Osborne in a fix as US Fed balance shifts towards rate-rise hawks

A rise in rates will make a nonsense of the Chancellor’s Budget

UK Chancellor Osborne…rate rises will destroy his Budget predictions

A surprise increase in the number of inflation-phobic Federal Banking Board members augurs a swifter rise in rates than either Mervyn King or George Osborne would like. In particular, the Chancellor’s Budget projections would be blown miles off course – and the Government-owned banks plunged into further crisis.

The Slog has posted before about regional US Fed bank heads getting their day in the sun to tell everyone that Washington is wrong. More often than not, I’m bound to observe, the speeches they make offer a lot more commonsense than either Geithner or Bernanke. (I’ve given up mentioning the President in this regard, because he clearly hasn’t a clue about the economy and its fiscal management).

So far, folks from all points of the compass (most notably Dallas) have given Big Ben a roasting about QE and the spiralling US debt in general, and the need to raise rates in particular. This is an interesting tendency, given that any rise in rates will accelerate the growth of US debt overnight: if rates went to, say, 3.5% again, one tax dollar in three would go to servicing the country’s debt. The local Fed members do have a point – but the rock and hard place theory now applies to all US actions, and is an unavoidable diktat.

However, on Friday last we saw the first effects of recent rolling Board membership change, and an increase in those regional bankers wanting inflation to be tackled with higher rates. Philadelphia Federal Bank member Charles Plosser proclaimed his desire for the Federal Reserve to change to a strategy of inflation control only – that is, stop QE and raise rates. We have been endlessly through why Ben, Osborne and Trichet have to  rush to the lavatory every time such things are suggested, but there remain some folks who think that society is more important than banks.

What was interesting, once Plosser had made his point, was the sudden headlong rush of other regional Fedders to get their three-ha’pence worth in. Chicago Fed President Evans hastened to the nearest microphone adding his support – and despite being stuck in a boring business meeting in Marseilles, Minneapolis Fed President Narayana Kocherlakota told the media that he too was for an abrupt end to QE. Finally, Atlanta member Dennis Lockhart said late on Friday that he just didn’t see the case for more QE – but he did see the case for dampening inflation.

Now as we’ve seen, George Osborne’s response to Bank of England MPC detractors has been to find a suitable Gulag somewhere else for them, as quickly as possible. But even this has still left a fine balance on that committee. And if stronger US payroll data emerge this coming week, the Fed’s rate hawks would have still more ammunition in favour of interest rate rises.

Much of Osborne’s Budget was based on the assumption of continuing low interest rates. Consider these extracts from his Commons speech:

‘Today our country’s market interest rates have fallen to 3.6%.We have a higher deficit than Portugal, Greece and Spain, but we have virtually the same interest rates as Germany. This is a powerful monetary stimulus to our recovering economy…..the [Office of Budget Responsibility] expect real GDP growth of 2.5% next year: they forecast it will then rise to 2.9% in 2013, 2.9% in 2014, and followed by 2.8% in 2015….Our fiscal mandate is to achieve a cyclically-adjusted current balance by the end of the rolling five year forecast period….that debt should be falling as a proportion of GDP by the year 2015-16…’

Even if the Government opts out of rate hikes to create a weaker Pound (and thus help exports) such weakness will reduce confidence and increase borrowing costs – as of course will rate rises being followed by those from whom we borrow. And if rate rises are adopted in the UK (let’s get real here, they must be) then the ‘monetary stimulus’ argument goes out of the window.


This is merely the latest stage in the continuing battle between the desires of banks and the needs of real people. Economies get depressed, but very few people die. Inflation destroys cultures and political systems given half a chance. But a rate rise to control inflation would immediately make the banks vulnerable to their lunatic rate-derivative bets.

Rate rises in the end are inevitable. Mervyn King knows this – hence his desire (along with Ken Clarke) to prepare people for the worst: a 2008 Part II to make the first part of this movie look like the first twenty minutes of the Exorcist: lots of creepy rumblings, but no Devils rising from Hell. The next time, every Satanic jackal will be unleashed.

The vast majority of us will benefit from it in the long term. The medium term, however, doesn’t bear thinking about. For George Osborne as the Chancellor of  a hugely indebted, economically imbalanced country, it is a nightmare he must think about. It is, after all, his job.

11 thoughts on “Osborne in a fix as US Fed balance shifts towards rate-rise hawks

  1. I fear you will be proven right, but its simply not the case that you must be.
    A Litre of petrol is currently 55p, with an additional 75p tax.
    The oil price could double, and yet the price of petrol could fall at the pump.

    Does George have the nads to do something so drastic?
    Probably not…

    I’m afraid we must think of the midlands, because to get to your grass is greener sunlight uplands, we’re going to have go deep into the fires.
    I’ve got my first four chickens, might pick up another four in a few months.


