What would it take for Ben Broadbent to vote for further Base Rate cuts?

This morning a speech was given by Ben Broadbent of the Bank of England which touches several of the themes of this blog. One of them -falling interest-rates- is pretty much a theme of my career as whilst there have been ebbs and flows the trend has been downwards. Of course at the time it has not always felt like that and I still have vivid memories  of 1992 when the UK found itself ejected from the Exchange Rate Mechanism or ERM and not only was the Base Rate moved from 10% to 12% but an additonal move to 15% was announced for the next day. Actually events were so fast moving that by then we were back to a fully floating currency and the latter rise never took place! If younger readers are bemused by the concept of 12% or 15% interest-rates let me apologise.

Let us start with the misrepresentations 

Towards the end of the speech we are told this with reference to the credit crunch era.

inflation has remained broadly close to target

Perhaps Ben  found the period where UK consumer inflation pushed over 5% in the autumn of 2011 so painful that he now suffers from a type of amnesia on the subject. Either that or the word broadly needs to go into my financial lexicon for these times. When you consider the extent of the impact of the credit crunch on the UK economy then the average annual official inflation figures of 3.3% for 2010 and 4.5% for 2011 look rather extraordinary to me. If we look at the Retail Price Index the average annual rate of inflation from 2010 onwards has gone 4.6%,5.2%,3.2%, and then 3% in 2013. Those who have seen their real wages drop due to this might like to wonder if Ben thinks that their wages are broadly the same.

The Excuses are next

Apparently when the Bank of England was cuting interest-rates it was just following orders or something like that!

This bears out, for me, that the real task for policy is to understand – and then adapt to – economic forces affecting the natural, or equilibrium rate of interest.

That is an interesting swerve of responsibility that I doubt we would have seen had policy been more successful. But I also have a theoretical challenge for the sentence above above which is that one thing we should have learnt from the credit crunch period is that the concept of equilibrium in economics is both bankrupt and otiose. There was no equilibrium in the pre credit crunch period and there certainly isn’t any to be found right now. Indeed even if we briefly enetered a period of it by fluke we would not know that we were there if we allow for the leads and lags of economic measurement. Let me go further I fear that it is economic models and theories pressing for their equilibrium that helped tip us over the edge.

So when the Bank of England slashed interest-rates in 2008 it was just following economic forces? As we now these days that market particpants spend their time front-running central banks can you spot the flaw in central banks responding to market particpants which are one of their measures of economic forces? That is a recipe for quite a mess,which of course is where we find ourselves.

Falling interest-rates

This has become a regular theme of Bank of England speeches recently. Do you think they might be warming us up for something? The situation is summed up the the sentence below

The yield on the 10-20 year portion of the indexed gilt curve, for example, was 4% in the mid-1990s; by the end of that decade it had dropped to barely 2%; on the eve of the financial crisis, in mid-2007, it was less than 1%; today it is -0.3%.

What he is doing here is giving us a measure of real interest-rates in the UK and he is using index-linked gilts to achieve this. The fall is quite something and is a fundamental change which preceded the credit crunch.
However whilst Ben tries to tell us that the recent move is nothing to do with the Bank of England he cannot avoid the isse of Quantitative Easing which set out to reduce bond yields directly

Work at the Bank suggests that the combined effects of the various stages of QE reduced 10-year gilt yields by as much as 100bp.

Are those the same yields which are nothing to do with Bank of England policy Ben or different ones? The  contradictions get worse I am afraid to say because we get told this about QE.

;As the Bank of England explained in a Quarterly Bulletin article a couple of years ago, without QE we’d have experienced higher unemployment,lower wages and lower inflation.

So we see it confirmed that if it feels it can claim something good the Bank of England is responsible for events. Nice of it to be judge and jury on itself don’t you think?

QE has not caused an increase in inequality

Ben has it a bit awkward here because of course he has just praised himself on the subject of QE so  a standard disclaimer will not work. Instead we get this.

