There is confusion all round. First the ‘markets’ were wrong-footed by Mervyn King and they asre justifiably somewhat miffed! However, the apparent change of direction is because the BoE has got decided cold feet at the failure of the economy to respond. So one more turn of the pump-primer with unpleasant consequences/
Then in the second piece here Ambrose Evans-Pritchard finds three very different views about where to go next and indeed even where we are now. (He clearly - as I do - favours the first!) As Irishman said when asked for directions to Ballymoney “Well, sir, I wouldna start from here!” As A.E-P concludes “the rest of us can only shake our heads in confusion.”
There is a third article in the same business sectiion making comparisons with Japan’s 10 year stagnation. It gets very detailed but for those interested may I point to: “Britain's crisis may differ from Japan's, but it could still suffer a lost decade”
Christina
TELEGRAPH 13.8.09
1. Mervyn King tells a puzzled City: 'It's the levels stupid'
If there's one thing that really infuriates the City, it is Mervyn King's attitude when it transpires that the Bank of England has wrongfooted the markets.
By Edmund Conway, Economics Editor
So it was hardly surprising that a collective groan of disbelief spread throughout the Square Mile on Wednesday morning as the Governor tried to explain why he thought so few in the markets had anticipated the Monetary Policy Committee's decision last week to extend Quantitative Easing (QE) by a further £50bn.
"I don't know why they got that impression", he said. "We couldn't have made it clearer".
According to one gilt trader, at this point the entire room at his investment bank started shouting at the television. Whoever you believe, the fact is that the past week has been something of a roller-coaster for gilt markets. In the days and weeks following the MPC's decision temporarily to hold off from extending QE in July, word spread throughout the City that not only was the policy near its end, the Bank would soon start reversing it, raising interest rates and generally leaning back on the economy next year and thereafter.
One can understand why: most of the economic signals over that period were promising; the purchasing managers' indices in particular suggested the recession was already over; moreover, various MPC members were also hinting in interviews that the whole process could soon come to an end. And so by the time of the decision last week, the markets had priced in quite a set of interest rate increases. According to the report, the implied path for interest rates over the coming years looked roughly as follows: 0.5pc until the end of the year, over 2pc by the end of next year, 3.75pc by the end of 2011 and a whopping 4.25pc or higher in three years' time.
Such forecasts were patently unrealistic, and this was confirmed in the inflation forecasts published as part of the Report. The graph that maps out what the Bank thinks would happen to inflation if rates followed market expectations shows that were borrowing costs to rise this high, inflation would be well below the Bank's 2pc target in two years' time.
Either way, the combination of last week's shock decision to raise QE to at least £175bn, and the soul-searching that it prompted (aided no doubt by the sizeable loss some banks made when that sent the gilt markets haywire) meant that by the time of Wednesday's decision, many, though not all, traders had realised that the Bank remains extremely concerned about the economy, and so is not yet ready to call an end to this radical policy.
Its main concern is the legacy of the current recession. Bastardising James Carville's famous exhortation to the Clinton election team ahead of the 1992 US Presidential election, Mr King said: "It's the levels stupid - it's not the growth rates, it's the levels that matter here." In other words, although the green graph of where the Bank thinks gross domestic product growth may go in the next few years looks as if the UK will stage a dramatic recovery, don't be fooled into thinking this means this drama is anywhere near over. The point is that the scale of this recession has been such that a sizeable chunk of Britain's economic output has simply been wiped out. Unlike in previous recessions where the economy shrank and then rebounded with such alacrity that it was soon back to normal, the problem this time around is that much of that output simply may never return. The UK will grow again, but will be faced with serious deflationary forces as a result of the so-called output gap this monumental economic dent has left in its wake.
The lesson is that although one may be inclined to assume that the 5pc-plus fall in GDP over the past year is ancient history, it leaves behind a legacy that will shape the path of the economy over the next few years. When you add on top of this the fact that banks' balance sheets remain in such a state that we won't see a return to normal lending behaviour for quite some time, the Bank's rationale for hanging onto its QE policy starts to make more sense. It is, as Karen Ward of HSBC – a former Bank economist – puts it, an "insurance policy".
So where does this leave QE in the future? The short answer is that, waft away the smoke and it is clear that the policy is nearing the end of its life. Another chart from the report shows that if the MPC leaves rates unchanged at 0.5pc, proceeds with its £175bn programme and does nothing else for the next two years, then come mid-2011 inflation will be soaring skywards. The firm implication is that £175bn is probably as far as the Bank will go, and that it is prepared at some point in the next year or so to start raising rates, or alternatively selling gilts back into the market.
At such a point, however, life starts getting even more uncomfortable. Many economists fear that by next year investors, having been force-fed many hundreds of billions of government bonds from all over the world, could suffer serious indigestion if on top of this central banks start disgorging their stash of bonds as well. The Bank will soon be in the unenviable position of owning almost half the entire gilts market. The recipe hardly sounds promising. Unlikely as it may sound given how hectic the past 12 months have been, next year could well be even tougher for Mervyn King.
