New ECB chief must act as Europe again stares into the abyss

Welcome to Bedlam Mr Draghi. Yes, it's Mario Draghi's first day in the office as the new European Central Bank president, and if he was hoping, after last week's "comprehensive settlement", for a reasonably settled start, he had better think again.

We all know what Mr Draghi should be doing; he should be immediately reversing the last two interest rate increases and at the same time engaging in a much more wide ranging programme of quantitative easing through sovereign bond purchases. Tomorrow, Mr Draghi chairs his first meeting of the governing council. It's his chance to start with a bang.

Yet despite the renewed turmoil sparked by the Greek referendum announcement, it seems quite unlikely he'll take it. By temperament, he's quite orthodox in his approach to central banking, and the fact that he is an Italian will, paradoxically, make him even keener to stick to conventional monetary disciplines than if he were an Axel Weber-like, anti-inflationary head banger. He'll want to disprove the Italian steriotype. And he's terrified of doing anything that might upset Bundesbank traditionalists. So there is no reason to believe his arrival will presage an immediate change in approach after the "strong vigilance" of his predecessor, Jean-Claude Trichet.

That's not to say we won't see a cut in interest rates. The last meeting was split in leaving rates on hold, so with a fast deteriorating economy, it's possible the doves will this time gain the upper hand. Eurozone inflation at 3pc is beyond what would normally be regarded as tolerable, but everyone knows that on a medium term view, the inflation rate is going to fall well below the 2 per cent target. So a rate cut can easily be justified.

But I'd be amazed if we saw anything new on bond purchases. The ECB doesn't regard it as any part of its job to monetise the public debts of the eurozone periphery. Of course, there is a fair amount of pretence in this stance.

The ECB has already done quite a bit of bond buying, which it has disingenuously dressed up as a way of helping the "monetary transmission system". The sophistry of this explanation is ridiculous. No, what the ECB has been doing is trying to drive bond yields in the distressed single currency nations down to more tolerable levels.

Even so, the numbers have been very low against what the Federal Reserve has been doing in the US, and the Bank of England in the UK. As long as Germans believe that bond buying by the central bank is essentially monetisation of public debt – the sort of stuff that led to the Weimar hyperinflation of legend – it will be blocked from meaningful action.

Mr Draghi's challenge is therefore to persuade Berlin that bond purchases are for a different purpose – demand management. This is essentially the justification that underpins QE in Britain and the US. In both cases, the intention is eventually to sell the accumulated bond holdings back to markets, or to run down the positions by allowing the bonds to mature.

To better support this justification, ECB bond purchases would have to be much more widely spread than at present. It would have to include German bunds in proportion to the size of the German economy alongside Italian, Spanish and Portugese debt. But as I say, Mr Draghi faces an uphill struggle. Germans would prefer to suffer, or even see the euro collapse completely, than tolerate such an unconventional approach.

Volcker is right: a little inflation is a dangerous thing

Paul Volcker, chairman of the Federal Reserve

Ouch! It's even worse than we thought – or perhaps that should read what forecasters thought. For most of us, news that CPI inflation last month reached 5.2pc won't come as much of a surprise; it's been obvious from our utility bills and shopping baskets for some time now. The older, RPI measure of inflation is worse still, at 5.6pc.

And still the Bank of England likes to pretend it's trying to meet the inflation target. More monetary stimulus in the form of a further £75bn of "quantitative easing", with the inflation rate at 5.6pc? If the economic bind the country finds itself in were not so serious, it would be almost laughable.

Everyone expects inflation to come down sharply over the next year, as the current round of fuel price increases and the January hike in VAT work their way out of the index, but then the Bank, the Government and most City analysts have consistently underestimated inflation for the best past of the last three years. What reason do we have to believe them now?

Sir Mervyn King, Governor of the Bank of England, has long argued that to have taken the action necessary to keep inflation on target would have meant inducing a recession and therefore well below target inflation further out. The elevated inflation we are enduring now is framed as part of a necessary adjustment to living standards as the country adapts to its plainly more straitened circumstances.

It is also sometimes argued in justification for the present "blind eye" approach to inflation, though not by the Bank itself, that it provides a way of gently inflating away the country's debt burden. The first argument may hold more water than the second, but both look questionable.

The problem with inflation, repeated historical experience has demonstrated, is that once out of the bag, it is extremely difficult to put back in. There is only so much wage erosion through inflation that people will take before they start to demand compensating pay rises. True enough, fear of unemployment has been sufficient to deter widespread inflationary pay increases so far, but there have been a number of instances of key worker groups managing to obtain them. The danger is that relatively high inflation creates a kind of wage apartheid of those who are able to keep up with inflation and those who can't – mainly the unskilled and those who live off their savings.