(i) interest rates are low because central banks have chosen to keep policy rates low and (ii) this has pushed up the price of risky assets, benefiting only those who happened already to own them. I’m not sure either of these is true.

Unless the credit crunch has lasted a lot longer than I have realised Ben slips in a change of timescale here.

But over the last 15 years, equities have done poorly.

I know that sometimes it feels like the credit crunch has lasted that long but the truth is that it has not managed even half that. Those of a mind more prediposed to conspiracy theories than me may be thinking that Ben has been planning some sort of catch-up for equities.

My summary of the excuses and misreprentations made by Ben Broadbank today and more generally by his central banking colleagues can be summed up by this from the Spinners.

It’s a shame….It’s a shame

What about interest-rates?

We do get a clue from this speech as shown below.

I’d say that neutral real rates are likely to stay low for some time yet – with the implication that any rises in official policy rates are likely to be “limited and gradual” – but that, eventually, as the headwinds previously highlighted by the MPC dissipate, they are likely to rise.

Now let us add in this bit below.

For a variety of reasons, and over a long period of time, this underlying rate has been driven remorselessly downwards. An official interest rate that might once have been considered inflationary is now contractionary;

You may note that interest-rate rises have been moved to some unspeciifed future date whilst the trend to wards lower interest-rates and yields is apparently ongoing.


I would like now to look at todays retail sales figures from the UK. The numbers for September exhibited both disinflation (falling prices) and deflation over the numbers for August. Some care is needed as whilst disinflation has become rather ingrained in the retail sales numbers recently there has been much . the quarterly figures remain positive in volume terms as do the annula ones. But should this be the new trend how long would the Ben Broadbent of this speech take to recommend an easing of monetary policy and Base rates? After all he would only be reflecting economic forces.

Oh and if we link to today’s news a possible turn downwards in retail sales is about the last thing that Tesco needs right now.

Is it the ECB or Euro area banks which most resemble Agent Smith?

This week has seen a new stage in the battle between the European Central Bank and the economic malaise which is affecting much of the Euro area. One factor in this has been that it announced this on Friday.

The ECB announces that the Eurosystem starts covered bond purchases on Monday 20/10.


Covered bonds that are eligible for monetary policy operations in line with section 6.2.1 of Annex I to Guideline ECB/2011/14 ….. and are issued by credit institutions incorporated in the euro area, shall be eligible for outright purchase under the CBPP3. Multi-cédulas that are eligible for monetary policy operations in line with section 6.2.1 of Annex I to Guideline ECB/2011/14 and are issued by special purpose vehicles incorporated in the euro area shall be eligible for outright purchase under the CBPP3.

I have taken out a little of the detail there but left in the bit about special purpose vehicles qualifying as that is the sort of thing that can return to haunt a central bank. But the crucial point is that the ECB began to purchase covered bonds again this week. The operations  have been observed by market traders. According to Bloomberg it did this on Monday.

The ECB bought short-dated French notes from Societe Generale SA and BNP Paribas SA as well as Spanish securities.

Yesterday it did this.

The European Central Bank bought Italian covered bonds …………Debt issued by Intesa Sanpaolo Spa (ISP) was included in the purchases,

I think most readers will be clear why Italian and French debt was chosen although it is less clear why the debt of the supposedly recovering Spanish economy was chosen. I suspect that the mortgage related problems of the Spanish banks are far from over.

What will it achieve?

According to the ECB it will be all-singing and all-dancing when combined with its existing measures.

the CBPP3 will further enhance the transmission of monetary policy, facilitate credit provision to the euro area economy, generate positive spill-overs to other markets and, as a result, ease the ECB’s monetary policy stance, and contribute to a return of inflation rates to levels closer to 2%.

Does it also supply apple pie and ice cream?

What is a covered bond anyway?

Here is the definition from the Financial Times.

