Sunday, 2 November 2008

The New Normal

There have been some encouraging signs recently to suggest that a semblance of normality is returning to the financial markets. The LIBOR has fallen in recent weeks to a level that is nearer normal than exceptional (for example, on October 30th – the latest date for which we have figures – LIBOR was in excess of Base Rate by six and a quarter Basis Points). Further confirmation of a return to normality came this week from our mortgage provider. It also gave us an idea of what the new normality might look like.

Apparently, “Following a recent review of our interest rates, we are writing to let you know that from 3rd November 2008, we’re decreasing our … interest rates by 0.5%.” In plain language, they have passed on the full benefit of the recent half percent reduction in Base Rate. This is in sharp contrast to a previous letter, where it was said “Following a recent review of our interest rates, we are writing to let you know that from 7th July 2008, we’re increasing our … interest rates by 0.25%. This change reflects current market conditions.” In April whilst Base Rate fell by 0.25%, retail rates rose (in June) by 0.25%. It was at this point that we felt that monetary policy was not working.

What has happened to make monetary policy start to work again? There is a great deal more liquidity in the banking system at present, but our view is that the key difference between our mortgage provider now and how it was in April is that The Treasury (the UK Finance Ministry) now owns 60% of our mortgage provider, and that passing on the rate cut was more of a political decision than a financial one. The view that monetary policy is becoming subject to political pressure was further strengthened by a speech by the UK Chancellor (the Finance Minister) this week. In it, he stated an expectation that Base Rate would be cut again when the Bank of England Monetary Policy Committee meets next week (see report). If rates are cut, then the independence of the Bank of England could be called into question, as some are doing already.

Of course, the backdrop for this is a more interventionist Fiscal Policy. The ‘Golden Rule’ of Fiscal Policy (a balanced budget for current spending over the economic cycle) is set to be broken, and politics has returned over the advisability of spending increases compared with tax cuts to provide a fiscal stimulus (see report). In some quarters, recent events have been interpreted as the triumph of Keynesianism over a cruder form of Monetarism. In the new normal, not only will there be more political control exercised over the monetary system, but also there is likely to be a greater propensity for the State to take a more interventionist approach to fiscal policy.

The stage is now set for some sort of recovery in the financial markets. The prospect of a deep recession has restrained share prices in recent weeks, but that may well change soon. The US votes for a new President next week. Many independent pundits point to Senator Obama to become President. More interestingly, this choice would resonate around the world. The Economist has held a mock on-line election with a global constituency (see results), which shows that Senator Obama is the choice of the world (only Algeria, Iraq, and Congo plump for Senator McCain).

One of our colleagues has undertaken research into the degree to which global stock markets ‘bounce’ after a US Presidential Election. It would appear that we could see a substantial gain next week if Senator Obama wins the election, to be followed by a period of prolonged advance. The conditions are right for this to resound around the world in a short space of time. As we stated previously (see post), there are bargains to be had in the market, the most unpopular President in living memory is about to leave office, and a degree of normality has returned to the financial markets.

The conditions could not be better for Barak Obama to appear in a messianic role next week.

© The European Futures Observatory 2008

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