BOE Minutes Showed a 6-3 Split on Interest Rate Hike

The dollar sold off through most of the day on Tuesday, but seems to be stabilizing this morning. The selloff began early yesterday morning with the release of US housing data and the industrial production numbers. Housing starts, which were expected to show a small increase, were actually down 10.6% MOM. And the future isn’t so bright either, as building permits also fell 4% MOM in April. The previous month’s numbers for housing starts were revised up slightly, but this revision was offset by March’s permit number, which was revised down. As I wrote yesterday, the US housing market continues to be a drag on the economic recovery, and a rebound isn’t in sight.

The other big data released yesterday were the industrial production and capacity utilization numbers for May. Industrial production in the US was flat, and capacity utilization edged lower. Both numbers were less than estimates, and reflect an economy that is struggling to find a foothold on the climb back out of the depths of recession.

The biggest news on this morning’s wires is the Bank of England’s release of the minutes from their May 5th meeting where they left rates unchanged. The vote was 6-3, with one member calling for a 50 basis point increase and two others for a 25 basis point rise; but the majority still warned against any rate increase. The minutes stated that a rate increase now “could adversely affect consumer confidence, leading to an exaggerated impact on both spending and firms’ perceptions of their desired productive capacity.” The pound sterling (GBP) had risen in anticipation of a future rate increase by the BOE, so the minutes were not good for the pound which dropped 1.5 cents after the announcement.

The pound rose against the dollar yesterday as a report showed that inflation had accelerated 4.5% last month from a year earlier. But jobs data released this morning convinced the BOE that their economy is just too weak to allow a rate increase. Jobless benefit claims in the UK increased 12,400 from March and stand at 1.47 million.

The BOE finds itself in a very similar position to the FOMC, which shouldn’t be a surprise, as the US followed the UK down the path of QE. Both central banks are now dealing with risks to their economy of a stubbornly high unemployment rate offset by rising prices. The UK, like the US, has decided to try to stimulate their economy first, turning a blind eye to the inflationary pressures that continue to build. But while both economies benefited from the additional stimulus in the short term, neither economy seems to be able to pull themselves out of the malaise of low growth and continued joblessness. QE has not, in my opinion, had a long-term positive impact on either economy. And worse, this quantitative easing ‘experiment’ that both the BOE and FOMC have been conducting could have very dangerous consequences for the long-term health of our economies. Neither central bank seems able or willing to stop the ultra loose monetary policies. Stimulus spending has become a drug to which both administrations have become addicted.

As expected, the US blew through the debt ceiling yesterday, but Treasury Secretary Timothy Geithner prevented a default by arranging a short term ‘loan’ of billions from the government pension program. The money should allow the US to continue to pay its bills through the summer, and most are expecting a deal by congress to raise the debt ceiling sometime soon. To his credit, Secretary Geithner did sound warnings about the deficits, saying they put the US economic foundation in danger. He warned that “neither Congress nor the administration should be able to use unrealistic assumptions about future economic growth or future political courage, or any other forms of magical thinking, to minimize the magnitude of the reforms that will be necessary”. Strong words by the Treasury Secretary, and hopefully they won’t fall on deaf ears (more magical thinking!).

The euro (EUR) gained against the dollar for a third day as European stock markets moved higher. The euro rose in spite of data that showed German investor confidence declined for a third month in May. The ongoing sovereign debt crisis, and higher energy prices have lowered the level of confidence in the German recovery. European Union President Herman Van Rompuy fired a shot at China, saying the euro is “too strong” compared with the Chinese renminbi (CNY). Von Rompuy was giving a speech in Beijing and was encouraging the Chinese leadership to invest into Europe, which would cause a further appreciation of the euro versus renminbi, which is exactly what he doesn’t want to see. He is in a similar position with the Chinese as the US. Both Europe and the US want and need the Chinese investments, but at the same time they are beating up the Chinese on the low value of their currency.

Sweden’s krona (SEK) climbed last night as the country said it would have a larger budget surplus than previously forecast. Sweden’s government surplus will be 99 billion or 3% of GDP according to a report released this morning. The surplus will remain in 2012, but narrow slightly. The Swedish currency is the second best performer versus the US dollar this year, just slightly behind the euro (both are up just over 6.1%). Sales of state held shares in two major Swedish companies helped boost the surplus, but increasing tax income from the ongoing economic recovery has also added to revenues.

Sweden is expected to grow 4.7% this year following a 5.5% jump last year, so tax revenues should continue to be strong. The government is using this surplus to pay down debt, reducing the amount of bond issuance by 8 billion krona in 2011 and 16 billion in 2012. Novel idea, a central bank that is actually spending less… What do you think the US would do with a surplus? I guarantee our elected officials would find ways to spend the extra money, and would be proud they didn’t have to increase the debt limit!

Riksbank Deputy Governor Lars Nyberg wants his government to charge its banks to cover Sweden’s costs to hold reserves in US dollars. The move is designed to persuade Swedish lenders to cut back on ‘risky’ loans in the US currency. Apparently Nyberg is worried about the falling value of the US dollar, and the mounting risks of the continued debts and deficits being run up by the US. While the total amount of US dollar reserves held by the Riksbank is small, it is another sign of the growing global concerns regarding the reserve status of the US dollar.

The Japanese yen (JPY) fell after Bank of Japan Governor Masaaki Shirakawa said his economy is in a ‘very severe’ state. Japan has been mired in a deflationary environment for the past several years, and ultra low rates haven’t been able to help boost the economy. The recent earthquake will add to the negative sentiment, and a report tomorrow will likely show that GDP in Japan fell at the fastest pace since the financial crisis. Surveys show that the central bank’s governors will keep interest rates near zero and maintain their quantitative easing programs when they meet later this week. There certainly seems to be a pattern developing for countries engaged in QE. It simply doesn’t work! It does promote spending while the money is flowing, but there is no way to exit the programs without taking away the gains that were produced.

To recap: US housing and industrial production data disappoint, and illustrates that the US continues to struggle to recover. The Bank of England minutes showed they were split on a rate increase, and markets pushed the pound lower. The US blew through the debt limit, but Geithner arranged a rescue using government pension funds. Sweden continues to be a star with a strong budget surplus, and Sweden’s central bank is looking to charge banks that hold risky US dollars. Finally, the Bank of Japan Governor warned that the Japanese economy is in a very ‘severe state’; so how’s that QE doing for you?

Chris Gaffney
for The Daily Reckoning

The Daily Reckoning