Five reasons why Mark Carney might be short of options when he becomes BoE Governor in July

Posted on 2 May 2013 by Jim Leaviss

Mark Carney, currently Canadian central bank governor, will become the Governor of the Bank of England at the start of July. Handpicked from outside of the official application process by Chancellor George Osborne, he comes with high expectations about what he can do to get the UK economy out of a downturn arguably more severe in GDP terms than was seen during the Great Depression (or The Slump as it was known here). This now famous chart from the NIESR shows the extent of the underperformance of the economy relative to past recessions.

Carney’s stock is high – whilst the UK and the Eurozone remain in, or around, recessions, Canadian GDP is growing at 1.7% year on year, and its growth has outperformed the US economy both during and post the financial crisis. Inflation in Canada has averaged 1.8% over the past 6 years, compared with 3.1% CPI in the UK – perhaps the real blemish on inflation puritan Mervyn King’s legacy.

With Osborne having ruled out fiscal policy as a tool to get the UK out of its current Slump, our hopes now rest on either a significant and speedy recovery of our biggest trading partner, the Eurozone economy (and that looks to be going in the wrong direction), or monetary policy. In other words do the government’s hopes all rest on Carney doing something new and different, or massively increasing the scale of what the Bank of England has done before? If so we might all be disappointed. Here are five reasons why Mark Carney’s degrees of freedom might be fewer than he, and we, had hoped…

1 You can’t cut bank rate in the UK because you hit the building societies.
Easy right, you fly over, cut rates and give a small but welcome boost to the economy. But bank rate has been stuck at 0.5% since early 2009, through double dip recessions and increases in Quantitative Easing. There is clearly scope to cut towards zero (like the Fed) and this would clearly have some benefit to consumers and companies who have mortgages and loans linked to base rate, or Libor. But the Bank has repeatedly rejected calls to cut from here – not because those benefits might be modest (although that was a line at one point) but because the building societies might well become loss making if further cuts were made. And we need our building societies – as banks’ appetite to lend has fallen, the societies now provide 22% of gross mortgage lending compared with 13% in 2009. Why do the societies get hit disproportionately by lower bank rate? The first problem is the amount of tracker mortgages that they sold historically, where homeowners pay interest explicitly based on a bank rate plus (and in some cases MINUS) basis, so revenues fall as rates fall. And at the same time the societies have very little share of the current account market, so to fund mortgage lending they rely on having market leading savings rates to raise deposits. In recent years much of this has been done on a fixed rate basis. The chart below shows that net interest income as a percentage of assets has been falling steadily as bank rate fell from 5.5% to 0.5% over that period. Once costs are taken out (the “net of costs” margin is shown in blue) there is little room for revenues to fall before the sector becomes loss making. As for negative bank rate (mentioned by Paul Tucker as being “unlikely…but we should think about all sorts of things”), that would be even more harmful.

2 You can’t target a weaker £ because the impact on consumption is higher than the boost to manufacturing.
A competitive devaluation of the pound would lead to a windfall for our manufacturing economy as exports become cheaper. Contrary to urban myth and legend, we do make stuff (manufacturing is 12% of the economy and the UK is good at making cars, jet engines, chemicals and military hardware). Carney could use Open Mouth Policy to talk down our Winston Churchill branded currency (slogan “I have nothing to offer but blood, toil, tears and sweat”), or failing that intervene by printing pounds and selling them to buy foreign currencies. We could even end up with our own Sovereign Wealth Fund! Again there is a “but”. It feels like the Bank of England already tried this, and realised that it wasn’t going to work – trade weighted Sterling fell by 7% in January and February this year before Mervyn King stated that “we’re certainly not looking to push sterling down…we’re moving to a properly valued exchange rate. I think we’re probably there”. The problem is that whilst manufacturing is important, consumption is much more so. Morgan Stanley research shows that contrary to popular opinion, UK manufacturing barely benefits from declines in the pound. And rising import prices as a result of a weaker pound mean that inflation rises, which means that real incomes fall, which means that consumption falls. And as the consumption impact is greater than the manufacturing boost impact (negligible), the impact of a weaker pound on the UK economy is negative.

