Markets rumbled inept government and weak Bank of England

How many academic economists does it take to change a light bulb? When it comes to the Bank of England’s Monetary Policy Committee, it seems the answer is nearly all of them*, with someone from the Treasury holding the ladder. That the MPC lost its way has been glaringly apparent to outsiders for months, but thanks to the narrow practical experience of its members it has taken rather longer for them to see the light.

But boy, have they had an education this week. Academic economists, like economists everywhere, can always find something to quarrel about, but the MPC lacks members with knowledge and understanding of how markets work and why it is so dangerous to ignore them. Nobody knew this better than Eddie George, the first chairman. The cumulative result of the many changes of personnel since was witnessed last week in the simultaneous crash in sterling and the price of government debt as the Casino Budget followed the MPC’s pusilanimous half-point rise in Bank Rate.

A fall in the exchange rate alongside plunging bond prices is a terrible combination, typically seen only in struggling third-world countries after years of economic blunders. It’s as if the UK was becoming a banana republic without the bananas. The impression is of an administration where half-baked ideas are imposed as policy without discussion of the risks or consequences.

This has been made worse by weak leadership at the Bank. Andrew Bailey demonstrated a triumph of hope over experience when he was promoted from the Financial Conduct Authority, despite its massive failure over London Capital & Finance on his watch. He is only one vote on the MPC, but the chairman sets the tone, and the tone has long been to pretend that interest rates at levels designed for a banking crisis were somehow the new normal. Even today, at 2.25 per cent, Bank Rate is at a level that might have been considered suitable only in an emergency not many years ago. Heavy hints that it will go up at the next meeting – still over a month away – have failed to turn the tide for sterling or government stocks this week.

As a result of the failure at the MPC to realise this last year, rates will rise higher than earlier action would have prevented. All the while, the political pressure will be on, with so many recent homebuyers unable to afford any significant rise in mortgage costs. Last Friday’s cut in stamp duty may be only the first desperate measure from the Chancellor to prevent a much-needed fall in house prices.

Successive British governments have turned home ownership from an admirable aspiration into something more akin to an addiction. Purchasers are led to believe that the housing ladder is an escalator, and experience has reinforced this belief to the point where most buyers need to take on extraordinary debts for very ordinary homes.

A housing market crash is the last thing the UK economy needs, but prices are grossly inequitable in a way never seen before, and must come down to rebalance the market towards the buyers. Of all the pressing supply-side reforms that we hear so much about, this is probably the most urgent. Perhaps the only good news in a truly grim week to remember came from Mark Carney, the unreliable boyfriend, former Bank Governor and fan of “forward guidance”. His contribution this week was to complain that the maxi-budget was undercutting the Bank. If his forward guidance is as good as it used to be, maybe things are not so bad after all.

*MPC academic economists: Broadbent, Ramsden, Pill, Haskel, Tenreyro, Mann, Dhingra.

Treasury: Cunliffe.

Let them burn wood

Who said: “Importing US-made wood pellets to be burnt for energy by power company Drax is not sustainable and ‘doesn’t make any sense’”. Who, that is, apart from anyone who has studied the push-me-pull-you that is the business model of what was once Britain’s biggest coal-fired power station operator?

The remark was made a little over a month ago by the Business Secretary, now Chancellor of the Exchequer, Kwasi Kwateng. The world has been turned upside down since, but the process makes no more sense today than it did then. Cutting down trees, making wood pellets, shipping them across the Atlantic to be stored in expensive containers before burning them to make electricity sounds like something straight out of Dr Doolittle.

It’s only worth Drax doing this because of the subsidies we pay it, £1.6bn in the two years to 2020, according to energy specialists Ember Research. All this for “the UK’s single largest CO2 emitter.” Even making the pellets is more brown than green. Drax has been fined $6m in Mississippi and Louisiana for pollution offences. Meanwhile, thanks to the absurd way power generating companies are rewarded, Drax is having a wonderful time with its prices, although it is clear from the shares’ recent performance that investors do not believe it can last. Quite right too. As an example of our “bonkers” energy policy, being paid subsidies to pollute is hard to beat.

We hate to lose you…

So farewell then, Andrew Formica, transported this week to Australia. Those who committed their savings to the fund management companies he ran will not be sobbing and waving their hankies. His last triumph here was running Jupiter, and in three years he has taken the share price from £4 to 93p, while billions have fled the company’s funds. When he announced his departure in June, he reckoned that he had “built a solid base” for the business for his successor. It’s a fine business, fund management – for the fund managers.

How on earth did the UK end up having to fling £150bn at the energy market just to keep the lights on? Is it just because of Vladimir Putin, or does it also involve poor decisions taken far nearer to home? In this week’s A Long Time In Finance Jonathan Ford and I talk to energy expert Nick Butler about the history of what happened, what went wrong, and how we might put it right.

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