It is also impossible to believe that the almost unprecedented amounts of liquidity that have been provided by central banks to western economies over the past three years – and continues to be so – will not in time prove highly inflationary. And even if in the fullness of time it has demonstrably proved only mildly inflationary, as its supporters claim it will, it doesn't necesssarily vindicate the policy.

Here's Paul Volcker, the Federal Reserve chairman credited with finally exorcising the inflation of the 1970s and early 80s from the US economy, writing recently in the New York Times.

My point is not that we are on the edge today of serious inflation, which is unlikely if the Fed remains vigilant. Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on.

No, inflation is never an economic panacea. Nor does it even help with the debt burden. If wages aren't matching inflation, then it is of no help in eroding the nominal value of household debt, and if taxes aren't keeping pace with inflation, then the same goes for government debt. Worse, many forms of government spending, most notably the bulk of benefit entitlements, are linked to inflation, so that we now have the absurdity of benefit claimants being better protected against price increases than wage earners.

These figures are not just uncomfortable for the Bank of England and the Government. They are a disaster. It took twenty years finally to exorcise the ghost of Britain's post war inflationary past, and to win credibility as a stable, low inflation economy. All that work is in danger of being thrown away

Volcker is right; a little inflation is a dangerous thing

Ouch! It's even worse than we thought – or perhaps that should read what forecasters thought. For most of us, news that CPI inflation last month reached 5.2pc won't come as much of a surprise; it's been obvious from our utility bills and shopping baskets for some time now. The older, RPI measure of inflation is worse still, at 5.6pc.

And still the Bank of England likes to pretend it's trying to meet the inflation target. More monetary stimulus in the form of a further £75bn of "quantitative easing", with the inflation rate at 5.6pc? If the economic bind the country finds itself in were not so serious, it would be almost laughable.

Everyone expects inflation to come down sharply over the next year, as the current round of fuel price increases and the January hike in VAT work their way out of the index, but then the Bank, the Government and most City analysts have consistently underestimated inflation for the best past of the last three years. What reason do we have to believe them now?

Sir Mervyn King, Governor of the Bank of England, has long argued that to have taken the action necessary to keep inflation on target would have meant inducing a recession and therefore well below target inflation further out. The elevated inflation we are enduring now is framed as part of a necessary adjustment to living standards as the country adapts to its plainly more straitened circumstances.

It is also sometimes argued in justification for the present "blind eye" approach to inflation, though not by the Bank itself, that it provides a way of gently inflating away the country's debt burden. The first argument may hold more water than the second, but both look questionable.

The problem with inflation, repeated historical experience has demonstrated, is that once out of the bag, it is extremely difficult to put back in. There is only so much wage erosion through inflation that people will take before they start to demand compensating pay rises. True enough, fear of unemployment has been sufficient to deter widespread inflationary pay increases so far, but there have been a number of instances of key worker groups managing to obtain them. The danger is that relatively high inflation creates a kind of wage apartheid of those who are able to keep up with inflation and those who can't – mainly the unskilled and those who live off their savings.

It is also impossible to believe that the almost unprecedented amounts of liquidity that have been provided by central banks to western economies over the past three years – and continues to be so – will not in time prove highly inflationary. And even if in the fullness of time it has demonstrably proved only mildly inflationary, as its supporters claim it will, it doesn't necesssarily vindicate the policy.

Here's Paul Volker, the Federal Reserve chairman credited with finally exorcising the inflation of the 1970s and early 80s from the US economy, writing recently in the New York Times.

My point is not that we are on the edge today of serious inflation, which is unlikely if the Fed remains vigilant. Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and “reasonable” 4 percent becomes 5, and then 6 and so on.

No, inflation is never an economic panacea. Nor does it even help with the debt burden. If wages aren't matching inflation, then it is of no help in eroding the nominal value of household debt, and if taxes aren't keeping pace with inflation, then the same goes for government debt. Worse, many forms of government spending, most notably the bulk of benefit entitlements, are linked to inflation, so that we now have the absurdity of benefit claimants being better protected against price increases than wage earners.

These figures are not just uncomfortable for the Bank of England and the Government. They are a disaster. It took twenty years finally to exorcise the ghost of Britain's post war inflationary past, and to win credibility as a stable, low inflation economy. All that work is in danger of being thrown away

With inflation approaching 5pc, do we really want more QE?