3 You may be the boss, but the only power is in voting last and thus having a deciding vote.
And right now 6 out of the 9 MPC members don’t want to do more monetary stimulus. You could be in the minority forever, although a prudent Governor probably realises that this kind of split might be damaging for perceptions of stability – not what you want when foreigners are net buyers of on average £6 billion gilts every month. The Canadian monetary policy framework is based on “consensus” rather than voting – my gut feel is that this delivers more power to senior Council members in comparison to a straight vote.

4 If there was a chance to review the Bank of England’s remit from the government to make it significantly more pro-growth, it may have gone.
In the March Budget, George Osborne set out a new remit: “the new remit explicitly tasks the MPC with setting out clearly the trade-offs it has made in deciding how long it will be before inflation returns to target”. He is also changing the timing of the exchange of letters between Chancellor and Governor when the inflation target is breached. And he asked the Bank to review its communications policy (it “may wish” to provide forward guidance). But Osborne didn’t wait for Carney to arrive before changing the remit and given the market’s expectations of a much more pro-growth Governor arriving (helped by Carney’s Nominal GDP speech to the CFA Society of Canada in December), these remit changes feel modest. Perhaps the only hope for a more radical Bank comes with that potential change in communications strategy – does that open the way for statements linking future rate hikes to sustained GDP growth rather than just inflation changes?

5 And finally, the UK is not Canada.
Our banks are broken (Canada didn’t even have an official bailout during the credit crisis, although some speculate there was significant support through the state mortgage agency the CMHA). Our biggest trading partner is broken (Canada’s biggest export market is the US, which is far stronger than the Eurozone). Our natural resources are in decline (North Sea oil is producing 1.5 million barrels per day compared with 4.5 million in 1999; Canada is the world’s largest uranium and hydro-electricity producer, and the world’s fifth largest energy producer in total). And most importantly Canada had its fiscal crisis in the 1990s. S&P cut it from AAA to AA+ in 1992 triggering a consensus amongst politicians to reduce the national debt burden. Debt/GDP peaked in 1996 at around 70%, and by 2002 Canada was AAA/Aaa again. The UK is in a very different economic position, and one with substantially greater fiscal headwinds than those experienced by Mark Carney during his time in charge of Canada’s central bank.

But it’s not all bad news. Although there are clear limits to what Mark Carney will be able to do, he might have luck on his side when it comes to timing. To quote Deputy Governor Paul Tucker, who spoke last night, “looking over the past year (the UK economy is) perhaps not as bad as the headline figures suggest…I think there’s a long way to go but there’s certainly reason for hope”.

The bond vigilantes are being zombified, but the currency vigilantes are rampant

Posted on 12 March 2013 by Mike Riddell

We have written extensively on this blog in the last year about what we’ve termed ‘central bank regime change’ (eg see Jim’s article here from a year ago), where we have argued that in the years ahead, central banks would care less about inflation and more about growth and unemployment. We have since seen a number of examples of this playing out – the Federal Reserve has started targeting the unemployment rate, the Bank of Japan is trying to generate inflation, and the ECB has said it will do “whatever it takes to preserve the euro”.

More recently we’ve seen the Bank of England join the party, where 3 of the 9 members of the MPC voted for additional asset purchases despite forecasting that inflation is likely to remain above the 2% target for the next two years. And then last week we had the bombshell in the Financial Times that conversations are being had about changing the BoE’s remit, which looks suspiciously like a leak (again today it was reported that Carney has met with the Treasury to discuss remit change).

Richard wrote about the ‘currency vigilantes’ in 2010 (see here), where he discussed how QE was taming the bond vigilantes, how in the new topsy turvy world the highest inflation economies could have the lowest bond yields, and how the currency vigilantes will take the bond vigilantes’ place to enforce discipline. If you look at FX performance year to date then the currency vigilantes are clearly on the hunt – the world’s worst performing major currency at the time of writing is the Japanese Yen (-9.7% vs USD) and the second worst is the British Pound (-8.5% vs USD).

Meanwhile, QE has successfully turned the bond vigilantes into bond zombies. Market participants no longer appear to be forcing up profligate countries’ nominal government bond yields; they are instead buying up these countries’ inflation linked bonds. So in another topsy turvy development, it is becoming cheaper rather than more expensive for these governments to borrow. Cynics would argue that was the whole idea.

