Bank of England warns banks of risk of sharp global interest rate rise

Reuters is out with an intriguing bit of news.

Mervyn King, the governor of the Bank of England, has issued a stunning warning:

The Bank of England warned banks and borrowers on Wednesday about risks from a potential abrupt rise in global interest rates, and said banks might need to further bolster their capital cushions to protect against this.

The past week has seen a sharp rise in global bond yields since U.S. Federal Reserve Chairman Ben Bernanke said that the U.S. central bank may scale back bond purchases later this year.

BoE Governor Mervyn King said on Tuesday that markets had "jumped the gun" in their sharp reaction to Bernanke's comments, but the BoE's half-yearly Financial Stability Report said more bond yield rises could hurt UK banks, insurers and borrowers.

The BoE said that it had ordered an investigation into the vulnerability of Britain's financial institutions and borrowers to higher interest rates, to report back by September to its new risk watchdog, the Financial Policy Committee.

"Financial institutions and markets are also vulnerable to an abrupt rise in global interest rates. And some UK borrowers remain highly indebted, which could result in losses for UK banks," the FPC said.

It's an intriguing statement because King, as we all know, steps down at the end of this month as the head of the Bank of England.

His replacement? Former Canadian central bank chief Mark Carney, who many economists expect to advocate a long-term commitment to low interest rates as a way to keep down bond yields.

King's call for higher capital requirements has bankers privately complaining that higher capital requirements and limits on leverage are hampering their ability to lend. But this is strongly disputed by the BoE, which says healthier long-term capital levels make it cheaper for banks to borrow.

Wednesday also saw the BoE allow banks to scale back some of the short-term cash they hold against shocks to encourage more lending to the economy.

Many believe the BoE is a long way from tightening monetary policy, and a minority of BoE rate-setters have been voting for more stimulus for the past few months due to the weak state of Britain's economic recovery.

So what gives with Mervyn King and his warnings of a sharp global interest rate rise on the eve of his departure of BoE governor?

Is his looming retirement giving him the freedom to say what he really fears?

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The 2011 Great Global Bailout

The big news today is a massive bailout of the banks of Europe by the US Federal Reserve and the world's reserve currency.

Faithful readers know that we are fond of saying the financial debt crisis of 2008 is very much alive and it is clear for everyone to see that it had only been treated with a paper band-aid known as Quantitative Easing 1 and QE2.

Those economic green shoots touted in 2009? Nothing more than weeds.

The breadth and depth of the financial earthquake the world suffered in 2008 was so great that the repercussion's are only just beginning to be understood.  And the recession it triggered has not ended... it has only just begun.

One of the news stories that flowed well under the mainstream media radar screen back in July was the results of an audit of the US Federal Reserve.

The first ever Government Accountability Office (GAO) audit of the US Federal Reserve Bank in the Fed's 100 year history indicate that the bank dished out $16 trillion in emergency aid to U.S. and foreign banks, corporations and governments in what the Fed calls all-inclusive loans during the financial crisis.

$16 Trillion!

In all the Fed disclosed more than 21,000 transactions which it utilized after Lehman failed to push as much liquidity into the worldwide financial system as possible to stabilize things.

Fast forward to today.

The debt escalating debt contagion stories coming out of Europe the past two weeks have been breath-taking.

It has forced the US Federal Reserve to step in again and bail out Europe's banks with unlimited access to US Dollars.

Here is the European Central Bank announcement:

• The Governing Council of the European Central Bank (ECB) has decided, in coordination with the Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank, to conduct three US dollar liquidity-providing operations with a maturity of approximately three months covering the end of the year. These operations will be conducted in addition to the ongoing weekly seven-day operations announced on 10 May 2010.

As noted over on The Fundamental View, the global printing presses are now running full tilt in the most historic liquidity event ever.

In essence the Governing Council of the European Central Bank (ECB) has decided, in what is being deemed as a coordinated effort with the US Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank to conduct three US dollar liquidity-providing operations.

Short term this saves the Euro from the collapse it was facing just last week.