The Bank has announced 75 billion more QE (Photo: PA)

On the basis that inflation is better than depression, I suppose it is just about possible to go along with the Monetary Policy Committee's decision to increase "quantitative easing" by a further £75bn.

But I worry about it. I worry both that it will be ineffective in terms of stimulating investment and growth, I worry that it is going to be very difficult for the Bank of England to unwind these now vast holdings of government debt, I worry that we are now perilously close to outright monetisation of the deficit (a policy approach which all economic history shows ends in abject disaster), and I worry that ultimately, it's bound to be inflationary.

In a speech two or three weeks back, Adam Posen, until recently an outrider on the MPC in demanding more QE, said that such fears were "unfounded" and "unwarranted", but answer me this. How's the further plunge in the value of the pound that greeted this announcement not inflationary? Even the Bank of England's own analysis of the effect of QE to date, which is based on quite questionable methodology, estimates that it has added 0.75 to 1.5 percentage points to CPI inflation for a maximum gain in real GDP of 2pc. That doesn't seem to me to be a particularly good trade off.

And you cannot help but think that the long term impact of all this money printing is almost bound to be highly inflationary. Already, the Bank of England has bought up around 20pc of the national debt, equal to some 14pc of GDP. This will expand it to close to 30pc.

Since a fair old chunk of this debt is in the form of inflation protected gilts, which have not been part of the asset purchase programme, the proportion of the conventional gilts market that will be sitting on the Bank of England's balance sheet by the end of the latest batch of purchases is going to be rather more than a half. When something looks mad, it generally is. Yields on ten year gilts are already at historic lows at less than 3pc. Is it really sensible to be driving them even lower?

In his speech, Mr Posen said "we will know that monetary policy has done enough for long enough when long term interest rates rise due to demand for capital from our private sector taking on risk and making investments". But why would they rise when there's the open cheque book of the Bank of England willing to buy up almost anything that comes onto the market? And if they do rise, it's much more likely to be because investors expect inflation than than a sudden return to rampant business investment.

Despite these concerns, I guess it's just about possible to support what the Bank of England is doing given the extreme downside risks to the economy that have swept in from the Continent over the last month or so. With all this talk of coordinated action, we have to assume that other central banks are poised to follow suit, though I'll believe it when I see it as far as the European Central Bank is concerned. Jean-Claude Trichet is holding his monthly press conference shortly, so there may be more to say on this later.

But it's a disappointment that the Bank's statement made no mention of the "credit easing" flagged by George Osborne, the Chancellor, in his conference speech. This is an idea worth pursuing – a way of getting the newly released funds to the bits of the economy that really need it and stimulating some much needed business investment.

As it is, I fear that it will again be the investment bankers who are the major beneficiaries. QE is like a drug; once hooked, it's very difficult to wean yourself off. Just how many fixes are required before you realise you are an addict?

What's more, as every addict knows, to get the same effect, you have to keep increasing and repeating the dose. The way things are going, the entire gilts market will end up in the hands of the Bank of England. I'm sorry, but I fail to see the difference between such an extreme position and outright monetisation of the deficit, the sort of thing they got up to in Weimar Germany. In that case, the end result was not just the destruction of middle class savings, but the currency itself.

Pressuring the Fed Can Backfire

In a statement this afternoon, the Federal Reserve announced that it was engaging in more stimulus, by extending the average maturity of the securities on its balance sheet. This was basically what markets had expected, even though the Republican Congressional leadership wrote a widely reported letter to Ben S. Bernanke, the Fed chairman, urging him not to engage in any more easing.

Scratch that: “Even though” may not convey the right causal relationship between those two events. Some may argue that the letter could have encouraged the Fed to issue another round of monetary stimulus.

CATHERINE RAMPELL

Dollars to doughnuts.

Dollars to doughnuts.

The Federal Reserve is officially an independent body, and its autonomy is intended to shield it from short-term political interests that may be popular now but bad for the economy later.

Truth be told, though, efforts to put political pressure on the Fed go back much farther than this week. There have been many letters sent by Congressional committees and individual senators and members of Congress in just the last few years telling Fed officials to do or not do something or other, as well as in previous decades.

The letters linked above were generally for less significant decisions, of course. But in Congressional hearings and the like, legislators have attacked interest-rate policy and other important Fed actions, like quantitative easing, as well. Such confrontations, watched by a handful of people on C-SPAN, generally seem to be intended more as grandstanding than efforts that may actually change Fed policy.

When officials from the legislative and executive branches actually expect to influence Fed policy, they’re more likely to voice their arguments out of the public’s view, and in private meetings.