A bond backed by assets such as mortgage loans (covered mortgage bond). Covered bonds are backed by pools of mortgages that remain on the issuer’s balance sheet, as opposed to mortgage-backed securities such as collateralised mortgage obligations (CMOs), where the assets are taken off the balance sheet.

What does this mean?

We see that there are two very familiar themes to this particular operation. The first is that apparently the way to rescue the real economy is always via another bank bailout or subsidy. The second is that most of these moves involve the housing market and finance on it. If we stay with the concept of an implicit bailout for the banking sector we see the depth of their troubles I think  as bailout follows bailout. The theme here is along the lines of Agent Smith in the film the Matrix Revolutions as he cries “More,More” as he replicates and clones himself throughout the system. Indeed Agent Smith has another line in that film which reminds me of the modern banking sector.

This is my world! My world!


What has so far been missing in the Euro area has been any real transmission of the ECB’s policies to the economies of the weaker nations. It has got stuck in the banking system in these places and has never emerged. After all the traditional measure for firing up the engines of the various housing markets (or stopping price falls) has been to reduce mortgage rates by cutting official interest-rates, except with a headline rate at -0.2% we can see that this has been tried. There have been various extraordinary measures too such as LTROs and now TLTROs as the ECB has gone acronym crazy but what has been missing is any real sign of economic recovery.

Even worse the banks started to give some of the money back earlier this year and at times this has approached a flood. Along this road the balance sheet of the ECB which reached a peak of 3 trillion Euros has shrunk to just over 2 trillion. Last Friday saw yet another example of this.

Accordingly, on 22 October 2014 EUR 3317.70 million will be repaid in the tender 20110149 by 4 counterparties and EUR 2504.50 million in the tender 20120034 by 6 counterparties.

Thus another 5.8 billion Euros departed the balance sheet of the ECB in what has become a regular Friday drumbeat. This poses a darker problem than you might think as it looks as though the banks feel that they have enough liquidity and do not want anymore however cheap it appears. The prospect of them lending more in such an environment do not look optimistic as we see something of a reverse for this type of extraordinary monetary policy. They no longer seem especially keen to borrow such funds and put the cash into sovereign bonds which I suppose is a side-effect of the lower level of bond yields available these days.

Is there an element of deja vu here?

Actually you could say deja vu squared as the ECB has had two goes at this before and the clue is to be found in the 3 of CBPP3. This has been missed by much of the media which has announced that this is the ECB’s first effort at Quantitative Easing. There were Covered Bonds Purchase Programmes in both 2009 and 2011 and the ECB still has some 45 billion Euros of bonds from those purchases.

Here of course we hit a problem, if the past purchases were such a success how did we get to this position? Why did the ECB start and then stop it twice? The truth is plain that the purchases did not seem to be ing having either the required or the hoped for effect so they were quietly binned. As they had little publicity anyway  this was not that hard to do.

Accordingly I note that the ECB is back not because it really believes that such purchases will work but because it is a large enough market for it to look like it is doing something substantial. Here monetary policy morphs into a form of public relations.

What about Asset Backed Securities?

As 2014 progressed we saw Mario Draghi offer ever more impassioned pleas for the ABS market to grow. But the truth is that the amount available to buy may only be of the order of 15 billion Euros.

What about Corporate Bond purchases?

This subject roared into life only yesterday as rumours that the ECB would announce purchases at its December meeting spread like wildfire. Those who recall that November comes before December might have already been wondering what happened to it?

One plus of entering this market is that it is a large one and the ECB would be able to expand its balance sheet substantially by buying some of it.


Having pointed out that bankers have become like Agent Smith in our economy  it is even more true of central bankers. If we recall that 2014 was supposed to be the year of recovery it is a way especially troubling to see the ECB both planning new measures and reheating old ones. The supposed end product of boosting small and medium-sized businesses always seems to morph into a subsidy for the banking-sector in reality. Yet the cry goes up again and again “More! More!”. One day there will have to be a valuation of the paper,bonds and markets they have got involved with  and I expect there to be “surprise” shortfalls.

