 6 month data, and the PMIs. There is always, in a world of geopolitical risk, and an economy like the UK which imports so much, including energy – and so there’s more upside risk than downside risk – that’s how it feels in mid-2024, anyway.

They closed the meeting thanking Broadbent for 128 meetings – that’s a lot of experience to walk out of the door, but Lombardelli is no slouch and has a super CV, so I am sure there will be continuity at the Bank. BB was there on the committee for 13 years, and did very little for the first 5, dropped rates when the referendum came, and then around 2019 it got more interesting until it got a lot more interesting come 2020! Feels a bit like a cricket test match, really, doesn’t it?

That should make it clear, in detail, why the Bank has done and is doing what they are doing, and the likely cut in August 2024. Don’t expect yields to drop 0.25% when they do it though, although if the PMIs are better in July and look more steady, it is possible we will be at about 3.7% for the 5 year at that point. As the meeting draws closer, it already gets priced in and lenders often hold off on cuts, so that it looks like they are following base rate, but not really. I’d expect cuts closer to 0.1-0.2% rather than the full 0.25%, from where we are today.

So – there’s one more Bank-related discussion point I want to get into here. In a way, we are indebted to the Reform party for making a point of this. We’ve seen this week that Farage is most likely a Putin sympathiser, which we knew anyway, and the more light that gets shone on him, the more chinks that will appear in that armour of bravado. However, Reform has raised a good point, even if their solution is somewhat Swiss Cheese. As always, there’s a third – or fourth – way that no-one is proposing or talking about. I find that annoying in the extreme, and so I’m left to try and talk about it!

There’s some fairly sensible commentary out there about all this, although because Farage is such a divisive figure it tends to take one side or another. I’m not a fan of Nige, but I do think that a) it is a good idea to have the odd disruptor in Parliament, and the country IS a better place for it – the same way I look at a George Galloway – and b) I can be relatively objective and non-partisan, as I have practised that approach over many years. Better to be right than to like the outcome of your analysis, is the phrase I live by!

What’s the backdrop? Well, you know the phrase Quantitative Easing. QE. Came to prominence in the UK in the wake of the 2008 Great Financial Crisis. What IS it though – the central bank printing money (or in today’s world – creating money) to buy ASSETS. What assets? Government bonds, for a start. We stuck to QE for buying Government bonds almost exclusively (£20bn did get out there to buy commercial bonds as well).

Here’s how the Bank of England describes it relatively simply, albeit in a way that could put them under attack (shows that not many read the website): “Here’s an example. Say we buy £1 million of government bonds from an asset manager. In place of those bonds, the asset manager now has £1 million in cash.

Rather than hold on to that cash, it might invest it in other financial assets, such as equities.

In turn that tends to push up on the value of equities, making households and businesses and other financial institutions that own equities wealthier. That makes them likely to spend more, boosting economic activity.

Higher prices for corporate bonds and equities also lowers the cost of funding for companies and this ought to increase investment in the economy.”

Pretty accurate, all in all, although making people wealthy boosting economic activity – it just didn’t really work like that. Instead, in reality, it was a wealth transfer – lending money at super cheap rates to those who could afford it and were good credit risks.

I like to think I knew this at the time. I think I did, although I was slow to the party – years too slow, to be honest. But my point would be – once you understand it, you either play the game or you don’t, because you aren’t going to change the system. Defeatist? Maybe. Opportunistic – definitely, guilty as charged.

You would expect the Bank to be able to explain it relatively easily. They are good at that. Indeed, QE DID lower the cost of funding for a long time. The (relatively simplistic) logic once rates started to go up was “QE isn’t needed anymore”.

Here’s the rub, though. These bonds were purchased when bond prices were incredibly high – when rates and yields were incredibly low. Thus, selling them off when “you don’t need them anymore” leads to a significant loss. The alternative is just letting the bonds mature and not crystallising that loss (although that’s not the ONLY alternative – more on that later).