Why? As Bruce Bartlett, a former Treasury official from the George H.W. Bush White House and a contributor to Economix, explained by e-mail:

Historically, one of the main things that has held back politicians from publicly criticizing the Fed is that it can easily backfire and encourage it to do the opposite of what they want it to do. Certainly there have been many times in the ’80s and ’90s when administrations wanted an easier monetary policy. But they knew that the Fed jealously guards its independence and cannot allow itself to be seen as caving to administration pressure. Therefore, administration pressure to ease would force the Fed to remain tight lest it appear that it was caving to pressure. For this reason, administrations quickly learned that the best way to influence the Fed is through back channels. Historically, this has been done through the Treasury. I don’t know if it is still true, but for many years the Treasury secretary and the Fed chairman had breakfast every week, privately, no staff. This is the forum for the administration to tell the Fed what it should be doing.

I asked Mr. Bartlett whether he knew of specific cases where the Fed appeared to take an action precisely because there was pressure to do the opposite. He replied that he suspected such an incident occurred with Mr. Bernanke’s predecessor, Alan Greenspan:

When I worked at Treasury during the Bush 41 years, I had the definite sense that [Treasury Secretary Nicholas F.] Brady’s public criticism of Greenspan caused Greenspan to resist easing, which he might otherwise have done given economic conditions. Of course, I can’t prove it.

In today’s case, I doubt that the Fed decided to ease because of the Republicans’ letter; as I mentioned above, markets seem to think this was a sure bet already.

But because markets thought more easing was a sure bet, not easing after receiving this letter definitely would have made the Fed look as if it were caving to political pressure. In that sense, the Republicans’ attempt at exerting pressure seemed doomed to fail.

If the Bank of England is going to do more QE, it should get ultra adventurous

The Bank of England.

As regular readers will know, I'm not in favour of a new programme of "quantitative easing" for the UK in current circumstances. Not until there is an extreme deflationary threat does it strike me as warranted. That moment may come soon enough, but we are not yet there.

Yet perhaps I've been a little too dogmatic here, for I have assumed that any fresh programme of QE from the Bank of England would, as before, target mainly UK government bonds (gilt edged stock), where yields are already at record lows and where adding yet another source of demand to markets where investors seem unprepared to invest in anything else other than gilts would seem to be close to insane.

If the rate of interest on bonds is already close to zero, it's not clear that pushing it marginally lower still would persuade investors to put their money in higher risk assets. And if that's the primary purpose of QE, then what's the point of doing it?

But there are other ways in which the Bank could help. One quite attractive idea which the Bank has been exploring with the Treasury is that of so called "credit easing", which would be similar in some respects to QE but with significant differences. Instead of injecting new cash into the economy via the purchase of government bonds, the Bank of England would purchase ordinary banking credit.

By targetting credit directly, the Bank of England would be going to the heart of the problem, which is that in a period of vicious deleveraging, there's both a problem with demand for credit and the supply of credit. Bankers tell me that risk aversion has reached a point which threatens another funding crisis, similar to the one that took place in the run up to the Lehman crisis. Interbank funding markets have not yet closed, in the way they did back then, but there is again severe distress.

In circumstances where there are funding difficulties, the supply of new credit will become even more constrained. What the Bank of England must do is provide the funding that markets are refusing. What's proposed is something similar to the Special Liquidity Scheme of early 2008, when the Bank agreed to issue banks with Treasury bills – easily transformed into cash – in return for mortgage securities that at that stage could not be otherwise funded.

But under the SLS, these were legacy assets that the Bank was taking as collateral. What "credit easing" would do is attempt to create new credit by making cash available for new SME lending. The effect would also be to push down the effective interest rate businesses are required to pay for their loans, and thereby reduce what are at present exhorbitant spreads. It's already being done in Japan, and it may be worth a try here.

Sir Mervyn King, Governor of the Bank of England, has made clear that he's against the sort of QE that would involve the Bank in decisions about the allocation of credit, but assuming the Bank is properly indemnified by the Treasury, I can't necessarily see a problem with it.

In an era where bond yields are already as low as low can be, this type of QE promises to be a good deal more effective than simply buying another shed load full of gilts.

The Bernanke Rally?

Bravo Bernanke for telling the screaming markets to go to bed without their supper.

There can be no justification for QE3 at a time when core inflation is creeping up to 2pc.

Nor when the M2 money supply is growing at 10pc, or M1 growing at 20pc, or credit is at last returning from the dead and turning positive again. Credit has accelerated to an 8pc annual compound growth rate over the last three months. And remember, Bernanke is a “creditist”. Lending is his lodestar.