  2. I’d like to believe this, but I’m afraid I can’t. I can see ZIRP lasting indefinitely, just as it has in Japan.

    Fed and MPC hawks are just part of the theatre. A long, slow decline in living standards can be massaged by news management. A sudden crash can’t be.


  3. Welcome back JW :-)

    The trashing of zirp should be good news for many people if it happens, but I’m acutely aware of IntenselyRelaxed’s comments…he may well be right. Time will tell.

    Apart from the risk of a further banking crises caused by int/rate derivs, I have already articulated several times that zirp is not only immoral as it punishes the very people who did not play a part in the 2007-8 financial crises and rewards those who failed to conduct due diligence, but it’s also largely ineffective in helping to restore normality to our economy (house market still in the doldrums, borrowing at low levels, growth low etc). The major beneficiary is govt from higher inflation and the banks from running wider borrowing/lending spreads.

    It’s obvious why the venal Gordon Brown introduced zirp but Osborne should have dumped it soon after he came into office. He chose not to. Instead, he has reinforced it by dumping Sentance from the MPC and making his desire to retain zirp well known.

    The bare faced lies being spouted by Merv and Osborne about inflation being “external” and higher IRs would not deal with it, is quite appalling.
    They are taking people for idiots. More than any other single policy, continuing with zirp has caused me to lose a lot of trust/confidence in the Tory Coalition.

    I hoped the new Govt would be an honest and strong reforming govt, but they’re turning out to be another flavour (albeit a better taste) of the last socialist govt. They’re missing a once-in-a-generation opportunity of remodelling govt into somethng that actually works for people.

    It’s all very sad.


  4. “The bare faced lies being spouted by Merv and Osborne about inflation being “external” and higher IRs would not deal with it, is quite appalling.”

    Although I’m not one to put much faith in Bernanke, what he wrote about oil shocks not causing recessions, but central bank over reaction causing them appears to be borne out by results.
    The EU has acted on the oil price rises and has caused themselves huge problems by doing so, and for little gain.

    Any thoughts on when this is all going to fall apart. I really cant see it making it past August, but not sure if I’m just wishfully thinking it’ll last that long…


  5. I didn’t know that Bernanke had said that, but if so, IMO he’s wrong.
    If one accepts that we’re already in the peak oil phase of supply, then we can look forward to relentless rising oil prices over the coming years until it finally depletes.
    It isn’t clear to me that Brit politicos understand this and the media are mostly ignoring it.
    When the oil price fell after the financial crash, I predicted that it would quickly rise again when the global economy showed signs of recovery, caused by rising demand and constrained supply. That’s exactly what has happened (note that the oil price was already rising before the M/E and The Colonel got their knickers in a twist).
    That scenario makes it very easy for economic activity to be dumbed down by rising oil prices leading to quasi-long term recession, absent new, clean, green energies to replace the black gold. Way to go.


  6. Think of White Wednesday
    The UK kept raising rates in to the teeth of a recession, to fight inflation caused by (well, germans, but theres was caused by oil), as soon as we gave up, we entered the longest economic boom ever. Admitadly, we definatly should have popped the boom a decade earlier than we did.

    The price of oil was doing far less damage than the central banks inflation fighting.

    PO is a tricky subject.
    Yes, it will eventualy run out, but if you look at the production figures, economic growth was deshackled from it long ago. Production is barely above where it was just before the arab embargo, yet any measure of wealth would say we are 5x better off at an absolute minimum.

    If oil really does run out, we’ll crucify greenies and use coal liquids.


  7. Pingback: BREAKING….US Government bond spreads in historic narrowing | The Slog

  8. @TheRagingTory

    Nah, we’re not 5x better off, we’ve just ramped up credit creation (i.e. borrowing money from future production that isn’t going to happen) to give the illusion of being better off.

    Peak Oil means the end of industrial western civilisation, I’m afraid. Although I do agree we’ll shove any old muck into our petrol tanks to fend off the inevitable as long as possible.


  9. Ignore the 4×4’s and the villas in tuscany.

    How many kids in the UK in the 70’s had 1 pair of school trousers, 1 school shirt, 1 school jumper and 1 set of “playing out” clothes?
    Growing up, I had ‘a’ pair of jeans.
    I quite literaly have 30 pairs of jeans now.


  10. One for each day of the month?

    Well, we can only wait and see over the next 5-10 years to see which of us is right. My own opinion is that people in the West think progress only moves one way – there are loads of historical examples that show it doesn’t.


  11. IR
    Nar, just from stuff like, being out shopping, arranging to meet some mates, nip into ASDA and grab a pair of jeans, a shirt, a pair of shoes, and off you go.

    True, progress can be reversed, but my point was merely that despite the fat that oil production has gone up by 10-15% in the last 30 years, economic growth has been some 500%
    And remember, although you can borrow money from the future, you cant borrow energy or oil.


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