"Other assets” on the Bank of England’s balance sheet rose by a further £4.7 billion in the week to Wednesday 24th October, bringing the total increase since the run on Northern Rock started to £20.6 billion. This is the best available estimate of the extent of the Bank’s support to the lender.

The weekly increase of £4.7 billion is up from £3.0 billion in the prior week and is the largest since the week to Wednesday 26th September.

The recent liquidity crisis was the first significant test of the Bank of England’s new framework for money market operations introduced in May 2006. The result must be judged a failure, not because of the enforced bail-out of Northern Rock, which may have been unavoidable, but rather because two of the stated objectives of the framework were not met: first, to achieve a flat money market yield curve consistent with the official Bank rate out to the next MPC decision date; secondly, to ensure efficient liquidity distribution even in stressed market conditions.

Of course, other central banks have also struggled to maintain functioning money markets, but the Bank’s critics argue that it has underperformed its peers in several respects. The first charge relates to the speed of its response. Market rates globally began to rise sharply on 9 August. The ECB conducted to an emergency operation to add short-term funds on the same day, with the Federal Reserve following on 10 August. On 17 August, the Fed reduced the penalty rate charged for borrowing from its discount window from one percentage point above the Fed funds target rate to 50 basis points, while extending the term of such borrowing. The ECB followed up on 22 August with a further special operation to supply three-month funds at an auction-determined interest rate. The Bank’s first action outside its normal operating framework was on 5 September, when it announced a possible short-term operation a week later if market conditions remained stressed. The actual supply of funds on 13 September occurred over a month after the crisis had broken.

The second criticism relates to the Bank’s insistence on charging a penalty rate of (at least) one percentage point above Bank rate on any lending outside its normal short-term repo operations. This condition applied to funds accessed via its discount window (the standing lending facility) as well as the operations to supply three-month funds announced on 19 September. As noted, the Fed reduced the penalty charged for discount window borrowing to 50 basis points, while the ECB conducted additional three-month operations at auction-determined rates (average rates in these auctions were 52 - 61 b.p. above the ECB’s official repo rate). The Bank’s hardline approach appears to be in contradiction to its own documentation on money market operations (the “Red Book”), which states that a cut in the standing lending facility rate relative to Bank rate is one of the Bank’s instruments for relieving stressed market conditions (paragraph 22 on page 8).

Thirdly, and perhaps most seriously, banks’ ability to access emergency funds from the Bank may have been constrained by much stricter collateral requirements than employed by the ECB and Fed. Under normal circumstances the Bank restricts eligible collateral to securities issued by the UK and other European governments and supranational bodies with a credit rating of Aa3 or higher. British banks hold few such securities. By contrast, the ECB allows private as well as public sector assets to be used, including mortgages, with a lower rating threshold of A. The Fed’s definition is similarly broad, though without a specified credit rating minimum. (The Bank loosened collateral requirements for the auctions to supply three-month funds announced on 19 September, but continues to use the stricter definition in its normal operations.)

The Bank’s defenders deflect such criticisms by arguing that alternative actions or procedures would probably have made little difference given the extent of dislocation in global markets. They claim that the lack of any intervention by the Bank until early September reflected distinctive features of the UK system, in particular banks’ ability to choose their target level of reserves balances at the Bank once a month, with the Bank then supplying these reserves at a non-penal rate. On this view, it made sense to delay additional action until the start of the new reserves maintenance period on 6 September, when banks would be able to access additional funds.

In reality, market dislocation was never likely to be relieved simply by banks requesting higher reserves targets. Once targets are set, banks are required to maintain actual reserves within 1% of the specified amount on average over the maintenance period; deviations incur penalties. In other words, the additional reserves supplied on 6 September did not meet banks’ demand for a cushion to meet unforeseen liquidity demands. This was provided only on 13 September, when the Bank widened the permitted deviation of reserves from targets to 37.5%. Such action could have been taken much earlier and indeed is mentioned as a second instrument for relieving stressed conditions in the “Red Book”.

