Impact of the Quarterly Inflation Report

Gilt yields fell sharply yesterday, with the yield on 4 - 10 year gilts lower by around 11 basis points (0.11%)

This follows the statement by the Fed and the latest Quarterly Inflation Report from the Bank of England.

This will push swap rates similarly lower and open the door for lenders to cut fixed rates further, although some will no doubt prefer to rely on the very limited amount of competition to fatten their margins instead.

However, there must now be a good chance of a little more competition before the end of the month in the sub 4% 5 year fixed rate market.

The Governor of the Bank of England, Mervyn King, has said that the UK economy faces a “choppy recovery” over the next two years and that “It will take many years before bank balance sheets and fiscal positions return to anything like normal. In the meantime they will act as headwinds to the recovery.”

This outlook for bank balance sheets will clearly be a significant hindrance to the economic recovery.
 


The governor’s comments, plus the fact that the Fed and the Bank of England are broadly both singing from the same hymn sheet when it comes to assessing where the respective economies are going only reinforces concerns about the global economic recovery.

This increases the likelihood that Bank Rate will remain low for an extended period and that when it does rise from 0.5% it will only be slowly.

Looking further ahead the proposed Basle 3 rules will impose further constraints on all banks, and hence consumers, which will add to the factors hindering the economic recovery.

The fact that the authorities have agreed to delay implementation of these new more onerous rules, possibly until 2018, despite considering them necessary to ensure stability of the banking sector, is a further indication of the impact they are expected to have on the banks’ ability to support economies which are a long way from being out of the woods. 



Assuming, under the current Basle 2 rules, most banks survive until the new rules are implemented several years down the road it rather begs the question of whether tighter restrictions are really needed.

More onerous capital adequacy requirements on the banks will reduce their ability to lend, which will reduce new economic activity, which means tax revenues will grow more slowly and hence it will take longer for Western Governments to bring their budget deficits back into balance or to an acceptable level of deficit.



There is a fine line between appropriate and overly onerous regulation and it is far from clear that Basle 3 has drawn that line in the right place.

In the shorter term a much bigger worry for both the housing market and the economy is the potential impact of last month’s Mortgage Market Review: Responsible Lending paper, but more about that later.