THERE have been three occasions during its nine years of independence that the Bank of England has reduced interest rates in response to a global financial crisis. How long does the current period of extreme financial-market turbulence have to last before the Bank decides that a calming cut is needed? If a week is a long time in politics, a day can be an eternity when it comes to reading financial markets. We ended the week stronger but the fragility remains. The stock market’s performance this month gives a fair impression of the old caricature of red-bracered City traders, shouting “buy, buy, buy” in the phone jammed to one ear, and “sell, sell, sell” in the other. One day it’s party time, the next Armageddon.
It is, of course, an extreme caricature — only throwbacks to the Gordon Gekko era of the 1980s would dream of wearing red braces these days — but it deserves to go alongside other explanations of why financial markets have suddenly become wildly volatile and why, through all the volatility, equity prices are significantly down on their recent peaks.
There is an economic explanation, which can be traced back to the Far East, and the first hints from the Bank of Japan earlier this year that it was contemplating an end to its long period of zero interest rates. That, apart from having a potential impact on so-called carry trades (borrowing at zero interest in Japan and investing in higher-yielding US securities), was also taken as a signal that the cheap-money era is over.
Add in the uncertainty about how far American rates would go up, the European Central Bank’s aggressive tone and the about-turn on UK interest-rate expectations and there was certainly something for the markets to get worried about.
What about the dollar? Some economists trace the current market trouble to the meeting of G7 finance ministers and central bankers on April 21, which apparently put the skids under the dollar. The G7’s statement, saying exchange rates should reflect economic fundamentals, was innocuous enough, but the markets read between the lines to see a strategy of deliberate dollar devaluation.
It is possible that what we are seeing under the general heading of “risk aversion” is a return to more normal conditions. The timing of the volatility in the markets, in other words, is less important than the fact that there are good reasons for it.
Thus zero interest rates could never be a permanent condition in Japan. Nor, perhaps, could extremely low long-term real interest rates. Mervyn King, the Bank governor, spoke earlier this year about both low rates and what he described as the fact that “risk premia have become unusually compressed”, saying “it is questionable whether such behaviour can persist”.
His warning was perceptive. Not only have risk premiums dramatically “decompressed” but the Organisation for Economic Co-operation and Development, in its twice-yearly Economic Outlook last week, warned of a further significant rise in rates, which could put pressure on house prices, notably in America, France and Spain. It noted, however, the “good chances for soft landings” in Britain and Australia.
So, to return to my initial question, how should the Bank and for that matter other central banks respond to these shifts, if at all? The previous occasions when the Bank did respond, in the autumn of 1998, after the September 11 attacks on America and before and during the Iraq war, were all characterised by extreme market nervousness. In 1998, the Russian and hedge fund (Long Term Capital Management) crises, piggybacked on to the Asian financial crisis. The Bank’s monetary policy committee cut base rate from 7.5% on the eve of its October 1998 meeting to 5% the following June — a dramatic easing of policy.
In the aftermath of the September 11 attacks, which included one emergency MPC meeting, the rate was cut from 5% to 4% in the space of two months. In 2003, base rate was cut from 4% to 3.75% in February, on the eve of the Iraq invasion, and further, to a modern-day low of 3.5%, in May that year.
Was there a common theme in these moves? The 1998-99 episode and the Bank’s post-September 11 response were both part of an international move to cut rates and restore confidence in the global economy. In 2003, too, central banks took the brave decision to ignore rising global oil prices and cut rates because of the risks to growth.
What would it take to produce a similar move this time? In America Ben Bernanke, the new Federal Reserve chairman, will be keen to avoid his version of the “Greenspan put” — a term from the options markets — the belief among investors that it was safe to push share prices higher because if anything bad happened the Fed would cut rates and thereby boost the market.
Here, the MPC, whose new member David Blanchflower played a straight bat in evidence to the Commons Treasury committee last week, has got to a position where the expectation is that the next move in interest rates will be up, although probably not for some time. Fellow MPC member Paul Tucker said he was concerned about heightened inflation expectations.
Its reluctance to cut will be based on the risk of a British version of the Greenspan put. The “MPC put”, perhaps, is the belief among homebuyers that if anything bad happens, base rates, and therefore mortgage rates, will be cut. The stock market’s woes will, at the margin, have in any case boosted the case among investors for bricks and mortar.
Not only that but the Bank will have been cheered by tentative signs of a rebalancing of the economy. The CBI’s industrial-trends survey last week reported weak demand at home but an encouraging pick-up in export orders, the strongest for a decade. Business investment also showed a welcome rise in the first three months, official figures showed.
It comes down to a question of two things. Just as the Bank has cited strong equity markets this year as a source of strength for the economy, so a falling market has the potential for generating a decline in confidence and economic weakness. The MPC will have to gauge how powerful this effect is.
The Bank will also be on the lookout for evidence that the volatility in financial markets is spilling over into the general economy and threatening Britain’s “hard-won stability”.
For the moment, market volatility has probably done enough to snuff out thoughts of base rate going up any time soon, which is good. But markets will have to fall further to really put cuts back on the agenda.
PS: When politicians talk about the work-life balance, as David Cameron did last week, the intention is obvious: to tap into the concern of people up and down the country working all the hours in the day, not to mention the weekends, and never seeing their families.
Many people reading this, even if they think the Tory leader’s “money isn’t everything” message last week was a bit rich coming from him, will recognise at least part of his diagnosis. But how downtrodden are we? Everybody knows the claims that Britons work the longest hours in Europe, that as a nation of workaholics we are destroying the family and so on.
In fact, official statistics show that average working hours are declining. The average weekly hours of work for all people in what are described as full-time jobs has come down from 38.8 in 1996 to 37.1 in the first quarter of this year, according to the Labour Force Survey.
What’s going on? The European working-time directive has had an effect in bringing down the average, by reducing hours for those previously averaging more than 48 hours. There is also, inevitably, a wide distribution of working hours within the average. There are, in other words, plenty of workaholics. But there are also quite a lot of people who enjoy an easy life.
