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New BOE Rate Setters Wonder Why Spain Priced Like Gilts

Bank of England Monetary Policy Committee Member Kristin Forbes
Bank of England Monetary Policy Committee Member Kristin Forbes. Photographer: Kelvin Ma/Bloomberg

Kristin Forbes says there’s something amiss if Spain can borrow at the same rate as Britain. For Andy Haldane, it’s a sign market stresses may return.

The two newest members of the Bank of England’s Monetary Policy Committee said yesterday that the search for yield amid low borrowing costs could sow the seeds of a new crisis. Forbes, a professor at the Massachusetts Institute of Technology who will join the MPC next month, said a key sign is the fact that Spain can borrow for 10 years at the same rate as Britain.

“Something’s not quite right; some investors are too sanguine to think Spain is the same riskiness as the U.K.,” Forbes told lawmakers at her appointment hearing in London. Policy makers need to take to the “bully pulpit” to “remind investors there is going to be a change in interest rates at some point in the future,” she said.

At a separate event in the evening, Haldane said appetite for risk is “voracious,” pushing up assets such as equities and houses and lowering yields on sovereign and company debt. Their comments came as the BOE signaled borrowers may need to get ready for an increase in U.K. interest rates sooner rather than later.

“This period of very low rates, which have meant borrowing is basically free, this period will end,” Forbes said. “People need to be prepared.”

BOE Policy maker Martin Weale, who says there may be less spare capacity in the economy than officials estimated in May, said today that Britons should be preparing for higher borrowing costs.

‘Different Matter’

“I don’t think anyone could expect us to maintain the bank rate at half a percent indefinitely just because we were worried about what might happen were it to go up,” he told BBC Radio Ulster. While there is no immediate need to tighten policy, “later in the year would be a different matter,” he said.

For Forbes and Haldane, risk is at the heart of their work. Forbes made her name studying financial contagion, while Haldane, who started on the MPC this month as the central bank’s chief economist, was previously its executive director of financial stability.

The yield on Spain’s 10-year government bond was at 2.72 percent today. That’s down from about 5 percent a year ago and compares with 2.70 percent on the 10-year U.K. gilt. The Chicago Board Options Exchange Volatility Index has fallen 23 percent this year and is at the lowest since 2007.

‘Rumble of Thunder’

“In one sense, rising risk-taking is evidence of the monetary medicine working. If there are adverse side-effects, then an alternative drug can be called upon –- macro-prudential policies,” Haldane said. “But if risk-taking becomes broadly based, a broadly-based response may at some stage be appropriate -– a rumble of thunder rather than a strike of lightning.”

In his comments, made in a speech in Scarborough, northern England, Haldane borrowed an analogy from former U.S. Treasury Secretary Larry Summers on calculating asset prices.

“Pre-crisis, the second bottle of ketchup looked fairly valued relative to the first,” he said. “But even if asset prices are consistent among themselves, this need not imply they are consistent with reality. So it was pre-crisis, as the price of risk became far too cheap relative to fundamentals. With the first bottle of ketchup woefully over-priced, finance theory ensured that the second bottle was similarly marked up.”

“The risk of this cognitive dissonance is once again rising,” Haldane said.

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