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Burning rubber
by Tony Butcher
2007-10-06 09:43:24
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What a massive policy change professional economists can make in two months. These highly paid individuals employed by the biggest names in the corporate banking sector have switched instantly into reverse gear over the past 60 days as the wheels have come off the commercial lending markets.

As their tyre tracks mark the road of economic growth I would not be surprised if the Monetary Policy Committee could smell the rubber burning. Experts who were calling for a further 25 basis point hike on August 2nd are now urging the Governor Mervyn King and his eight other members to begin shaving rates before the year is out.

Not long ago all of the global central banks were unified in their commitment to “not bail anyone out” of high risk investment positions. So the Federal Reserve’s first response was to cut 50 basis points on the discount rate (the rate at which commercial banks borrow from the US Government), then a further 50 basis from the Fed Funds rate. The European Central Bank backed away from its “Strong Vigilance” commitment to a quarter-point hike in September and it seems Mr King is under enormous pressure from the UK Government to steer the best course through the choppy waters of Northern Rock.

We all saw the queues of people waiting to cash in their life savings from Northern Rock after they approached the Bank of England for emergency funding. They became a high-profile victim of a complete evaporation in commercial lending which has seen overnight and 3 month interest rates reach multi-year highs in Europe and across the pond. The problems are still evident and every day we get a little more detail of the problems that are currently handicapping parts of the commercial banking sector.

It is reckoned that Northern Rock borrowed a total of around £10bn from the Bank of England during their troubled times, so while JC Flowers does due diligence on the books to place a bid for the largest mortgage lender in the UK, the news wires are reporting the extent of the damage at investment banks across Europe with Deutsche Bank reporting a drop in profits and UBS announcing job loss within their fixed income department. Does anyone else remember reading those glamorous headlines of record city bonuses at the start of the year?

So what do we have to look forward to before year end…well in about a fortnight we have the 20 year anniversary of 19th October 1987, the second largest percentage drop in the Dow Jones Industrial Average. If the stock markets love anything, it is an anniversary. We have the next round of GDP figures to be released and although they will not contain all the effects of the recent turmoil central banks need a gauge of the problems they face. Will the MPC or ECB cut rates?

I haven’t slammed into reverse yet, I have just changed down to a lower gear for the steep incline we face over the next few quarters. I also think the Federal Reserve in the United States will keep their remaining power dry, especially as they will be keen to see if inflation starts to creep higher as elevated crude oil prices and agricultural inflation begins to enter the economy.

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Emanuel Paparella2007-10-06 14:54:52
As the saying goes: it's a global market now. It never ceases to astonish me how we know everything there is to know about each other's ecomomy on both sides of the Atlantic pond. One wishes there was the same interest in cultural matters. Alas, those tramsatlantic bridges of understanding that our grandparents built after World War II are now ready to collapse and few are ready to repair them. At the risk of sounding like a prophet of doom here is a prediction (which is not determinist however...): when those bridges of understanding collapse in the West, the global economy will also collapse with them and no demiurge called "the market" will be able to save it.

Asa2007-10-06 20:37:55
Welcome back to the Ovi Team, lil bro!

Simon2007-10-06 21:23:21
Did you know that Mervyn King is married to a Finn?

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