Let me dwell on that for a moment. They bought bonds with nearly zero interest at therefore pretty much face value (call it £1000). Those bonds paid tiny interest coupons – say £1.25 a year – and that money is paid from the Treasury to the Bank (who are underwritten by the Treasury). Ergo – that does NOT come out of the taxpayers pocket.

IF you then sell the bonds when the yields are more like 5%, that’s an annual gain of £50 – or a LOSS of £50 if you are the seller. In reality, you don’t sell it and pay the £50 a year – instead, you bought at nearly £1000 and if there are 3 years left to run, you only receive £850 (that maths isn’t exact, but close enough) – realising a 15% loss.

On £1 trillion of QE – that’s £150bn and that DOES come out of the taxpayers pocket.

So – if you think about this like I first did – why the hell would you do that? Well, it takes money OUT of circulation (and one of the big problems over Covid was how much extra money went IN to circulation, via the most extreme form of QE – straight to the consumers or small businesses, via furlough, grants, and Covid loans. This leaks STRAIGHT into the real economy, and is SPENT, because that’s what the smaller economic agents do – and leads to inflation. Burning money rather than printing it reduces the money supply and reduces inflation. That’s true – but at what cost?

What DOES happen when QE is OVER, or in the unwinding stage? That’s where the Bank gets a little sketchy. The words “uncharted territory” spring to mind. There’s no real consensus on whether QE in its first, “pure” form was inflationary or deflationary. Economists still argue over it. The difficulty is, we don’t know what would have happened WITHOUT QE – most would agree it wouldn’t have been pretty, but it becomes a question of how much, and when to stop – and then how to stop.

The Bank does address the inequality point as well, that has been made since the first uses of QE – with a working paper that looks at the economy between 2008 and 2014. Too out of date to even discuss.

Now bear in mind the unwinding stage, or QT – can lead to two possible outcomes. There’s a sum total of 7 lines of text on the Bank of England website about this: “The process of ‘unwinding’ QE is sometimes called ‘quantitative tightening’, or QT. This can be done by not buying other bonds when the bonds we hold mature, by actively selling bonds to investors, or a combination of the two.

Unlike QE – which is used to reduce interest rates and therefore support inflation – the aim of QT is not to affect interest rates or inflation. Instead, the aim is to ensure that it is possible to undertake QE again in future, should that be needed to achieve the inflation target.

Just as with QE, it is the Monetary Policy Committee (MPC) that decides on QT.”

They link to the August 2023 MPC report to talk more.

If I put into context that the expected bill from selling bonds rather than waiting for them to mature is to the tune of something like £100bn, does it seem like 7 lines of text is enough? It seems like a conspiracy of silence to me. I think it’s a disgrace, and it makes me about as angry as I get. ONE HUNDRED BILLION POUNDS OF TAXPAYER MONEY.

That’s why Reform piqued my interest when they brought up the subject of QE (not QT, sadly). I’m not convinced that anyone in the party remotely understands this aside from Richard Tice, chairman and minority shareholder.

Here’s their argument. The £700bn or just under that is still outstanding, is sitting in the commercial banking system, on deposit, getting interest.

Now – between 2009 and 2021, that wasn’t an issue. Base rate was 0.5% (high 0.75%, low 0.1%). Interest money being paid on this money was “only” £5 billion or so per year. Now stop for a minute.

That isn’t “free money” for the banking system. Sure – it feels like money for nothing. BUT – it allows them to operate their businesses at lower margins on savings and lending. If you withdrew it – a good chunk of that loss would be absorbed by those who use the banking system – all of us. Margins would have to increase – as it stands today, savings rates would go down and borrowing rates would go UP. (Yes, sound the klaxons). What would that LOOK like – well, you know the 2% margin I often go on about around the premium that the banks charge on the SONIA swap rate? That might have to look more like 3%. Or even 4%.

So – like every idea – there is no way it is a victimless crime. I think one of the most helpful ways to think about it is as a subsidy for the Banking sector. I’m not saying it isn’t too large – I absolutely believe that it is. What I am saying is the idea of just “taking it away” and that saving “£30 or £40 billion” (we now live in a world where you can say things to the nearest £10bn and that’s OK!?), is clear hogwash and would have significant consequences.