But as this story on Yahoo headlines "Dollar access no long-term fix for Europe's crisis but could buy time for banks"

Officially this confirms the view that the banks around the world are pretty much insolvent given their exposure to the mounds of toxic sovereign debt.

Basically governments and banks are broke because they lent money out to other banks and governments.

The ECB said it would hold three separate operations between October and December to help see banks through the year-end period. Basically the Americans, the British and the citizens of any non-Euro nation in the West are now watching their central bank printing dollars at the expense of their children's’ future’s so that it can bail out banks from other parts of the world.

This is what we get in a world of global economic collaboration when every bank is somehow tied to each other through invisible lifelines. Point being, if one major institution goes down, others will fall like dominoes given that they have all lent money to one another via exotic instruments in order to keep the global banking ponzi scheme alive.

The bottom line is that the US Federal Reserve - as it did in 2008 with $16 Trillion, just backstopped a massive loan to European banks to keep them solvent.  

As the Fundamental View asks, "How closely tied are American financial institutions to the European banks needing the bailout for the Fed to take such measures overseas?"

The world's problems are literally being papered over. But the reality is that the situation is much graver than most people realize.

And what just occurred was a very short term, temporary solution.

The breadth and depth of the financial earthquake the world suffered in 2008 is only just beginning to be understood.

And the recession it triggered has not ended... it has only just begun.

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Stagflation, anyone? (updated)

It is said that history doesn't repeat itself, but often follows similar patterns.

And if you have followed this blog for any length of time you know my thoughts about inflation are that we are following patterns similar to what we experienced in the 1970s.

Since Quantative Easing began in 2009, I have cautioned that the biggest looming threat is not deflation, but the inevitable inflation that all this liquidity is going to trigger combined with a stagnating economy.

Inflation is already with us.

It has been taking root around the world for the past 6 months, machinations of a deliberate monetary policy to debase the world’s reserve currency.

All that debasement has had one objective... the creation of a little inflation to get America and the west out of the deflationary spiral caused by the failure of those horrid financial instruments known as OTC Derivatives and un-payable government debt.

Around the world, inflation has erupted in global food prices. Most of the world has no savings to get through difficult times and “hedge” inflationary outcomes.

Those outcomes appear quickly and change realities violently. American monetary policy and the global “race to debase” is the reason you are seeing raging crowds on TV from Ireland to Greece and Egypt.

Looking at China and India alone, despite the fact that the yuan and rupee rose 2.4% and 1.3% respectively against the dollar through November of last year, inflation rates in both countries dwarfed the relatively tame readings we are reporting in North America; Chinese consumer prices up 4.4% and India's up 8.6%.

Frequently you hear people say "if inflation is such a problem, why isn't it registering in the consumer price index?"

The answer to this supposed riddle of non-existent inflation: inflation is all in how you measure it.

In North America food, along with energy have been stripped out of our CPI, and the result is a more tame inflation reading.

But those price pressures still exist notwithstanding.

30 years ago when Ronald Reagan entered the White House, it was precisely the spike in food and energy - ignored today - that had Reagan and others so concerned about inflation.

Times change, and governments become slick and manipulative, and now those price pressures have supposedly 'disappeared'.

Calculate inflation today the way it was calculated in the 1970s, 1980s and 1990s and the federal government's measure of inflation would be substantially higher than what we are currently being told.

Once you understand that... then the latest statements from the Governor of the Bank of England that standards of living are about to plunge are not all that surprising.

Mervyn King, Britain’s counterpart to the Bank of Canada's Mark Carney, has delivered a stern, sobering message to his country:

• "In 2011, real wages are likely to be no higher than they were in 2005... One has to go back to the 1920s to find a time when real wages fell over a period of six years."
  
  "The Bank of England cannot prevent the squeeze on real take-home pay that so many families are now beginning to realise is the legacy of the banking crisis and the need to rebalance our economy."
  
  "The squeeze on living standards is the inevitable price to pay for the financial crisis and subsequent rebalancing of the world and UK economies."
  
  "Furthermore, inflation may rise to somewhere between four per cent and five per cent over the next few months."
  
  "The idea that (we) could have preserved living standards, by preventing the rise in inflation without also pushing down earnings growth further, is wishful thinking."
  
