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What The Latest Bank Of England Inflation Report Means To You And Me

By Andy Shaw | January 23, 2010

Originally Posted 16th November 2007

The BOE released its latest inflation report this week, and much to my relief and disgust at the same time they have finally reached the conclusion that they have over corrected the market – better very late than never I suppose.

I apologise for repeating the next bit if you’re a regular reader, but it explains the economy and my view of it really well to all new comers:-

I think the economy is like flying a plane, and a plane has a number of controls, the ailerons, the flaps, the rudder (I have a Private Pilots License but I can’t remember if that’s the right name as it’s been so long since I flew!), the power, the wind (you don’t control that, but you can choose where you want to go and data is made available to you from various different indicators to allow you to ascertain the likely speed and direction of it- but this force is obviously outside of your control), and finally the trim.

Applying very slight positive or negative pressure to most of those items alters the course. When I was taught to fly, I was taught to make minor changes and then wait and see what happened, then make further minor adjustments to correct the course. If something in the weather started to look poor then I would take precautionary measures to try and remain on a comfortable course. The point was always to be in the precautionary state rather than the reactive state.

Well the BoE in my opinion flies the economy in the reactive state in other words they wait until they know it’s way off course before correcting instead of being able to feel that it is going off course and make a minor correction. When you leave a correction too long, then you run the risk of having to over correct, and this is where I feel the BoE is at its weakest. What’s worse is the BoE flies this economy just by using the power alone! And that’s no way to fly a plane.

I first used that analogy a few weeks ago, and if you read between the lines I made a couple of key points about how the BoE work. They use the power alone (interest rates) and they work in a reactive state instead of precautionary.

The funny thing is that they actually think they work from a precautionary state, trouble is how can accountants and actuaries ever be able to work from a precautionary state, all of the data they compile is based on what has actually happened – hardly precautionary!

I will continue with my bank beating in subsequent articles as frankly they deserve it, and even though my economist friend says that these people are ‘galactically clever’ I really do struggle with his conclusion. He recently said to me that I thought tenants were idiots, to which I replied by saying I would never class tenants at the same level as I do the BoE Monetary Policy Committee. I consider tenants honoured guests that have made a decision about their future and I am just a facilitator of their needs.

Whereas, I consider the BoE to have a severe lacking in forward predictive skills and therefore reckless control of the economy because of it. If it was based on their pure skills and knowledge then I could agree that they could be galactically clever, but if it is based on their predictive, forecasting and precautionary skill set then I have to disagree completely – as clearly they are lacking in this department having to always over correct.

What these guys need is a couple or three people on this policy committee that are known for predicting accurately, then they could combine that with their deep analytical view points and maybe, just maybe we’d have a BOE that could run the economy without continually having to over correct.

When they went up with 5 rises in a year, as I’ve said in previous articles I agreed with their first rise, I thought their second was needed but should have waited a couple more months – i.e. Make minor adjustments to the course and wait and see what happens, afterall they say they are not reactive, yet they clearly are with 5 rises in one year. Their third I totally disagreed with as they had not given it long enough to see what was happening, and then I was at a loss when they made their fourth and fifth rises as these were totally unnecessary then and thanks to this over correction report have now finally been proved to be.

Just a 0.25 point rise takes 2 years to really see the effect, and these guys rose it 5 times in a year and guess what their inflation report says this week…that the economy is going to experience a sharp downturn so we will be cutting rates 2 or 3 times over next year.

Now this on its own is what I’m talking about, they have now got and have had data for several months now which has shown what I’ve been saying for about a year, that they went up too high in the first place and they need to bring it down.

It’s clear data – they said so themselves, so what do they do, well in September they kept the rates on hold, and none of the MPC voted to lower them (i.e. no predictive/forecasting skills amongst the lot of them) and in October David Blanchflower was the only one of the nine of them to vote for a reduction – and he probably did it with an ulterior motive in mind.

