To Be, or Not To Be: Extending Economic Stimulus!

Today it is the turn of the Bank of England to once again address the issue of whether, on the back of the sharp rise in inflation last month, to leave interest rates alone or raise them and more importantly, whether February is the right month to announce that with the economy still so fragile that a further extension of quantitative easing is necessary. As is almost usually the case this is also the day that the European Central Bank will also decide interest rate policy across the Eurozone as well. Neither BoE nor ECB interest rates are expected to be altered today and as, by tradition, there is no FED meeting in February we may at least console ourselves that US rates are unlikely to change for many months yet and certainly not before the next meeting of the FED due on March 16th.

However, in light of what some now believe could be disappointing US Non Farm Payroll figures due Friday and despite the mixed reception that the Obama budget has so far received the question of whether or not to extend various of the Obama economic stimulus measures and whether maybe even that some of the older Bush tax incentives that are soon due to have run their course should be retained is I understand far from being done and dusted yet. Whilst the balance of US economic data over recent weeks and months has been more favourably disposed to positive news we note too that given recent housing news and uncertainty over new job creation albeit that there has been a surge in temporary employment of late that the balance of expectation toward sustainable growth may soon show signs of slipping.

Meanwhile most stock markets appear to be content to believe that recovery in the US, Eurozone and Asia will all be sustainable through 2010 into 2011 at least. I hope they are right although for now I will remain in the sceptical camp that prefers to believe there may be just a little too much wishful thinking in that argument. Mindful too of rating agencies upping their game with further warnings to the likes of the UK, the US and Greece that are, so to speak, certainly under increasing watch and possible downgrade if they miss out on growth this year such concerns cannot be understated. Sure, I may have little regard for the rating agencies following their own failure to play a larger part in the previous rot but that does not mean I can afford to ignore them. Neither can governments. The prospect of some countries suffering downgrades is not just a threat – it is real. It seems to me and some others that despite taking the view that stock markets have only been marking time since October despite some erratic movements in the meantime that there is still too much optimism around that all the problems have been solved. In the UK they certainly have not and neither have they in Greece, in Ireland, in Portugal or Spain. While stagnation remains a justified fear for the near term we continue to express a view that this is no time yet for governments to be talking exit strategies and certainly no time yet to take the foot off the stimulus pedal. Whether any or all of them have returned to growth yet or not there remains substantial work yet to be done by governments to bolster still low levels of growth return.

At the time of writing we are 30 minutes away from the February rate decision from the Bank of England MPC and to hear what it will say on QE. As of the end of last week the Bank had as far as we know completed £200bn of asset purchases that had been agreed under the first two tranches of the scheme. Bets are on as to what the BoE will do next on this – leave it alone this month staying out of markets for a bit watching which way the economy moves for maybe another month or say very firmly that it will soon be back with a Tranche 3 buying efforts that may total another £25bn. If the BoE does decide to move back into the market today the market will be both surprised and bewildered as to the mixed messages being sent. My guess is that Gordon Brown would be delighted. On the radio this morning I was asked my view whether QE had worked or not. An interesting question of course and one to which I concluded an answer that said whilst the process of QE is an imperfect science the likelihood is that there has been substantially more benefit accrued to the economy in recent months than there might otherwise have been. In other words it has part worked but it took an awfully long time to begin to show through. So, what now what will and what should the Bank of England be doing now that the £200bn spending exercise has effectively been completed on this largest of all UK stimulus measures? As I say, today perhaps nothing except to tell us loud and clear that the Bank is watching all options, watching the economy extremely closely telling us why it is worried and, mindful that the likelihood of a sustained period of growth emerging during 2010 looks slim, saying that it may well extend the £200bn asset purchase scheme further in the months ahead. When should that process begin? At the latest in April!

Late last evening the UK government chose to slip out news that it had decided to extend the car scrappage scheme by yet another month essentially because there was still room for about 70,000 potential uses of the scheme to benefit. Read into that what you will and I have no doubt that there may well be a degree of potential electoral politicking in the decision and also on a day that was already dominated primarily by negative news an attempt to keep up the momentum of initiatives for growth. Even so, while we agree that the overall benefit to the economy of the car scrappage scheme may be only about 0.1% GDP (a view expressed by Capital Economics today) that there is no getting away from the fact that this is one of the few stimulus measures that really did what it said on the tin. Indeed, we note today that UK January car sales rose by no less than 29.8% last month albeit from the lowest actual previous year January base almost in living memory. Note that as no new government money is involved the taxpayer will only suffer the loss that had been expected at the time of the last extension.

Back at the Treasury with a General Election just around the corner we may suspect that the Government has little intention of taking its foot off the stimulus pedal just yet. Desperate for good news and disappointed by the worse than expected Q4 GDP figures last week we may be sure that whatever short term measures the government can come out with and that don’t come with a too large up front cost will at the very least be maintained. Buy your new boiler and car now then! Neither do we expect that the upcoming UK Budget will do anything to change the pattern of providing whatever short term stimulus measures they can even if for the lost part we are talking doing little more than nothing to make the situation worse. I am in little doubt that stimulus measures do work of course or that for 2010 they must be continued. On the other hand I am also aware that at some point the crossroads that leads to balancing the books and beginning the long process of paying down the National Debt must begin. When should that occur in the UK? September this year at the latest from a perspective of beginning the process of cutting government spend but not so from the perspective of the Bank of England on either QE or interest rates.