For King and country
Bank of England Governor Mervyn King has not shirked his duty to try to save us from ourselves but investors are in no mood to listen
When a market has momentum, it is a brave man who stands in the way. Bank of England Governor Mervyn King has not shirked his duty to try to save us from ourselves but investors are in no mood to listen to the voice of reason.
Margaret Thatcher once famously remarked that you can’t buck the markets. At the time she was thinking more in terms of the Bank of England being unable to prop up the pound against the tide of global cash flowing in the opposite direction. Now, it seems, the Bank cannot stand against the thin tide of mainly domestic cash flowing into the London stock market.
King has done his best to shock investors. After last week’s stunner, when he asked for and was granted an extra £25 billion for his quantitative easing programme, he popped up again this week with a warning that the UK economy will fall further this year than forecast; it will take longer to recover than in previous recessions; and it will take several years before banks are lending normally to households and businesses.
Of these points, the last one is least worrying. What had become the norm for bank lending was to dish out money to people who couldn’t afford to pay it back. We shall no doubt get back to that in due course. We always do. When banks are awash with cash they become increasingly desperate to lend it and decreasingly picky about whom they led it too. The longer we stave off that state of affairs, the longer it will be before the next banking crisis.
However, we must take more seriously his warning that the recession will be deeper and last longer than forecast because it will affect what the Bank does with interest rates. King sticks to his view that the danger is deflation rather than inflation and that therefore interest rates will remain low for some considerable time.
I have made clear on several occasions that I believe inflation to be a far greater threat. The inflation rate in this country has stubbornly refused to fall as fast as expected, mainly because the sharp decline in the pound offset the drop in dollar-denominated oil prices. Although the pound has now recovered to some extent, the price of crude oil has picked up again.
King reckons the quantitative easing programme has been a success, arguing that without the massive injection of cash into the economy we would have fallen back further and unemployment would have been higher. It is impossible to prove this one way or another but the evidence does not support his view.
Quantitative easing has not prevented a deep and potentially lengthy recession, nor has it prevented unemployment from rising sharply despite the attempts of more employers to institute part-time working rather than sacking people outright.
What is much more damning is that the supposed easing has not actually freed up lending by the High Street banks. While payments on deposits are derisory or non-existent, lending rates have risen rather than fallen, as anyone trying to service a business loan or arrange a mortgage will testify. Money is as tight as ever.
If King genuinely believes that quantitative easing is working we may see the current ceiling of £175 billion raised again. However, it does look as if the programme is slowing and could end soon. The original limit of £150 billion has been raised by only £25 billion, not the £50 billion that newspapers and televisions wrongly insist on. The other £25 billion was still outstanding from the original batch. Given that £25 billion a month was originally dished out, it is clear that smaller amounts are now forthcoming.
All quantitative easing will do is help to fuel inflation, so any slowing of the programme is to be welcomed. If you do not believe me, don’t bother to fill your car with petrol or diesel while you have the chance. The price, already around 104p a litre, will shoot up by another 5p by September 1st, when another 2p government tax will be slapped on just as dearer wholesale prices are feeding through. That should bring the lesson home.
However, it is also clear that King and his team will continue with low interest rates for some time to come. The gap between borrowing and lending rates is admittedly bad news for just about everyone, as we are virtually all borrowers or lenders or both. But it is good news for the banks and the sooner they rebuild their profits the sooner the government can get out, so it is indirectly good news for the economy.
Investors are, therefore, right to think that the market rally will continue, albeit probably with a pause for breath next month. Companies with low debt, making profits and paying dividends look as attractive as ever.
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