EcPoFi's  Instablog

In the opening remarks of The Bank of England (BoE) Inflation Report for February 2013, Mervin King today stated, after first having explained that "Inflation has remained stubbornly above the 2% target, and was unchanged in January at 2.7%",

You might be tempted to think that an above-target inflation forecast justifies a tighter monetary policy. Certainly, ensuring that inflation returns to target in the medium term is our primary responsibility and objective. But the MPC's remit is to deliver price stability in the medium term in a way that avoids undesirable volatility in output in the short run. The prospect of a further prolonged period of above-target inflation must therefore be considered alongside the weakness of the real economy. Attempting to bring inflation back to target sooner would risk derailing the recovery and undershooting the target in the medium term. So long as domestic cost and price pressures remain subdued, we will continue to look through the temporary, albeit protracted, period of above-target inflation in order to support the recovery in growth and employment.

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That policy stance is already exceptionally supportive of output. Interest rates are close to zero and the Bank's balance sheet has expanded by a factor of five since before the financial crisis. Expressed as a share of GDP, the increase in our balance sheet since 2007 is greater than that in the United States, Japan or the euro area. But, if necessary, we will do more. At its meeting last week, the Committee agreed that it stood ready to provide additional monetary stimulus if warranted by the outlook for growth and inflation.

So, expect more money printing by the BoE going forward which should provide upward support for the UK stock market (and other assets). Not quite so good for the pound sterling though.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Discount window borrowings for U.S. banks in January 2013 was USD 565 million, the lowest level since February 2008.

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Of course, with more than USD 1.5 trillion in excess reserves there is little need for borrowings through the discount window.

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The Fed has certainly succeeded in shoring up their banks, which is, after all, its primary task. At the end of 2007, cash as a percent of total assets for U.S. commercial banks was 3.0%. As of January 2013, the percentage was 13.6%. At the end of 2007, the equity to total asset ratio for the commercial banks was 10.4%. In January 2013 this ratio now stands at 11.4%.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Background

As we have reported for quite some time, money supply and bank credit in the U.S. have both been expanding steadily for quite a few years now and in the aftermath of the financial crisis of 2008/9. At the same time, interest rates and yields on U.S. Treasury Securities have been pushed down as the Federal Reserve has bought treasuries in the market (QE1, 2 and 3) and kept the Federal Funds Rate near zero.

This report, the U.S. Money, Credit & Treasuries Review, includes data and charts on all these three key economic statistics in one report. Money supply, credit and treasury rates are crucial to keep track of in the U.S. economy (and many other economies) where the Fed manipulates the financial markets and as such has the power to artificially create booms and busts, inflate and deflate asset prices, in tandem with banks being able to create money through fractional reserve banking. Fed policy and bank lending hence affect all sectors of the financial markets, including the value of the dollar, bond markets and stock markets, e.g. (real) interest rates driven lower will normally, other things being equal, result in an increase in both bond and stock prices. Furthermore, increases in money supply will also normally help inflate stock market prices as there is more money available (some of the newly created money is likely to be allocated to the stock market). Finally, the three statistics are crucial ingredients in the Austrian Business Cycle Theory which helps explains peaks and troughs in an economy. As opposed to the Movements in the U.S. Monetary Base and Money Supply (bi-weekly) report, this report focuses on the broader measures of money supply. The date are the bi-weekly figures published by the Federal Reserve Bank of St. Louis (FRED).

U.S. Money, Credit and Treasuries Review as of 23 January 2013

All broad measures of money supply continue to increase substantially on last year, from 6.06% for M2+IMF+LTD* to 8.04% for MZM, while they were all lower than two weeks ago. Bank Credit increased 5.43% on last year, but declined 0.41% from two weeks ago. All money supply measures and bank credit are near all-time highs.

The 1-Year and 10-Year U.S. treasury yields both remain extremely low in a historical perspective, but compared to same time last year the 1-Year treasure rate has increased 0.03 percentage points (from 0.11% to 0.14%). During the last two weeks the yield has however declined by 0.01 percentage points. The 10-Year treasury rate declined by 0.11 percentage points compared to same time last year, but is up by 0.02 percentage points compared to two weeks ago. The spread between the 10-Year and the 1-Year treasury yield is currently 1.73 percentage points, which is a slight decline from one year ago and a slight increase from two weeks ago.

*The Federal Reserve stopped publishing its M3 Money Supply series back in 2006. As an incomplete substitute, the M2+IMF+LTD money supply is a broader measure than M2 and consists of M2 + Institutional Money Funds + Large Time Deposits, data series which used to be included in the M3 series and which are still reported on a regular basis by the Fed.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.