Quite why markets seemed so assured that he would intervene to prop up Wall Street is beyond me. It shows how deranged this game has become.

Bernanke looks at fundamentals, which include the wealth effects of Wall Street as just one variable. His real enemy is deflation and the Japan syndrome, though he has been remarkably bad at articulating this.

As he said in Jackson Hole, the economy is very slowing healing itself in spite of fiscal tightening (some might even say because of it). Indeed it is. US corporations are sitting on $2 trillion. Households are chipping away at their debts (admittedly by defaulting on mortgages in many cases, but that too is debt clearance).

I have a hunch that Bernanke’s first hints of cautious optimism may prove better rocket fuel for a durable rally than the Fed’s body-language of despair, whatever the markets say over coming days.

Nobel laureate Edmund Phelps advised the Fed should keep its “finger on the trigger” just in case the deflation threat returns, or Euroland blows up, or the world takes another nasty turn.

Europe may indeed blow up. The German constitutional court will rule on Sept 7 on the legality of the EU bail-outs, and that might be a moment to fasten your seatbelts.

What is ever clearer to me after spending a few days in Germany again is that the Bundestag is in no mood to increase the EFSF rescue fund by one pfennig beyond €440bn, let alone contemplate the €2 trillion figure deemed necessary by City banks. Which means Italy and Spain will be left to their fate once the ECB’s bond buying hits the limit (October?).

But the Fed cannot set policy on the basis of EMU contingencies. It sets policy for America, and America is not as sick as it looks.

How Much More Can the Fed Help the Economy?

With the risk of another recession on the horizon, many economists and investment analysts are hoping that Ben S. Bernanke will signal on Friday that the Federal Reserve is ready to step in once again and save the economy from disaster. After all, Congress seems wholly unwilling to engage in fiscal stimulus, and instead is planning further fiscal tightening.

But there are reasons to believe the Fed’s remaining tools may be losing their potency.

Monetary policy works best when the Fed cuts interest rates, giving banks a good opportunity to extend more loans. If more loans go out to people and companies, those people and companies can buy more goods and services, creating more demand and eventually more jobs.

CATHERINE RAMPELL

Dollars to doughnuts.

Interest rates are already at zero, though (and have been for a while), so the Fed cannot lower them any further. That’s why the Fed has engaged in more unusual — in some cases, unprecedented — measures.

Dollars to doughnuts.

Twice now the Fed has engaged in large-scale asset purchasing, a process known as quantitative easing. (Hence the nicknames QE1 and QE2.) This is meant to lower long-term interest rates, which should, in theory, stimulate economic growth in two ways.

First, it should encourage more borrowing, so companies and consumers will have more money to spend.

Second, lower long-term interest rates could encourage investment in riskier assets, like stocks. Why? Because if long-term Treasuries don’t offer much in the way of returns, investors will seek higher yields elsewhere. If investors do start buying up riskier assets, those asset prices rise. Consumers then see that their portfolios are worth more, causing them to feel richer and so more comfortable with spending. This is known as the wealth effect.

But this two-pronged attack is probably less powerful today than it was three years ago.

After two rounds of quantitative easing, long-term interest rates are already quite low. It is not clear that lowering them further with a third round of quantitative easing (QE3) would do a whole lot more to encourage investment in riskier assets, or to increase lending. Many companies are choosing not to borrow primarily because demand is so weak, and not because credit is expensive.

Additionally, if investors do start increasing their investments in assets with higher yields, they may pour more money into commodities like oil. And commodity prices are already higher today than they were a year ago; pushing energy and food prices further up could actually discourage consumers from spending.

And many economists are still debating whether the last round of quantitative easing was terribly useful.

“It’s hard to make the argument that QE2 was a rousing success or we wouldn’t be on the verge of seeing QE3,” the economists at RBC Capital Markets wrote in a client note. “The market may very well get what it seems to desire, but we believe there is no magic bullet here.”

There are other measures the Fed could take besides quantitative easing. These include changing the composition, rather than the size, of the assets already on its balance sheet so that they have longer maturities. Like quantitative easing, this could lower long-term interest rates, with many of the same pros and cons. There would probably be less political resistance to reconfiguring, rather than expanding, the central bank’s debt holdings.

The Fed could also lower the interest rate it pays banks on their reserves. Maybe this would encourage them to hold less cash and increase their lending. There is some debate about how effective this measure would be. If demand for credit remains low, encouraging banks to lend more may not be helpful.