The result is that as real yields fall versus nominal bond yields, market implied inflation expectations are by definition increasing. One measure of market implied inflation expectations is the 10 year breakeven inflation rate, which is the gap between the 10 year real yields and 10 year nominal yields. The chart below shows that US 10 year inflation expectations are at the highs of the range of the last 15 years. Today the UK 10 year breakeven inflation rate hit 3.36%, the highest since September 2008. If you consider that the UK breakeven inflation rate is priced off RPI, and RPI is likely to be around 1% higher than CPI over the long term, then the UK bond market is still only pricing in a 10 year CPI average of just over the current 2% target. We think this still has a lot further to go – and we still hate sterling.

Conference Call replay link: the UK’s AAA White Elephant – thank goodness it’s gone, now we can try to grow again.

Posted on 25 February 2013 by Jim Leaviss

In old Siam (now Thailand), kings would ruin unliked courtiers by presenting them with a white elephant – supposedly a badge of honour, but actually a dung producing money-pit. As Wikipedia describes it, nowadays a white elephant is an idiom for “a valuable but burdensome possession of which its owner cannot dispose and whose cost (particularly cost of upkeep) is out of proportion to its usefulness or worth”. The AAA credit rating that Moody’s gave to the UK was one such white elephant. A nice trophy to have, but one where the government believed that costs of upkeep included extreme austerity, now and into the future. The good news is that Moody’s has downgraded the UK, and best of all, has done so ahead of the Budget in March. The white elephant is dead, and now George Osborne can do a bit of fiscal stimulus – housing and infrastructure spending have huge positive growth multipliers, and can be justified easily, especially whilst gilt yields are so low. And if all else fails, we can always “QE” the yields lower still…

In this conference call from this morning, I look at the downgrade, the UK fiscal outlook, and the implications for the markets. The link below takes you to the slide deck and the audio.

http://www.iviewtv.com/teleconference/uk-downgrade-reaction/

RBS – The Goodwin Lottery?

Posted on 13 February 2013 by Richard Woolnough

Vince Cable has suggested that the government’s shareholding in Royal Bank of Scotland should be parcelled off to UK citizens. The UK government’s ordinary shareholding in RBS Group (A shares) today stands at 65.29%, which goes up to 81.15% including B shares (shares with priority over dividends).

Assuming the UK government would distribute A shares only, this would give us roughly 63 shares each that would be worth £222 based on yesterday’s closing share price of £3.54. This very simplistic way to dispose of the government’s ordinary stake could well be described as fair, though it would leave lots of individual holders and create administration and system chaos. Is there a better way? How can you reduce this administrative nightmare, make the give away more popular, or improve RBS’s future prospects?

How about simply having a lottery, as opposed to the shares being split? We could have a lottery based on the electoral roll for example. However, winners would get substantially more shares each, say 300,000, which at £3.54 a share would be worth just over a million pounds each. We could in effect create more than 13,000 new millionaires. It could maybe even be marketed as the Goodwin Lottery!

A second alternative would be to actually embrace free choice and the market economy via selling tickets for the lottery. This could not only create the same amount of millionaires, but would raise extra revenue for the government. The use of the existing Camelot lottery network would make that relatively efficient.

A third alternative would be to basically “de-mutualise” it. This would involve an open offer for sale of the government’s share holding to individuals, with all proceeds raised contributing to new equity for a new invigorated bank. This would act as a deeply discounted rights issue with the government stake being 100% diluted, and their huge loss being the new investors’ gains.

The ideal solution for the UK economy is to have a thriving competitive banking sector, at a minimum cost to the taxpayer. If the politicians decide the best way to do this is to simply give the shares away then hopefully they may improve their plan to get some of the potential benefits outlined above.

Nominal GDP targeting for the UK, coming sometime, maybe?

Posted on 23 January 2013 by Jim Leaviss

This speech by Mark Carney, incoming Bank of England Governor, to the CFA Institute in Toronto, is potentially very important for UK monetary policy. He appears to suggest that targeting a level of Nominal GDP (NGDP) can be more powerful than an inflation target. Importantly he also emphasises the “history dependence” of such a policy regime, and that “bygones are not bygones”. Central bankers would be compelled to make up for past misses. Holes in growth, caused by recessions and slowdowns, need to be filled in.