Another claim is that the more timely actions of the ECB and Fed had little effect. It is true that term premiums in money market rates in the Eurozone and US remained unusually high, but they were consistently lower than those in the UK over the month to mid September.

Finally, the fall in term rates in recent weeks, including relative to Eurozone and US rates, is cited as evidence that the Bank has regained control of markets. Some commentators even suggest that banks’ unwillingness to bid for funds at the three-month auctions supports the Bank’s earlier inaction. Such claims neglect the liquidity impact of the Bank’s enforced lending to Northern Rock, which succeeded where its operational actions had failed in breaking the logjam in markets. Term rates began to decline significantly on 14 September – the day the Bank announced its lender-of-last-resort support. In effect, Northern Rock’s shareholders paid the penalty rate demanded by the Bank to supply the banking system as a whole with greater liquidity. Without Northern Rock, market rates would almost certainly have been higher and banks would probably have borrowed funds in the three-month operations.

At a minimum, the Bank faces charges of tardiness and a failure to use the full range of instruments available for relieving stressed market conditions according to its own “Red Book” framework. However, changes to the framework itself also appear to be necessary in light of recent events, in particular a widening of the definition of eligible collateral and the addition of term auctions as an instrument for maintaining functioning markets.

IBES figures on changes to equity analysts’ earnings forecasts in October are now available. A useful summary measure is the world “revisions ratio” – upgrades minus downgrades divided by the total number of estimates. The ratio moved further into negative territory, reaching its lowest level since 2003. More grist for the bears?

Perhaps not. The revisions ratio exhibits a seasonal pattern, with a clear tendency for analysts to become less optimistic (more realistic?) on their return from summer holidays. As the chart shows, after adjusting for seasonal factors the ratio is still at a level consistent with moderate G7 industrial growth.

Two further points are worth noting. First, the regional breakdown shows more downgrades in the Eurozone than the US in October (after adjusting for seasonals). This fits with my view that the consensus is too fixated with US economic weakness and is underplaying downside risks in Euroland.

Secondly, the measure shown in the chart excludes emerging markets, for which analysts are still marking up earnings estimates. Solid emerging world growth remains an important offset to economic weakness elsewhere.

World stock markets climbed 11% from their August low to the recent peak on 12th October (as measured by the MSCI World index in local currency terms). Momentum and sentiment measures were at overbought levels at the start of last week and equities were ripe for a correction, for which surging oil prices provided fundamental justification.

Some analysts claim there is a four-year cycle in global stock markets, perhaps related to US presidential elections. If so, an examination of market behaviour four, eight, 12 etc. years ago may provide some clues to the future. Much attention is currently being given to the twentieth anniversary of the October 1987 crash but market movements so far this year show little resemblance to 1987 and fundamental conditions also look very different. The MSCI World index rose 32% from its 31st December level before the 1987 decline started; the maximum gain this year has been 10%. The 1987 crash occurred at a time of tightening global monetary conditions when equities were significantly overvalued relative to bonds; neither is true today. The only significant similarity is the weakness of the US dollar.

In terms of the four-year cycle, the closest fit to the present is probably 1999. The chart shows the behaviour of the FTSE 100 index this year compared with 1999; similar results are obtained using other global indices. In both years stocks peaked around mid year, fell sharply into August and recovered into early October. In 1999 a subsequent lurch down took the FTSE 100 index below its prior low, after which it rallied to new highs. The decline this October has been less pronounced (so far) and the index remains well above its summer trough. The comparison suggests a low may be close in terms of time though not necessarily price.

Like 2007, 1999 was the third year of a second term presidency. Global growth was solid at mid year and monetary conditions looked benign, as they do currently. The setback in equities mainly reflected worries about computer disruption associated with the Y2K date changeover. It seems strange in retrospect but most economists expected a significant negative impact, with some even forecasting recession. There is arguably a similarity with current uncertainty about the economic effects of credit and money market dislocation.

I am still hopeful of further upside for equities beyond the current bout of weakness but such a scenario is likely to depend on a retreat in oil prices.