Many economists have suggested that the most powerful tool the Fed might employ would be an announcement that it is raising its medium-term target for inflation.

If prices are expected to rise, banks, businesses and consumers will be more eager to spend their money before it loses value. That could have positive effects throughout the economy, since spending means more demand for goods and services, which means companies need to hire more employees, which means more spending, and so on. That is the much-sought-after virtuous cycle.

The problem, though, is that inflation has some major downsides too — especially if coupled with sluggish growth, as seen during the “stagflation” of the 1970s. Not having a good sense of how much your next gallon of milk or gas will cost is stressful, particularly if your wages aren’t rising to match the higher prices.

Today inflation is pretty low, but it’s higher than it was a year ago when the Fed last engaged in quantitative easing. Already the more hawkish members of the Federal Open Market Committee are getting antsy. Since Mr. Bernanke cannot unilaterally carry out any of these stimulus strategies, the chances that the Fed will increase its inflation target in the near future seem low.

But hey, the Fed has surprised people before.

Only a brave man would bet against Bank of England policy flipping round again

The Bank is itching to raise rates but needs evidence it wouldn't quash fragile confidence

How quickly the world can change. Three months ago, three of the Bank of England’s nine rate-setters were voting for an increase in interest rates. Now, as the Bank’s minutes revealed today, none of them are and discussion has turned to restarting quantitative easing (QE).

If you think policymakers are fickle, though, try the markets. Earlier this year, traders reckoned it was a nailed-on certainty that rates would have started rising by the May just passed. Now, they are pricing policy to be unchanged until the middle of 2013.

Events have changed, of course, and when they do so, as John Maynard Keynes famously remarked, “I change my mind”. But the one lesson that can be taken is that forecasts must be taken with a pinch of salt. As Sir Mervyn King is fond of saying, the only thing he can promise about his forecasts is that they will be wrong.

Reading policy nowadays is all about reading mindsets. And the Bank has, to my mind, been dropping a few clues recently. As much talk as there may now be about restarting QE, the impression seems to be that it will remain just talk unless Europe’s leaders plunge the world back into crisis.

As for rates, the Bank is itching to raise them but needs evidence that doing so would not quash fragile business confidence and trigger a severe slowdown. It nearly moved in February before data was published showing the shock contraction in the final quarter of last year. And, this time, the rising clamour of voices on the MPC calling for a rate rise has been silenced again by worries about growth – this time global.

For the time being there is no need to risk spooking businesses with the threat of a rate rise. The global slowdown has been confirmed by weak numbers last month from the US and, this week, from Germany and the eurozone. According to the Bank’s agents, business confidence is already ebbing away and hiring intentions are falling.

Today’s jobs data, which showed that unemployment rose from 7.7pc to 7.9pc in the three months to June, is equally unsettling – but is still lower than the 8.2pc official forecast for this year as public sector cuts come through. Latest wage settlements, at 2.2pc, are not about to spark an inflation surge.

But I would not be surprised to see rates start to rise early next year, assuming the world isn’t plunged back into crisis. The Bank has already lowered its estimates of spare capacity twice, which means any pick-up in growth will feed more rapidly through to inflation.

The Bank has said it expects pay rises to accelerate as employees demand catch-up for the sub-inflation settlements of the past two years. Companies may also start to rebuild their margins, it warned today, following a big increase in costs.

“Margin levels in consumer-facing sectors probably remained below their pre-recession levels, and any attempt by those firms to rebuild their margins could put upward pressure on inflation,” the agents’ report said.

The squeeze on households will also ease next year as inflation falls back beneath wage deals, allowing for real-terms pay rises.

In his letter of explanation to the Chancellor on Tuesday,  for soaraway inflation, Sir Mervyn said there is “a limit to what monetary policy can do” – a message interpreted as saying more QE is unlikely.

In the minutes, the suggestion was that QE would only be considered if “some of the downside risks [were] to materialise”. Those downside risks were all to do with the eurozone triggering another crisis rather than domestic issues.

It took three months for the Bank’s hawks to abandon their position and turn the direction of monetary policy on its head. It may seem counter-intuitive, but it would take a brave man to bet against policy flipping round again in the next three months.

The Bank is itching to raise rates but needs evidence it wouldn't quash fragile business confidence

How quickly the world can change. Three months ago, three of the Bank of England’s nine rate-setters were voting for an increase in interest rates. Now, the Bank’s minutes revealed today, none of them are and discussion has turned to restarting quantitative easing (QE).