George Osborne, UK Chancellor, has appeared to be warm to a discussion about a change in the UK’s monetary policy regime (and he appointed Carney to the Bank). But what would it mean in practice? Nominal GDP targeting means that monetary policy would aim to hit a combination of growth and inflation over time consistent with its trend. In the case of the UK this might be 2.5% real growth and 2% inflation, so 4.5%. But the wonderful thing about nominal GDP targets is that you don’t really care about the mix, so 4.5% inflation and 0% real growth is as good as 4.5% real growth and 0% inflation. Or at an extreme, a fall in real GDP of 10%, and inflation at 14.5%. I think that many of us would regard this indifference between growth (“good”) and inflation (“bad”) as strange. Is this an example of a policy that turns failure (having persistently higher than target inflation rates) into a triumph? Not even, I’m afraid as we haven’t achieved a 4.5% nominal GDP rate in the UK in recent times as real growth has hovered around zero.

I have some other issues about the proposed policy too. The estimation of the trend itself becomes very important. On this chart I show, in green, the level of UK nominal GDP. If we draw a trend line, using the period from 2003 to 2007 and project it forward, it appears that the level of UK growth is still significantly below trend. On my calculations it’s around 12%, but I’ve heard estimates (including from within the Bank) of 15-16% below trend too. You can see that given how weak real growth is in the UK (we may have gone back into recession), we would need to generate a significant amount of inflation to return to the trend level within the next couple of years. After all, the Bank would be “compelled to make up for past misses”.

But what if that trend rate of growth was too high? 2003 to 2007 was in the white heat of the credit bubble, and growth came from all directions, consumer spending and government spending. It seems very plausible that we were growing above our potential at the time, thanks to cheap money and leverage. If we show the same chart with a trend line from the period before credit exploded, say 1997 to 2003, we get a very different gap. In fact the yellow line here shows that the current level of Nominal GDP is bang on where we might expect it be. Perhaps this explains why the UK’s employment situation has been relatively strong in the period since the credit crisis, and perhaps it explains why inflation has been so sticky to the upside – maybe we are operating around full capacity already?

There are other objections of course – inflation data are never revised, whereas GDP numbers are, sometimes drastically. So central bankers could be aiming at a historical number that might change significantly (most economists expect UK GDP to be revised higher for the period since the credit crisis). But perhaps the greatest criticisms are reserved for the damage this might do to monetary policy credibility – does not caring about the mix of inflation and growth increase the risks of inflation drifting further away from 2%? And some have suggested that countries that have followed a NGDP regime have experienced higher volatility of both output and inflation compared to those that target inflation alone.

So on the face of it, I’m not a fan. But I am a pragmatist, and the debt to GDP ratios that we have now (or are baked in the cake for the future thanks to demographic trends) can only be dealt with by either above trend growth (are we going to see 4% real growth in the UK for any sustained period?), or higher inflation. No central banker will ever tell you that this type of regime change is taking place to erode the national debt. But if growth continues to stagnate, and politicians remain reluctant to take difficult decisions on pensions, tax rates and benefits, inflating the debt away looks to be the only option. Outright government bond defaults are unnecessary in countries with their own currencies – but subtler defaults will happen – against populations as we find that the promises made to us about our old age or child benefit no longer apply, and with inflation reducing the real liabilities of the government. This is Central Bank Regime Change, and you won’t like it.

Metroboom – Lessons from Britain’s Recovery in the 1930s by George Trefgarne. And win a copy!

Posted on 29 November 2012 by Jim Leaviss

In my last blog, about the many positive signals for US housing and the massive potential for that to drive US growth over the next couple of years (see here). I mentioned that I’d met recently with George Trefgarne, the author of a Centre for Policy Studies booklet called Metroboom. In it he pointed out how important housing construction had been in the UK’s recovery from the “slump” of the 1930s – I suggested that house building would be a very powerful way for the UK to get out of our current growth problem. As we’ve pointed out before, the UK’s growth performance from the credit crisis onwards is actually far worse than it had been in the 1930s in terms of lost GDP.

Metroboom is definitely worth a read. It certainly adds to the debate on the austerity vs fiscal stimulus debate, and (perhaps controversially) argues that it was a combination of spending cuts and tax cuts that helped to restore economic growth in the UK in the 1930s. The paper also argues that the view of the 1930s as universally gloomy in the UK is overstated. Areas that relied on shipbuilding and coal mining (the Special Areas) did remain depressed for much of the decade, and only re-armament ahead of the war stimulated growth again, but for much of the nation recovery came much earlier. Trefgarne claims that the UK was well ahead of most of the rest of the world in coming out of depression (only Germany grew faster), and that the period was one of industrial and technical innovation (and an obsession with world speed records!), an infrastructure and housing revolution, and improved leisure time (paid holidays, a cinema boom).

