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Yesterday’s Bank of England minutes kept the stage set for another UK rate hike in November.
Members of the Monetary Policy Committee voted to keep rates on hold at 4.75% earlier this month, but they made it clear they are still worried about inflation. Even the dovish David Blanchflower (he’s the economist who discovered that sex makes people happy, you‘ll no doubt remember) resisted voting for a cut, amid fears that wage inflation might pick up.
In the meantime, on the other side of the Atlantic, the Federal Reserve under Ben Bernanke voted to hold US interest rates once again at 5.25%. But his team of policy makers was less happy with the decision – and it’s not hard to see why…
There is dissent in the ranks of the Fed. The US central bank’s meetings were once famed for their harmony and unanimity. Unlike the insubordinate crew staffing the Bank of England’s Monetary Policy Committee, the interest-rate setters of the US have always preferred to present a united front to their citizens.
Now, however, Richmond Fed president Richard Lacker has voted against his colleagues for the second meeting on the trot, favouring a rise to 5.5% .
The Fed acknowledges that “some inflation risks remain”. Of course, the Fed is a master of understatement. Its reaction to the sharp downturn in the housing market – which many generally sober commentators have described as a ‘freefall’ – was to change its description of what’s happening to the market from “gradually cooling” to “cooling”.
But in any case, it’s clear that Mr Lacker reckons quite a lot of inflation risk remains. And as Capital Economics puts it: “If Lacker was willing to make his dissent explicit again it is likely that other members of the committee are still sympathetic, if not outright supportive, of his views.”
Mr Lacker’s right to be worried. Inflation has a much stronger grip on the US economy than on the UK‘s. There’s a simple explanation for that – it’s because real interest rates are far lower in the US and have been for a long time.
The labour costs that are worrying the Bank of England are already rising sharply in the States. And yet the Fed seems to be pinning its hopes on a slowing housing market to take the wind out of the economy‘s sails. But it’s by no means certain that a housing-led slump will mean lower inflation.
In fact, it seems to us that a dive in the housing market will force people to agitate for higher wages. We’ve talked about this in previous Money Mornings. Consumers on both sides of the Atlantic have grown used to easy money. They don’t have to confront their boss or have uncomfortable conversations about wage rises – why bother, when you can just borrow all the extra disposable income you need against your house?
If there’s one thing that is utterly predictable about human nature, it’s that most of us will be at least tempted to continually select the path of least resistance when deciding on a course of action. And when faced with the choice between justifying a pay hike to a sceptical boss, or phoning a nice friendly salesperson to top up a secured loan, it’s no surprise that lots of people would rather reach for the phone.
But when the nice friendly salesperson suddenly stops offering you money – and in fact, starts to want it back – then there’s no one else to turn to except the grumpy boss. And there’s nothing like the fear of being unable to meet the monthly mortgage payments to sharpen up an employee’s negotiating skills.
So as the housing market goes into meltdown and interest rate payments on all those adjustable-rate home loans (the US equivalent of interest-only) increase sharply as the initial period of lower rates ends, you can be sure that pressure on wages – certainly in the short-term – will go up, not down.
That could mean stagflation – and as we point out in this week’s issue of MoneyWeek, out tomorrow, that’s a very scary prospect indeed.
You can read more about the US housing market in tomorrow’s issue. If you’re not a subscriber yet, you can get access to all the content on the MoneyWeek website and sign up for a three-week free trial of the magazine, just by clicking here: Sign up for a three-week free trial of MoneyWeek.
Turning to the stock markets…
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The FTSE 100 closed 34 points higher yesterday, at 5,866. Blue chips were lifted by bid talk and expectations that the Fed would leave interest rates on hold. Takeover chatter saw British Airways make the biggest gains of the day. For a full market report, see: London market close
Elsewhere in Europe, the Paris CAC-40 ended the day at 5,192, a 76 point rise. The Frankfurt DAX-30 was also higher, climbing 80 points to 5,954.
Across the Atlantic, lower oil prices and strong earnings boosted stocks, despite some disappointment that the Fed has not ruled out further interest rate hikes. The Dow Jones closed 72 points higher at 11,613. The Nasdaq closed 30 points higher at 2,252, a four-month high. And the S&P 500 ended the day 6 points higher, at 1,325.
In Asia, the US interest rate decision saw the Nikkei recover from a shaky start to end the day 115 points higher, at 15,834.
The price of crude oil fell again yesterday, but had risen slightly to $61.13 a barrel this morning. In London, Brent spot had fallen over 1% overnight, last trading at $59.21.
Spot gold last traded at $578.50, down from $580.10 in New York last night.
And in London this morning, Britain’s fourth-largest supermarket, William Morrison, posted a first-half profit of £93.4m. The return to profitability was secured by reducing costs related to its acquisition of Safeway, including closing distribution centres and cutting jobs. Shares in the grocery chain rose by as much as 12p in London this morning.
And our two recommended articles for today…
Is the bull market in commodities over?
– The gold price has fallen by 20%. Commodity prices in general are down 10%. Some economists, such as Stephen Roach (see tomorrow’s MoneyMorning for more from him) are feeling bearish again. But Steve Sjuggerud is still confident that the commodities bull has further to run. To find why he thinks we are merely undergoing a correction – and how long it will last – see: Is the bull market in commodities over?
How the Fed failed to prevent the housing bubble
– We have been featuring a lot of different opinions on the US housing slump lately, but its impact on the global economy cannot be understated. To find out why Kurt Richebächer of the Daily Reckoning thinks the Fed’s monetary tightening policy was a farce, and what the fallout from the US housing slump will be, read: How the Fed failed to prevent the housing bubble