There would need to be a taper, there would need to be good communication, and there are other options. Here’s what the ECB do, for example.

The European Central Bank has the advantage of being quite young. So, it can and has let others make mistakes first! It has three reference rates, the “middle” of which we normally talk about. These are those rates:

  • The interest rate on the main refinancing operations, which is the rate banks pay when they borrow money from the ECB for one week.

  • The rate on the deposit facility, which banks can use to make overnight deposits with the Eurosystem

  • The rate on the marginal lending facility, which offers overnight credit to banks from the Eurosystem.

And guess what? They introduce their own margin. Much lower than the commercial banks’ margins, of course. Because they are not a profit making entity. Also – they are the only game in town, to an extent, so they have ALL the volume!

So right now the “rate” that we talk about at the ECB, recently cut from 4 to 3.75%, is the rate they pay on the deposit facility. Want to borrow for a week? 4.25% per annum instead. Want to borrow overnight? 4.5% per annum instead.

Nice bit of business, that, isn’t it? Why not replicate it? Because no-one has cared enough to try and make that happen. It isn’t “their” money. It is CLASSIC public sector behaviour, and again, is frankly shameful.

The current level of commercial banking deposits with the Bank of England is £750bn. That is nicely close to the level of QE, although if it was withdrawn overnight (the £700bn QE) the Banks would scramble to recapitalise and be calling in loans all over the place. The chat from Reform makes people very nervous, because they never talk of HOW it would be done (because they don’t know, and don’t care – like all super-populists, they just want to say popular stuff).

Let’s be REALLY honest though – brass tacks. It WOULD save money. Gordon Brown has been the only one who has been vocal about doing something like the ECB, which would save £3bn or so a year (not to be sniffed at, and if you have been looking at the tax landscape and budget costings etc for Labour, that could go a long way). No-one has really advocated for anything stronger, but not “Reformy” which could bring down the house. How about that?

Well – here’s a thought. What if Banks got a small operational premium on their average deposit rates for deposits made with the BoE? Let’s say 0.5% (you’d need better inside knowledge to know what this should be). To be clear – I’d want to set this 0.5% at enough to cover costs, but not profits or bonuses. Aligning incentives a LOT better.

So – at the last count – sight deposits (those are instant access) are being paid at 2.12% across the sector on average. So, MY Bank of England would pay 2.62% (instead of 5.25%).

Why sight deposits? Because the ability to take them out overnight is matched by the ability to take them out of the Central Bank too. Longer term deposits are getting better rates – 4.4% at last count. That’s too high – and is being subsidised by the QE rates. This SHOULD be gilt yield minus operational (and profit) margin by the banks. We can’t (and shouldn’t) tell them what to do – but what I’m saying to you is, right now, QE paid for by everyone is subsidising those with money. That CANNOT help with inequality.

Likewise – to borrow over the shorter term costs either: Base, or gilt yield plus operational margin (the higher of the two). That right now would be 5.25%, so there’s a LOT of margin there for the banks in lending it out, and it carves up the margin in sitting there NOT lending.

It aligns incentives.

Commercial banks NEED to keep sensible reserves, but we SHOULD NOT support a system whereby they can sit making money and not doing their jobs. The profits HAVE to come from doing what they are supposed to be doing, and the Government’s role (outside of the Bank) is to ensure they can provide support, grant funding, badly-named “wealth funds” or the likes in order to incentivize the people on the ground to take the risks and get the rewards.

My savings would a) live between £3bn and £30bn, more on the £15bn per year side but more importantly b) not upset the apple-cart. They would act more like a windfall tax on the commercial banks. You could – in a way – achieve the same revenue raise WITH a windfall tax but it sends negative messages and also it doesn’t solve the problem – it just sweeps up until the next problem happens.