Perhaps one problem that we face today, that makes the UK’s 1930s solution difficult to implement today is that the tighter fiscal stance then could be offset with looser monetary policy – a policy tool that Trefgarne says was necessary to run alongside the austerity. As we approach the zero bound in interest rates around the western economies, and when the Bank of England hints that it finds diminishing returns from more and more Quantitative Easing, those monetary tools are unavailable. Olivier Blanchard, chief economist of the IMF, suggests that the reason for the negative fiscal multipliers being perhaps 3 times higher in this current downturn than they had expected them to be (1.5x versus 0.5x) is exactly this effect – monetary policy can no longer offset fiscal policy tightening. Additionally, when the UK came off the Gold Standard in 1931, the depreciation of sterling was very beneficial to UK exporters – I think that this currency depreciation was the most important factor in the UK’s eventually recovery. It’s also interesting to note that at the recent IMF/World Bank meetings in Tokyo (see my video here), Blanchard used the UK in the 1930s as an example of exactly why austerity failed, so the data from that period can be interpreted in very different ways!

I highly recommend you read Metroboom – it’s a short and concise economic history of the UK in that period with some great colour too (Neville Chamberlain at the time was regarded as a dynamic, media savvy “Man of the Year”, the Navy came close to mutiny following wage cuts, and 180 lidos were built in the decade). It’s interesting to have a different view to the commonly held one that the UK’s policies were disastrous whilst the New Deal Keynesian policies of the US proved to be the way to get out of Depression.

We have 20 copies of the Metroboom booklet to give away to the first names out of the hat with the correct answer to this question:

Which famous train broke the speed record between London and Edinburgh in 1938?

Terms and conditions here. Enter here or email us at bondvigilantes@mandg.co.uk

Congratulations to the 20 winners named below – we will be in touch to get your copy of Metroboom to you. My question turned out to be a little ambiguous. I was looking for The Mallard as the answer to the question, as it hit a record speed of 126 mph at one point between London and Edinburgh in 1938. However, the Flying Scotsman set the record time for the entire journey between London and Edinburgh. In light of the confusion I generated, both answers were accepted. Thanks to everybody who entered, and good luck if you are attempting the annual Bond Vigilantes Christmas Quiz!

William Blake, Quilter
Chris Summers, FAMC Ltd
John McLaughlin, Brewin Dolphin
Nigel Farmer, Charles Stanley
Rachel Revesz, Citywire
Harry Rogers, Bentley Reid & Co
Joanna McIntyre, Standard Life Investments
John Slater, Medicas
Chris Spink, Thomson Reuters
Chris Rule, Kingfisher Financial
Herman Bakker, VSB
Jacob Nelson, BIS
John Topalian, Topalian Associates
Neil McHaffie, KM Financial
Mateusz Malek, Killick & Co
Mark Jones, Brewin Dolphin
Debbie Behrens, Charles Stanley
Richard List, J O Hambro Investment Management
Ian King, The Times
Bill Crowley, Independent IFA

5 years on

Posted on 10 October 2012 by Richard Woolnough

On the 9th October 2007 the totem pole of capitalism, the S&P 500, peaked at 1,565. Last night it closed at 1,441. So, five years into the crisis, where are we in terms of clearing up the banking crisis?

There’s good news in the US. We have commented on the initial driver of the crisis in the world’s largest economy – the boom and bust of the housing market – on many occasions. Recently, we’ve noted that we’re beginning to see improvement here. This is an important sign that the US is moving on from the financial crisis. Although unemployment remains stubbornly high, it is moving in the right direction and the financial system is looking sound once again. The government’s combination of supportive measures – such as taking equity stakes in banks – and allowing some pain to occur – in the case of Lehman Brothers and housing repossessions – seems to have been largely successful.

The UK economy and financial system have not yet returned to the same state of health and the government still holds legacy stakes in some of the bigger banks. It appears that the problems the country faced five years ago remain, even though they are not as severe as they were. These difficulties are highlighted by today’s Financial Times where the two headline stories relate to the FSA easing bank rules further to encourage lending and help the financial system, and the governor of the Bank of England’s speech at my old university last night where he talked about giving central banks greater flexibility with their inflation targets to help avoid financial crises.

