The MPC – What comes after the rate cuts? by John Redwood, Evercore Pan-Asset, 9th April 2009

April 9, 2009 - PRLog -- This month’s meeting of the Monetary Policy Committee would be a good opportunity to review their progress with the latest adventure in monetary policy, quantitative easing. Few think the MPC is going to cut interest rates. Most accept they will keep them at a very low level for the foreseeable future. All that implies people remain pretty gloomy about prospects for the real economy. One would assume as soon as recovery becomes apparent the interest rates will have to go up to start to contain the inflationary pressures which current easy money will then generate.

Over the last month longer-term gilt edged rates have risen, despite the government’s purchase programme and the presumed intention to get the government’s borrowing rate down. It would be helpful if the MPC would provide the markets with more guidance about how much money they intend to create and spend on buying gilts. Is it £75 billion, or the full £150 billion they have permission to spend? Did the Governor’s warning note mean they might not create even the first full £75 billion? It would also be useful to know what level of interest rates for say 10, 20 and 40 year money they want. After all, it will be a rigged market for a bit, and they are the ones who can print enough and buy enough to move the rates. I would guess they will spend all the first £75 billion and then review again.

It would also be helpful if they could provide some commentary in their next minutes of what they are trying to achieve with quantitative easing. Clearly it is not to hit an immediate inflation target, as they remain 60% over target on the latest figures.  Is to hit some future inflation target? If so, why are they so sure we face declines in prices next year and the year after unless they print more money? Have they taken full account of the impact on prices of the lower pound, and of the aggressive pricing now being put through by branches of government and the nationalised industries?

If the aim of quantitative easing is to create more deposits, to literally print more money, then can we know how much more they want? Money growth has been faster in recent months. How much faster do they want it to be , and how are they measuring it? If the aim is to achieve a given level of longer-term interest rates, let us know what they are. If it is to achieve a given level of corporate bond funding at a specified average interest rate, let us have some indication of what they are trying to do.

Markets dislike uncertainty, but also move and thrive on it. It is not usually wise for authorities to look shifty or uncertain. We do need to know more of their intentions. We remain negative on UK prospects, whilst these uncertainties are sorted out.

Meanwhile, in the real economy, industrial output is now down by more than 10% over the last year. We should expect more job losses and continuing problems in many sectors. Rental falls are now most marked in the West End as well as in the City. Dividend cuts are common. It is still not possible to form a considered view on what is the sustainable income level on UK shares, or to be precise about how much damage to the long-term trend rate of growth this Credit Crunch will do. What we can be more sure about is dividend paying capacity remains much impaired, and the medium-term growth outlook will be worse than in the credit turbo-charged days before 2007.

# # #

We belive that carefully considered asset allocation decisons is the cruicial part in the investment management process and argue that identifying the correct asset classes in which to invest is more important than selecting the underlying stocks.