You hear a lot about a lady called Kate Barker as she sits on the MPC and she wrote ‘The Barker Report’ on housing in the UK. Now I did hope following some of the things I read in her report that she would have a bit more of an understanding of the UK economy and its intrinsic link to housing, but obviously I was once again mistaken. I really would one day like to meet an expert that is in the media spotlight that is an expert, as I really would like to see an expert at the yolk.

I could go on for hours picking holes in this lot, as they are easy targets and they really do deserve it, but it just frustrates the hell out of me that I seem to be able to give more accurate predictions to the way the economy should head than the best experts the government can pull together.

I am not in anyway saying I’m cleverer than these guys, on the contrary they understand things that I only know to a very basic level, but they sure are bad at keeping us heading in the right direction. I keep saying they should be able to run this within a 0.75 point margin and yet they don’t seem to be able to.

Actually that brings up another point, I’ve never bothered asking before but why do they raise it 0.25 at a time as surely a better way to keep the economy on track would be minor rises like 0.10? The only thing I can think of is that the Mortgage lenders wouldn’t increase or decrease the rates if they were altered like that. And if that is the case then this is the change needed.

The governor said in the press conference that despite them raising the rates 5 times, only 50% of that actually filtered through into mortgage rate rises because of the squeezing of lending criteria. He sort of scoffed as he said well that won’t be happening in future, i.e. you’ll do as you are told. This guy is out of whack with modern & traditional business and clearly doesn’t understand a free market in the way he professes to.

When squeezed business finds a way to keep prices at the level they were before because they are in competition with others doing the same thing. I used to be in the manufacturing business and when I started in it a meter of glass sealed units cost me £19.25, when I left it 13 years later it cost £14.50 despite near constant raw material increases. Business finds a way by being squeezed to make the same or less money work.

Now if those banks had done as they were told then Mr King’s policies would have corrected far sharper and he would have probably been in the position of being able to say see I was right to raise rates at that pace. Unfortunately it doesn’t work like that Mr King, and as you don’t understand the free market then you went the wrong way too late, too far, too fast and for too long. That’s why we are in the mess now and why we have a sharp downturn in the economy coming in 2008.

When he spoke about where house price inflation would be he said that it was almost impossible to judge, well obviously then I am doing the near impossible then year after year. I can do it and I’m nowhere near as clever as those nine people. And they have more time to study it than I do :-)

Anyway following their now predicted 2 or 3 rate cuts next year they are still predicting that growth is still set to suffer a severe setback which was triggered by past rate increases. Now I don’t agree at all with the way America manages mortgage rates, cutting them by 0.50 in a day and then 0.25 a month later either, but at least these guys react when they realise they have got it wrong.

They new all this last month, they could have easily taken a precautionary cut by 0.25 in November, but they continued to head in the wrong direction. It infuriates me when experts can’t admit THEY GOT IT WRONG! Instead they persist heading in the wrong direction making their clients suffer (i.e.us) while they are in the back room praying that something will happen to bring their heading back into the right direction without them needing to change course – I want to swear here but I won’t!

The key question was whether “the slowing we are going to see bigger than we had wanted to see”. Yes bloody yes, there’s a mountain we’re about to fly into, if you would just look out of the front window for once, rather than looking out of the rear one, then maybe we can still avoid it! Correct your damm course you buffoon! Don’t wait till next year, don’t wait for the data to be even more certain that you got it wrong, change the rate, move on and learn from it!

They won’t do that though, trying to predict what these people do is a nightmare as I seem to be looking at much the same info as them and reaching entirely different conclusions, so even though they’ve said they’ll cut the rates I don’t actually believe them right now, but if they do then this is what should happen. A rate cut of 0.25 in December and a rate cut of 0.25 in March, and then if they want to reduce it by a third one then this shouldn’t come in until June. But what do I know.

Knowing them one of their indicators will throw up an anomoly and that will indicate a rate increase :-) I am beginning to hear the Muppet Show theme tune when I think of the BoE now as well, and that is very disappointing.

The minutes of their last months meeting are out soon, so we’ll see if any more of them did actually vote for a rate cut this month.

Best wishes


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