  "Unpleasant though it is, the Monetary Policy Committee neither can, nor should try to, prevent the squeeze in living standards, half of which is coming in the form of higher prices and half in earnings rising at a rate lower than normal."
  
  "I sympathise completely with savers and those who behaved prudently now find themselves among the biggest losers from this crisis.”

The Governor of the Central Bank of England has looked his country in the eye and admitted that he is completely powerless to prevent the inevitable decline in living standards that inflation and a stagnating economy are about to ravage upon us.

Meanwhile in Canada, our Central Banker has been sounding alarm bells since last February about high debt and the impact of significant looming interest rate hikes combined with an economy that will not grow fast enough to offset them.

Both Governors can see what's coming.

And as the blog has repeatedly posted, it's all about inflation, a stagnating economy and the looming spectre of rising interest rates.

Meanwhile Reuters reports that more manufacturer's are warning of rising input costs.

Emerson CEO David Farr said inflation ran well ahead of the company's own projections, and the company was spending three times as much on materials as on labor.

"We'll have to significantly increase prices around the world because this is not a momentary blip," Farr told analysts on the company's conference call.

"In my opinion, I think net material inflation could run at higher levels for the next two or three years. That's a plus and a minus in many regards but in reality this is an issue we'll have to deal with. It's not going away."

Earlier this week, Illinois Tool Works, which makes a variety of products for the automotive, residential construction, and industrial marketplace, warned it might not be able to fully recoup all the raw material price increases it is seeing - even though it expects to raise prices this year.

Officially it's known as cost-push inflation. Wages don't rise, jobs don't increase and the economy founders, but manufacturing costs rise anyways pushing up prices.

QE1 and QE2 are the causes. And now there's talk of QE3.

Inflation has only just started.

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I light a fire...

Faithful readers know that in the inflation/deflation debate I side solidly on the side of looming inflation.

We may go through a period of deflation first... but inflation is coming: guaranteed.

That's why I note today's decision by the Bank of England to keep interest rates at historic lows.

Bank of England Governor Mervyn King has announced he is setting aside his inflation target to protect the economy from the biggest budget cuts since World War II.

And this action is taken as a split widens on the nine-member British Monetary Policy Committee (MPC) on the danger posed by rising prices. Resisting calls to increase interest rates, King insists it may be a “considerable” time before the benchmark interest rate of 0.5 percent returns to “normal.”

Prices continue to rise in England and King is tolerating faster inflation as Prime Minister David Cameron’s push to slash the Group of 20’s largest budget deficit threatens to hurt the economic recovery. Policy maker Andrew Sentance, for now the only advocate of higher rates, counters that growth is solid enough for the bank to withdraw emergency stimulus.

Inflation has exceeded the bank’s 2% target since December.

“King is willing to take risks with inflation,” said Steven Bell, chief economist at London-based hedge fund GLC Ltd. and a former U.K. Treasury official.

The combination of persistent inflation and budget cuts has widened the debate about when to raise rates in England.

Sentance voted for higher rates at the last two meetings of the MPC. And while there are calls for the central bank to be “incredibly vigilant” on prices, inflation was allowed to rise to 3.2% in June and has exceeded the government’s 3% limit since March.

King said last week the rate is likely to stay above the bank’s target “for much of next year”. King “sees no need to try and offset what is likely to be rather a temporary continuing overshoot,” said former Bank of England policy maker Charles Goodhart.

Fears of continued recession have economists and central bankers eager to ignite inflation and King's actions are sure to be echoed in North America.

Goodhart says officials may find it hard to justify their actions after a “pretty poor” forecasting record in the past two years.

With the inflation overshoot set to persist. Goodhart make an interesting observation.

“In a sense we’re in the worst possible situation, with inflation above target and output growth well under target.”

Meanwhile, on the real estate front in Vancouver

Check out this Global TV clip on the declining real estate sales environment.

How desperate is the climate getting in the industry?

At the end of the clip we have our favorite downtown huckster, Ian Watt, actively encouraging buyers to start pitching low ball offers to undercut asking prices.

Will wonders ever cease?

(hat tip to Observer in yesterday's comments)

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