The Reform fear is that they say “£30-£40bn”, then assume £40bn, then make all these promises with that £40bn. If you implemented that one single policy badly, bond yields would be over 6%, and possibly over 7%. It is double the impact of a Liz Truss budget, quite literally, when you add up all their policies and look at a sensible, independent think tank’s assessment of them (or mine!).

It’s also the case that you need to look at the other costs when you change ANYTHING, rather than just pushing things around on a spreadsheet, which the public sector does on a professional level!

In summary, I like the challenge of Reform, I like the subjects being raised, but these aren’t the people to do it. It is like some of their energy policy – they are dead right, nuclear HAS to be a big part of any sensible solution going forwards, and I hope that some other parties adopt some of these policies (but make them robust, and not those that will smash the fragile system to smithereens again), and make a difference with them. Not just because they sound popular……

One more alternative here for consideration – because I don’t want to present this nearing-thesis length piece as “the answer”. It isn’t necessarily and would need a lot of critique, iteration and work – although that should be done publicly, not behind closed doors. How about this – having studied the yield curve far too intently for the past couple of years:

I’ve spoken at times, openly, about my views on the pricing of various gilts and resultant yields. I focus on the 5-year, as any regulars know, because we take 5-year fixed mortgages as a rule. However……

If you remember what happened in any level of detail after the Liz Truss budget – in spite of just announcing Quantitative Tightening, the Bank was forced to intervene in the bond markets – particularly on gilts of longer duration. These gilts above 10  years in duration are much more lightly traded – and the pension funds were invested in leveraged LDI (liability driven investment) funds that were losing value because the bond prices were plummeting and the yields rising.

There have been points over the past 2 years – including late Sept/Early Oct 2022, but also in the middle of 2023, when those longs – particularly the 30-year – have traded above 5%. I have consistently said at these points that that price is utterly ridiculous.

That’s best thought of as an average. For a government backed investment to pay 5% each year, effectively, for the next 30 years – this would have been dismissed as utter fantasy just a few years ago. It would have to have as many years at or above 6% as those below or at 4%, if you imagine a normal distribution.

That’s not happening. Zoom out and our economy looks better than Japan’s in terms of prospects, but not markedly different. The stock market is lagging behind – one large American company is the size of the FTSE. Our people are getting older, and the only other magic pill that will work because the birth rate has already collapsed – immigration – is a significant political football. This is NOT an economy that will average a base rate of interest of 5% or anything like it over the next 30 years.

So what? Well, the one thing I WAS delighted about during the aftermath of Truss, was that the Bank were stepping in to buy £60bn+ of bonds at these sorts of levels, with long durations. What great timing – for ONCE, we were actually, as a country, buying high to sell low a bit later on (which we did). Phenomenal.

Now – if you think about the yield curve – remember, it plots the yields of all the bonds of increasing durations as it goes along. The base rate sets the starting point for the yield curve, but the further away you get from the starting point, the less influence that the yield curve has. 30 years out, today’s base rate really should have very little relevance at all.

So what? Well, the so what is, instead of selling bonds at a rate of knots, how about selling shorts and replacing them with longs, as and when the longs are at a higher rate than the shorts? Yes, it becomes a “bet”. Yes, it arguably isn’t for the Bank of England. But let’s say I could sell a 2 year bond at a 4.5% yield and buy a 30 year bond at a 4.8% yield. I’ve made a positive trade in the first place. I am in position (as a Government agent) to hold that bond to maturity, and I, and therefore we, the taxpayer, are benefiting from not paying that 4.8% yield to others, but keeping it “in-house”.

The arguments against this get somewhat nuanced. We needed to lower our money supply (it is still rising, by the way, but QT has made some difference. Some.) However, creating profit rather than loss from this situation would ease the need to raise taxes (or debt) to pay for the losses that have been made instead. Here’s the tale of the tape in terms of what has actually happened (and these figures are more than a year old, this report was from March 2023) – source, the OBR: “Since quantitative easing (QE, the purchasing of government debt and other assets financed by the issuance of central bank reserves) was introduced in the wake of the 2008 financial crisis, central banks around the world have made large profits on these interventions. This is because the interest they pay on the reserves that finance QE asset purchases has been lower than the interest received on those assets for much of this period. In the UK, by March 2022 this had allowed the Bank of England to transfer £120 billion of cash profits on the APF to the Treasury (which both receives the profits from, and indemnifies the Bank against any losses on, the APF).”

