Rates On Hold as Election Focuses on Deficit
Public finances, the lynchpin of the UK election campaign, have taken centre stage on both sides of the Atlantic
Neither the Bank of England nor the European Central Bank proffered up any surprises on Thursday—both confirmed interest rates will be maintained, as will Quantitative Easing—but the equity market’s ennui with regard to election fever meant that concerns about Greek debt continued to weigh on UK and European equities.
Today’s decision by the Bank of England to keep the Official Bank rate at its historically-low level of 0.5% and to hold the QE programme capacity at £200 billion means that neither will now be changed until after the General Election. But then we all knew that already, in fact rates hikes aren’t expected to start until the end of 2010 at the earliest and even then at a lowly pace. The Monetary Policy Committee’s next meeting has now been postponed from May 6, which is now the date of the General Election, to May 10, by which time it will also have the quarterly inflation report under its belt (to be announced May 12). At 3%, the rate of inflation dipped back into the Bank of England’s target of 2% +/- 1% in February and is expected to continue to fall as price pressures remain weak.
The largest threat to a sustained period of expansionary monetary policy remains the prospect of imported inflation owing to a weak sterling and a strong recovery in the East, economists at the Centre for Economics and Business Research said today. “Petrol prices reached an all-time high this week as the highest oil price in 18 months combined with a weaker pound to leave motorists worse off at the pumps. Whilst soaring Asian demand has caused Australia to raise interest rates again this week, we still expect UK interest rates to be on hold for the remainder of 2010,” said the CEBR’s Benjamin Williamson.
The state of the UK’s public finances is now the main item on all political parties’ agendas—at least they agree that the Budget deficit needs to be cut, though exactly how to do this and when is still up for dispute. As such, the election campaign should provide some more clarity on the (ill) health of the nation’s balance sheet.
“So great is the size of Britain’s national debt mountain that all parties agree that it cannot be tackled simply through increasing taxation and cutting spending,” commented Richard Buxton, Head of UK Equities at Schroders, in an article published earlier today. “The next government is likely to be very business-friendly, since it is on companies’ ability to employ more people and deliver economic growth that the politicians’ re-election chances will rest,” he added.
“It is now imperative for the incoming government to clearly demonstrate a real cut in the Budget deficit and hence a reduction in the accumulation in the level of debt,” said Edward Menashy, Chief Economist at Charles Stanley following the Bank of England announcements.
Menashy also noted that a useful pointer for investors to judge the level of confidence in the course of the election campaign is to measure the gap between 10 year gilt yields and 10 year German Bund yields. “Currently this gap is made up of 4.06-3.10, i.e. 0.96 is the extra yield demanded by investors to buy 10 year UK Gilts. A lower spread would imply greater confidence and vice versa,” Menashy said.
Across the pond, Federal Reserve chairman Ben Bernanke yesterday upset Wall Street by cautioning against budget imbalances and warning that deficit cuts are needed to avoid higher taxes—a line that we are all familiar with at present on both sides of the Atlantic.
While here in Europe today, the focus was on Greece and potential additional QE measures to be implemented in the future as the European Central Bank kept interest rates at 1%.
Noting that the European Central Bank loosened the requirements for collateral accepted in exchange for central bank loans at the height of the financial crisis, and this measure is expected to run out at the end of this year, CEBR economist Jörg Radeke comments that this “would put further pressure on the price of sovereign debt and borrowing costs of marginal countries, such as Greece and Portugal, which have been or are threatened to be downgraded.” Radeke added that “[The ECB] has already indicated an extension of the looser requirements beyond 2010; however, there is still the issue of how ‘haircuts’ will be applied.”