Europe, the third major western financial system, faces its own particular problems. Five years on from the peak we had the strange situation of the German chancellor being taken in a convoy of cars through Athens past illegal demonstrators to try to sort out the continued funding of the Greek state. We have written many times about the questionable sustainability of a politically motivated single currency and the funding of states, individuals and corporates remains difficult in many parts of this system.

We believe financial systems need to be mended by a combination of government intervention and private sector responsibility. The US has led the way in this regard and the UK is trailing, hopefully successfully, behind it. However in Europe the problems have been exacerbated by the single currency regime, where the need for political intervention to solve the problem is relatively large versus the need for private sector adjustments. We are still concerned about whether the necessary political intervention will occur. So, five years on, it appears that the western world is still coming out of the credit crisis, albeit at different speeds and with different levels of success.

The UK’s current account deficit keeps getting worse. Terrible numbers today – time to reduce sterling exposure?

Posted on 27 September 2012 by Jim Leaviss

There were some reasons to be cheerful in today’s UK economic data – second quarter GDP growth wasn’t quite as bad as previously thought (the economy shrank by 0.4% rather than 0.5%), and stripping out the weak construction sector, the economy is growing at a reasonable (if below trend) rate.

But we also had news that the UK’s current account deficit showed a significant deterioration. The gap between imports and exports grew during the quarter, to a deficit of £20.8 billion – equivalent to 5.4% of GDP. Additionally the first quarter deficit data was revised higher by £4 billion to over £15 billion. The relative strength of the pound is hindering the effort of the UK to rebalance its economy away from consumption and towards manufacturing and exports. On a trade weighted basis, sterling is around a 4 year high – helping to feed our addiction to consumer goods (and as a positive side effect helping keep inflation below the BoE’s letter writing territory for the first time in ages).

The chart below perhaps acts as a warning for those of us who by domicile or asset allocation are exposed to the pound. It shows the UK’s current account position going back to 1955, and you can see that periods when the deficit exceeded around 3% of GDP, a severe weakening of the pound often followed. In the mid 1970s the pound fell by nearly 30% against the Deutsche Mark and US dollar, and big falls also followed in the early 1990s, and in the first wave of the credit crisis. Of course there are other things you can point to in all of these occasions (bad UK banks in 2008, leaving the ERM 20 years ago this month) but if the UK’s safe haven status comes under question (for example if we lose our AAA rating post the Chancellor’s Autumn Statement) that might give the currency markets an excuse to revalue the pound downwards.

Incidentally, on a purchasing power parity measure (PPP, which looks at the level of exchange rates needed to equalise the price of buying things in different economies) sterling is fair value against the Euro, cheap against the Australian dollar (which looks 23% overvalued – if you’ve been there on holiday and paid a million pounds for a schooner of lager you’ll know that’s true), but 15% dear against the US dollar.

The UK’s AAA rating looks increasingly vulnerable. Growth negative, borrowing up. It might not matter though.

Posted on 28 June 2012 by Jim Leaviss

On 14th February this year, Moody’s put the UK’s AAA credit rating on negative outlook. This means that the agency says there is a 30% chance of the UK being downgraded within the next 18 months (i.e. by mid 2013). A month later, Fitch moved the UK’s AAA rating to negative too – for them this means a slightly greater than 50% chance that there is a downgrade within the next two years. At the time Moody’s said that “any further abrupt economic or fiscal deterioration would put into question the government’s ability to place the debt burden on a downward trajectory for fiscal year 2015-16″.

Since that Moody’s action, we have seen deterioration, both in economic growth and on the fiscal side. Q4 2011 GDP was revised down from -0.2% to -0.3%, and now today to -0.4%, and an official recession is now occurring with 2012 Q1 GDP growth coming in at -0.3%. Whilst the latest survey of economic forecasts has a median Q2 GDP growth of +0.1%, the impact of the extra bank holiday on economic activity has 35% of forecasters expecting a third consecutive negative quarter. At the same time, and as a direct result of that weak growth performance, government borrowing is overshooting. In May the UK borrowed £18 billion, compared with an expectation of £14.5 billion. This is £3 billion more than in May 2011 and was driven both by weakness in tax receipts (-7% year on year) and higher government spending (+8% year on year).

