In the City
Back to Bank rate
Nicholas Davenport
It continues to astonish me that events which occur in the City of great importance to our working lives fail to get much notice, if any, in the general press. The fact that our official reserves rose by an incredible $3,067 million (i.e. 75 per cent) to $7,196 million in January was not even mentioned in The Week in the Spectator. It was an extraordinary event the like of which has never happened before and is not likely ever to happen again.
The reserves had been depleted in December by the repayment of the stand-by credit, and a third of the sharp increase in January was due to a first drawing of $1,160 million of the new IMF facility. Then the restrictions recently imposed on the sterling financing of overseas trade brought an inflow of dollars of an undisclosed but quite large amount. Next there has been an unwinding of 'leads and lags' and finally a speculative inflow of foreign money into the gilt-edged market. To top it all the Bank has actually been buying dollars to prevent the sterling exchange recovering too fast and upsetting the export trade. The turn-round from the dark dismal days of December when the reserves sank to $4,000 million has been breath-taking, if not miraculous. But no one seems to have taken much notice except the gilt-edged market on the Stock Exchange which has been booming away.
Another extraordinary event occurred last week in the City which will excite little comment outside this column. The Bank has virtually restored Bank rate. The complicated formula for determining the Minimum Lending Rate every Friday through the Treasury bill tender and issue has been suspended. The Bank on Thursday last week declared a Bank rate of 12 per cent. This meant another i cut in the MLR which has come down from 15 per cent since October. The market had expected a bigger cut—indeed, the Treasury bill tender would
have called for an MLR of I I per cent but the policy of the Chancellor, as he has often said, is to see a gradual fall in interest rates. This 12 per cent Bank rate peg is his attempt to slow down the boom in the gilt-edged market which has been forcing the rate of interest down and attracting 'hot' money from abroad, which we do not want. Willthe market act to Mr Healey's 12 per cent cue?
One firm of brokers, Messels, does not think so. They recall that the bull market of late 1975 and early 1976 began from an MLR level of 12 per cent. If the Treasury mandarins claim that they can stop the bull market of 1977 at the same point the market will simply not believe them. 'After three years of monetary restraint,' the brokers add, 'and with growing confidence that public spending is now under control the fundamentals are much more favourable than twelve months ago.' With this I agree. As I have remarked before, the government cannot control the men of the market who have more realistic views than the mandarins or the politicians. They know that they can secure much higher yields from British government bonds than anywhere else in the world except Italy and the banana republics. They know that no British government will ever default, especially when it readily submits itself to the discipline of the IMF money rules, especially when its assets in North Sea oil are going to increase for a decade or more. Surely it would be wise for the Government to let the gilt-edged market find a more natural level.
Of course, a market can get out of control, especially when speculators from abroad join in the fun of a rollicking boom, but our big savings institutions which dominate the gilt-edged market are not likely to overestimate Mr Healey's strength. He is trying like a juggler to keep four balls in the air at the same time—the rate of interest, the money supply, the budget deficit and the sterling rate of exchange. Sooner or later he is bound to let one drop. And one did— the money supply. While he reduced the money supply by gigantic issues of longdated gilt-edged stock to the non-bank public—such as the £1,250 million of Treasury 131 per cent 1993—money poured into the system from abroad and from the
Exchange Equalisation Account. The 'safety net' for sterling actually added to this embarrassment. One broker uncharitably remarked that Mr Healey's delight over the 'safety net' is a clear sign that he does not understand the new style of monetary management to which he is committed. This is not true. He understands it perfectly we" but the sterling crisis made a 'safety net' imperative at the time when he had to seek the aid of the foreign central banks.
There is always a dichotomy, as I have said, between the Bank's desire to keep interest rates at the right level for the sterling exchange and the Chancellor's desire to keep interest rates at the right level for investment and growth at home. NO government can consistently and Per' manently pursue an exchange rate eolicY and a money supply policy at the same time. But it must be admitted that for the time being things are going pretty well for Mr Healey. Public spending is getting under control (as the cash limits imposed are biting), the public sector borrowing requirement has apparently been over-estimated and the amount of 'tap' stocks alreadY issued and taken up by the non-bank public has been far more than was necessary t° keep within the money supply or the 13C. targets. So the wisest course would be stop issuing any more long-dated `taP stocks with high coupons, (whichincrease the appalling burden of the interest charge, on the budget) and let the market in 'longs find its own level. I would guess this to he five to ten points higher. All this should encourage and justify the Chancellor in offering a tax relief in his April budget of at least £1,000 million whicl; might win trade union support for a thiru round of wage restraint. There has been a lot of loose talk about his policy of 'industrial strategy' and this is likely to be more than ever confused by the Bullock recolm mendation for workers on a single board which the CBI rightly rejects as unworkable. If 'industrial strategy' means anything must mean an increase in productivity an if the workers can be induced to agree to it it will not be because of a seat on the board but by getting a share in the profits coming from increased productivity. The realistic French call this profit-sharing 'worker participation': they don't bother about a seat on the board. Academics may rir)t appreciate this but the men on the sitOP floor will. Until some agreement on Labour Phase 3 is reached I cannot see a 411` blooded boom in the equity share markets. (The index has dropped below 400 again on inflation fears.) But a further rise in the gilt-edged market may make it possible. Bullishness is a virus which spreads.
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