If you think policymakers are fickle, though, try the markets. Earlier this year, traders reckoned it was a nailed-on certainty that rates would have started rising by the May just passed. Now, they are pricing policy to be unchanged until the middle of 2013.

Events have changed, of course, and when they do so, as John Maynard Keynes famously remarked, “I change my mind”. But the one lesson that can be taken is that forecasts must be taken with a pinch of salt. As Sir Mervyn King is fond of saying, the only thing he can promise about his forecasts is that they will be wrong.

Reading policy nowadays is all about reading mindsets. And the Bank has, to my mind, been dropping a few clues recently. As much talk as there may now be about restarting QE, the impression seems to be that it will remain just talk unless Europe’s leaders plunge the world back into crisis.

As for rates, the Bank is itching to raise them but needs evidence that doing so would not quash fragile business confidence and trigger a severe slowdown. It nearly moved in February before data was published showing the shock contraction in the final quarter of last year. And, this time, the rising clamour of voices on the MPC calling for a rate rise has been silenced, again by worries about growth – this time global.

For the time being there is no need to risk spooking businesses with the threat of a rate rise. The global slowdown has been confirmed by weak numbers last month from the US and, this week, from Germany and the eurozone. According to the Bank’s agents, business confidence is already ebbing away and hiring intentions are falling.

Today’s jobs data, which showed that unemployment rose from 7.7pc to 7.9pc in the three months to June, is equally unsettling – but is still lower than the 8.2pc official forecast for this year as public sector cuts come through. Latest wage settlements, at 2.2pc, are not about to spark an inflation surge.

But I would not be surprised to see rates start to rise early next year, assuming the world isn’t plunged back into crisis. The Bank has already lowered its estimates of spare capacity twice, which means any pick-up in growth will feed more rapidly through to inflation.

It has said it expects pay rises to accelerate as employees demand catch-up for the sub-inflation settlements of the past two years. Companies may also start to rebuild their margins, it warned today, following a big increase in costs. “Margin levels in consumer-facing sectors probably remained below their pre-recession levels, and any attempt by those firms to rebuild their margins could put upward pressure on inflation,” the agents’ report said.

The squeeze on households will also ease next year as inflation falls back beneath wage deals, allowing for real-terms pay rises.

In his letter of explanation to the Chancellor on Tuesday for soaraway inflation, Sir Mervyn said there is “a limit to what monetary policy can do” – a message interpreted as saying more QE is unlikely. In the minutes, the suggestion was that QE would only be considered if “some of the downside risks [were] to materialise”. Those downside risks were all to do with the eurozone triggering another crisis rather than domestic.

It took three months for the Bank’s hawks to abandon their position and turn the direction of monetary policy on its head. It may seem counter-intuitive, but it would take a brave man to bet against policy flipping round again in the next three months.

More QE? Give us a break

A head of steam is building up for more quantitative easing in the US and the UK, though apparently not for the eurozone, which is the one place which really needs it. Here’s the case against more QE, which I was going to put on BBC Radio 4’s Today programme on Friday morning, except that we were diverted by the short selling issue.

I’d never say there are no circumstances in which another dose of it would be needed, but the only real justification is the sort of extreme deleveraging, deflationary threat that we saw post the Lehman Brothers collapse in the autumn of 2008. Things look very serious in the eurozone, but we have not yet had that extreme event. Market closure to a major sovereign such as Italy, with no mechanism in place to prevent default, would certainly be the trigger I’m talking about. But as I say, we are not there yet.

In the meantime, it is very hard to argue that in Britain at least with inflation heading towards 5pc and real interest rates deep in negative territory that anything would be gained from further QE. Bond yields are already as low as low can be. If the purpose of QE, by which is meant the creation of new money by central banks to purchase government bonds or other assets, is to depress bond yields, thereby forcing higher risk investment and spending, well, how much lower can they go? They are already at their lowest level in more than 100 years. There’s nothing to be gained by pushing them even lower.

It’s true that money growth in the UK economy is much lower than is consistent with reasonable growth, but it’s been at that level for a year now and it has not driven us back into recession. Anecdotal evidence is that velocity of money, which is the key indicator of economic activity, has fallen quite steeply recently, but let’s see it in the figures before spraying the economy with newly printed money again. In the US, meanwhile, money growth has picked up quite sharply, pointing to significant recovery a year from now. That doesn’t mean it is going to happen, but it is an encouraging sign.

About the only other piece of good news around at the moment is that commodity and fuel prices are falling again, taking the pressure off inflation and putting a little bit of money back in people’s pockets. Do we really want to stoke these prices up again for some kind of short lived and probably quite marginal boost to growth.