The government then came out and announced a freeze in petrol duty, postponing a planned 3p rise in the rate due to take place in August. The cost of this, whilst “only” £550 million, appears to be unfunded – there was talk of departmental underspends, although the monthly borrowing numbers don’t seem to reflect such savings yet. As Treasury minister Chloe Smith said in “that” Newsnight interview, “it is not possible to give you a full breakdown (of the underspends)…because the figure is evolving somewhat”. Whilst as a good Keynesian I’m all in favour of fiscal stimulus helping to support the existing monetary stimulus in the UK, this is not the implicit deal that Chancellor George Osborne made with the rating agencies – that being that he would deliver both growth and austerity together and thus get the UK’s debt/GBP ratios down in coming years. Failing to both get government spending down, and to grow the economy means that that debt/GDP ratio will continue to grow, and it becomes increasingly likely that the UK will lose its prized AAA ratings. Whether this matters is a different question – our sovereign CDS spreads are lower than AAA Germany’s (70 bps vs 103 bps), our bond yields are as low as they’ve ever been, and whilst the Eurozone crisis continues the UK remains a safe haven for capital. And as we know, when S&P downgraded the US last year its bond yields subsequently fell. It’s also unlikely that gilts will sell off, as UK rates are pinned at 0.5% (or lower) for the foreseeable future, and more Quantitative Easing is on its way. A downgrade might therefore just be an embarrassment for the Chancellor, rather than the starting gun for a race out of UK bond markets.

Lonesome George (Osborne) should get rid of one and two penny coins

Posted on 26 June 2012 by Anthony Doyle

Some sad news has reached us on the bond desk. Lonesome George, a giant tortoise that lived in the Galapagos Islands, has died. Lonesome George was known as the rarest creature in the world because he was the last known individual from his subspecies. Which is kind of relevant, as today’s blog will be covering another endangered species – one penny and two pence coins.

It was announced earlier this year that in an effort to cut costs, the Canadian government would be eliminating the penny from Canada’s coinage system. Canada isn’t the first country to pinch its pennies. Australia removed its one and two cent coins from circulation in 1992 due to the high cost of production, the United Kingdom lost the half-penny in 1984 when it became more expensive to make than its face value, and after getting rid of its one and two cent coins in 1990, New Zealand followed suit in 2006 with the five cent coin.

The Canadian government has asked businesses and consumers to simply round up (or down) to the nearest five cents at the cash register. Businesses will be asked to return pennies to financial institutions. The coins will be melted and the metal content recycled. Could the UK and Eurozone announce similar measures in the future?

Last year, the UK issued 304,304,000 one penny and two pence coins. The value of these coins is around £4 million pounds. They are copper-plated steel and are around 93% steel and 7% copper. Our rough estimate suggests that this equates to around 1,314 tonnes of steel and 100 tonnes of copper. For some context, a London double decker bus weighs about 15 tonnes.

At current market prices, the value of all this metal is about $1.2 million (metal prices are quoted in USD/tonne). But what if all the one penny and two pence coins in circulation were melted down? We could use this metal for other purposes (for example, the Aussies made Bronze Olympic medals out of their one and two cent coins). Using figures from The Royal Mint, we have found that there were 16.7 million coins produced between 1992-2011 (93% steel, 7% copper) and 14.2 million coins produced between 1971-1991 (97% copper), equating to 39,000 tonnes of steel and 73,000 tonnes of copper. If all the coins that were produced over this period were melted down, the value of all that metal on the open market would be $554 million (assuming that not a single penny was lost or destroyed).

The same analysis for the Eurozone shows that last year’s one and two cent issuance has a scrap value of $17.8 million. Do the peripheral Eurozone nations really have the spare change to mint these coins? The scrap value of all the one and two cent euro coins in existence is almost $200 million.

So is it time the UK and Europe did away with these fiddly coins to save on minting and metal costs for the taxpayer? Some monetary union countries already have. The Netherlands and Finland produce only a small number of one and two cent coins for collecting purposes only. In these countries, businesses round prices up or down to the nearest five cents (Swedish rounding) if paying with cash. Eliminating lower denomination coins in Australia and New Zealand had negligible impact on inflation. Speaking of inflation, one penny in 1970 would buy 13p worth of goods and services today. There are also efficiency gains to be had at shopping tills around the country as businesses move customers through their tills at a quicker rate. And hopefully I would be able to get on my bus faster.

At a time when we are all penny pinching, it’s about time that those in government – including the UK Chancellor George Osborne – started thinking about it too.

Page 1 of 312 3 »

Bond Vigilantes

M & G

Tag Archives: UK