2. RBS über-bear issues fresh alert on global stock markets
Three-month slide could hit record lows, Royal Bank of Scotland chief credit strategist Bob Janjuah predicts.
By Ambrose Evans-Pritchard, International Business Editor
Britain's Uber-bear is growling again. After predicting a torrid "relief rally" over the early summer, Bob Janjuah at Royal Bank of Scotland is advising clients to take profits in global equity and commodity markets and prepare for another storm as winter nears.
"We are now in the middle of a parabolic spike up," he said in his latest confidential note to clients.
"I expect this risk rally to continue into – and maybe through – a large part of August. What happens after that? The next ugly leg of the bear market begins as we get into the July through September 'tipping zone', driven by the failure of the data to validate the V (shaped recovery) that is now fully priced into markets."
The key indicators to watch are business spending on equipment (Capex), incomes, jobs, and profits. Only a "surge higher" in these gauges can justify current asset prices. Results that are merely "less bad" will not suffice.
He expects global stock markets to test their March lows, and probably worse. The slide could last three months. "A move to new lows is highly likely," he said.
Mr Janjuah, RBS's chief credit strategist, has a loyal following in the City. He was one of the very few analysts to speak out early about the dangerous excesses of the credit bubble. He then made waves in the summer of 2008 by issuing a global crash alert, giving warning that a "very nasty period is soon to be upon us" as – indeed it was. Lehman Brothers and AIG imploded weeks later.
This time he expects the S&P 500 index of US equities to reach the "mid 500s", almost halving from current levels near 1000. Such a fall would take London's FTSE 100 to around 2,500. The iTraxx Crossover index measuring spreads on low-grade European debt will double to 1250.
Mr Janjuah advises investors to seek safety in 10-year German bonds in late August or early September.
While media headlines have played up the short-term bounce of corporate earnings, Mr Janjuah said this is a statistical illusion. Profits were in reality down 20pc in the second quarter from the year before. They cannot rise much as the West slowly purges debt and adjusts to record over-capacity. "Investors are again being sucked back into the game where 'markets make opinions', where 'excess liquidity' is the driving investment rationale.
"The last two Augusts proved to be pivotal turning points: August 2007 being the proverbial 'head-fake' when everyone wanted to believe that policy-makers had seen off the credit disaster at the pass, and August 2008 being the calm before the utter collapse of Sept/Oct/Nov… 3rd time lucky anyone?"
The elephant in the room is the spiralling public debt as private losses are shifted on to the taxpayer, especially in Britain and America. "Ask yourself this: who bails out Government after they have bailed out everyone?"
Mr Janjuah said governments might put off the day of reckoning into the middle of next year if they resort to another shot of stimulus, but that would store yet further problems. "If what I fear plays out then I will have to concede that the lunatics who ran the asylum pretty much into the ground last year are back in control."
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Over at Morgan Stanley, equity guru Teun Draaisma thinks we are through the worst. "We were on course for a Great Depression in February, but Armageddon was avoided. Governments did not repeat the policy errors of the 1930s."
"We have seen the lows of this crisis. This is a genuine rebound rally, and it has been short by historical standards so far," he said.
Mr Draaisma, who called the top of the bull market almost to the day in mid-2007, has crunched the worldwide data on 19 major stock market crashes over the last century. They show that the typical rebound rally (as opposed to bear trap rallies, when markets later plunge to new lows) lasts 17 months and stocks rise 71pc. The 1993 rally in the US was 170pc over 13 months. Finland's rally in 1994 was 295pc. Hong Kong rallied 159pc in 2000. This rebound is only five months old. The key indexes have risen 49pc in the US and 42pc in Europe. Mr Draaisma advises clients to stay in the stocks for now, but stick to telecom companies, utilities, and oil.
Yet he too expects a nasty correction once this rally falters. The usual trigger at this stage of the cycle is when central bankers start to make hawkish noises, typically a couple of months before the first turn of the screw (normally a rate rise, but in this case an end to "quantitative easing". "As long as policy-makers are talking about how fragile the recovery is, equities are unlikely to go down much."
This moment can be hard to judge. There has already been rumbling from some governors at the US Federal Reserve and from the European Central Bank's Jean-Claude Trichet. Markets are pricing in rates rises by early next year.
The pattern after major financial bust-ups is that the rebound rally gives way to another fall of 25pc or so, lasting a year, followed by five years of hard slog as stocks bounce up and down in a trading range, going nowhere. Mr Draaisma suggests taking a close look at the chart of Japan's Nikkei index from 1991 to 1999. Gains were zero.
We are in uncharted waters, however. Monetary and fiscal stimulus has been unprecedented.
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Russell Napier at Hong Kong brokers CLSA says a powerful bull market is already taking shape as the American giant reawakens. Perma-bears will be left behind. He said: "It is dangerous to be in cash."
When the finest minds in the business disagree so starkly, the rest of us can only shake our heads in confusion.
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