QE is like a drug. The first dose was quite potent, but the more frequently it is used, the less effective it becomes and the more the addict demands. QE2 in the US, launched in response to a soft patch in the recovery similar to the one we are going through today, was almost certainly a mistake. Sure enough, it boosted asset and commodity prices, but it did very little for ordinary people. To the contrary, by raising food and fuel prices, it only made them poorer.

To maintain negative real interest rates over such a sustained period is unfair on savers and therefore morally and socially questionable. It certainly softens the deleveraging process, but only by punishing those who have been prudent with their money. Enough is enough. There’s no case for further QE right now. I’ll tell you when that changes.

The Fed is a Rogue Elephant (wonkish rant)

Ben Bernanke thinks the money data is a `Black Box’

Ben Bernanke has moved the goal posts yet again.

Headline CPI inflation in the US is 3.4pc. There is no deflationary threat at this stage that can justify holding rates near zero until the moon turns into blue cheese, let alone embarking on emergency money printing.

The Bernanke Fed has more or less ignored headline inflation until now, arguing that what matters is “core” inflation. This strips out energy, fuel and food, which none of us consume of course.

Unfortunately, core inflation has been catching up lately. The Dallas Fed’s “trimmed mean” measure known as core PCE has risen (on a six-month annualized basis) from 0.9pc in January to 2.1pc in June.

So what the does the Fed do? It switches tack and says that headline inflation is not such a bad gauge after all. They do this knowing that the oil and food shock has subsided and that the headline rate will fall back for a while. This will create the impression that inflation is abating. “Cheeky,” said ING’s global economist Rob Carnell.

Indeed.

As you can see from the two charts below, the broad M2 money supply is growing robustly at 8pc and narrow M1 is growing at over 15pc.

Yes, I know, Ben Bernanke thinks the money data is a “Black Box” that cannot be understood, and ultimately a form of medieval witchcraft. Well, perhaps he should rethink. This is not picture of an economy facing imminent deflation.

Note how weak M2 was fifteen months ago (and broader M3 – which Bernanke has abolished, but others track – was actually contracting at 1930s rates). That was a very good lead indicator of the economic relapse we saw in the first half of 2011.

I am wary of Bernanke’s sudden change of heart on headline inflation. It confirms my suspicion (shared by many readers) that the Fed is deliberately bringing about inflation and currency debasement to cushion the effects of debt-deleveraging. This amounts to a soft default on America’s debts.

QE1 was an entirely appropriate response to the threat of spiralling collapse and an implosion of the money supply. I backed it whole-heartedly, and make no apologies for doing so.

QE2 was a different animal. The threat of imminent deflation was bogus. The effect was to juice stock prices and increase the asset wealth of the rich, hoping for a trickle down. In reality it punished poor people through rising food and fuel costs long before any trickle came through.

Needless to say, it also punishes prudent savers in order to rescue improvident and promiscuous borrowers. This has immense social and moral consequences over time, and risks undermining the virtues that made America the world’s paramount power.

Dallas Fed chief Richard Fisher said in a speech last March, further QE would “only prolong the injustice that we have inflicted on savers.”

He warned of the risk that the Fed will be viewed as “a pliant accomplice to Congress’ and the executive branch’s fiscal misfeasance,” if it carries on down this road. “Barring some frightful development, I will vote against any program that might seek to extend or enlarge the substantial monetary accommodation we already have provided. The liquidity tanks are full, if not brimming over. The Fed has done its job. What is needed now is for business to be incentivized to commit that liquidity to creating American jobs. This is the task of the fiscal authorities, not the Federal Reserve.”

Mr Fisher stuck to his word. He voted against the Fed’s promise yesterday to keep rates near zero until mid-2013.

The Fed is engaged in dangerous forms of social engineering. Central banks should never enter this territory.

Yes, I have been critical of the ECB for other reasons. It allowed the Club Med bubble to build up from 2004-2007, misread both the oil spikes of 2008 and 2011, has allowed M3 to gyrate wildly, but the ECB is not — or not yet — a rogue elephant trampling social norms under foot.

An intellectual case can be made that inflation should be raised to 4pc to 6pc in the western world to lift us out of our debt trap. EX-IMF chief economist Ken Rogoff and others have made exactly that argument. Fine. Let debate be joined.

But if so, the Fed needs to state this openly and not carry out a social revolution by subterfuge. Any such decision should be subject to democratic endorsement by elected parliaments.

How can we bring these the central bankers to heel?