So – we were £120 billion up. Time to leave the casino, you’d think. The problem is with this game, and the rules of the game, you can’t just leave. But – you ARE the Government, so you COULD change the rules……

“In recent months, as Bank Rate and other market interest rates have risen and so market prices for government debt held by the APF fallen, these profits have turned to losses from two sources:

  • Interest losses, as the variable rate paid on central bank reserves exceeds the fixed rates paid on the assets purchased over the past 14 years (in the UK mainly gilts).

  • Valuation losses as the market value of the roughly £820 billion in gilts still held in the APF has fallen below the purchase value by about £165 billion. These ‘mark-to-market’ losses only crystallise under the Treasury indemnity as and when gilts are sold.”

Here was the forecast at this point, nonchalantly reported:

  • Interest gains/losses. In the 13 years to the end of 2021-22, the APF had received £175 billion in interest on its assets and paid £22 billion in interest on the reserves issued to finance those assets, yielding a net profit of £153 billion for the public sector as a whole. From 2022-23 onwards, this reverses as the interest rate on reserves rises above that on gilts and other assets – yielding a net loss that peaks on an annual basis at £17 billion in 2023-24. The net loss then declines across the forecast as Bank Rate falls back and the volume of assets held in the APF decreases. Total interest losses, and so borrowing, sum to £46 billion between 2022-23 and 2027-28.

  • Crystallised valuation gains/losses. In the 13 years to the end of 2021-22, £29 billion of valuation losses had crystallised in the APF. These losses increase across the forecast to a total of £61 billion, as gilt sales at prices below those at which those gilts were purchased add to losses crystallised on gilts that are redeemed at maturity.

Note from that first bullet point – far lower than Reform’s figure. Why? Someone at Reform googled it and just used the highest figure that they could. That figure came from October 2022, when base was expected to hit 6.5%, and was never right (it was just markets panicking at the time). Yes, seriously.

Still – use my methodology to change the system and cut those losses significantly. Why not? Bank share prices would go down and some pension funds would suffer as a result. Yep, that’s true – it isn’t the main driver though, the main driver is a lack of people within “the system” who are willing to be difficult, disruptive, and drive forward things that would benefit ALL of the people, the taxpayer, rather than special interest groups. Does that change with a Labour administration? You’d like to think so, but I wouldn’t get hopes up too far.

Now the second bullet. Another £32 billion to be saved if losses were not crystallised. Maybe just me – but I’d want a pretty bloody good business case to justify that £32 billion, and I don’t think there is one. My methodology would have – and would – make money, instead of losing it. It needs refining. It isn’t “the answer” – but it is surely to goodness a pretty good basis for a discussion!

The kicker – isn’t it nice when you have a parachute:

“Combining interest and valuation losses, total cash losses amount to £108 billion over the forecast, almost reversing the £124 billion cash profits to date. The APF is assumed to call on the Treasury for most of this loss within the forecast period, increasing debt excluding the Bank of England by £103 billion.”

And that, right there, folks, is why the public sector is never going to outperform the private sector, or get anywhere near. “£100 bn down” – oh, OK, who’s picking up the tab? Number 11 – ergo the Treasury – ergo the taxpayer. Honestly makes me sick – what specifically – the fact that WE DON’T EVEN TRY.

There’s another way.

This week I’d like to ask for a special effort in terms of likes, shares and spreading the word. I’d love to be involved in making a difference, to benefit the country, rather than sitting and moaning about it as so many in the media, or on social media, seem to do.

Well done as always for getting to the end – remember the last few Early Bird tickets for the next Property Business Workshop on Thursday 4th July –

There’s only one way to deal with all of this continual noise and election claptrap, of course – Keep Calm, ALWAYS read or listen to the Supplement, and Carry On!