Perhaps the one way this may impact the euro area economy is via a lower exchange rate and the value of the Euro has fallen. But in a way this is just exporting the problems of the Euro area to other countries as we mull the competitive devaluations of the 1920s.

Meanwhile rumours spread that 11 Euro area banks have failed the latest stress test.

The UK Public Finances continue to suggest a pre-election stimulus

Today sees the latest installment in the troubled path of the UK public finances. For a considerable period it was possible to blame underperformance in this area on the lack of economic growth in the UK economy. However that changed as the UK economy turned for the better and began its current growth spurt.at the beginning of 2013. Since the first quarter of 2013 we have seen quarterly economic growth go 0.5%,0.7%,0.9%,0.6%,0.7% and 0.9% in the second quarter of this year. Added to that is the expectation that we will see economic growth of the order of 0.7/8% reported later this week by the Office for National Statistics.

The Labour market has been strong too

One factor that  you might have expected to have been a major factor in the UK public finances if you had been able to pick the period of weak economic growth has been something of a dog that has not barked. This is social spending on the unemployed which has been kept lower than you might have reasonably thought by this.

There were 30.76 million people in work.Comparing June to August 2014 with a year earlier, there were 736,000 more people in work.

There were 1.97 million unemployed people, 154,000 fewer than for March to May 2014 and 538,000 fewer than a year earlier. This is the largest annual fall in  unemployment on record. Records for annual changes in unemployment begin in 1972.

So the background for social spending has been positive and if we look  at the explicit claimant count measure (Job Seekers Allowance) we see a fall from a peak of just over 1.6 million in late 2011 to 951,900 this September. So the quantity factor here as in the number of unemployed has been stronger than might have been expected.

Wages are a problem

It is in fact the other part of the labour market which has been posing a problem for UK tax revenues. This is the issue of the lack of wage growth and the increase in lower paid work combined with the trend towards self-employment. Added to this has been the policy of raising the Personal Allowance such that the starting point for income tax is a higher level of income. Putting all this together has led to these disturbing numbers below for the fiscal year (April onwards) so far.

income tax-related payments increased by £0.1 billion, or 0.1%, to £71.5 billion;

Whilst we need to make an allowance for the bonus  payments which were made last year to avoid the 50% income tax rate this is disappointing to say the least for an economy growing at around 3% per annum! If we look at the numbers for the month of September which should be clear of that impact they are better but still disappointing.

income tax-related payments increased by £0.2 billion, or 2.2%, to £10.7 billion

That is a fair distance behind the 4% growth in VAT (Value Added Tax) revenue in September.

The official view is that we will catch up with the lost revenue when the self-employed report and more importantly pay income tax on the more recent period of economic growth. I know that at least some of you think that there will also be some self-employed who will report very little at all due to pressure to leave the unemployment numbers. Also if you read read between the lines of this from the Office for Budget Responsibility there are plainly concerns about the ongoing situation.

Employment driven growth is less tax rich because a given amount of labour income attracts a larger number of tax -free personal allowances, reducing the effective tax rate. This suggests that recent increases in the income tax personal allowance will have been more costly than they otherwise would have been. And slow
earnings growth reduces fiscal drag the positive effect on receipts of earnings rising faster than tax thresholds and allowances.

Pension payments

This is a part of social spending which the government via its “triple-lock” for state pensions has boosted somewhat. To the individuals receiving it the amounts may not seem large but expenditure was pushed onto a higher trajectory by the surge in inflation in late 2011and has continued. It seems that public-sector pension payments are adding to this factor. Below are the figures for the fiscal year so far.

net social benefits (mainly pension payments) increased by £2.8 billion, or 2.9%, to £99.6 billion mainly as a result of increases in state pension payments (within National Insurance Fund benefits) and social assistance payments and public sector pension payments;

Actually the rate of increase in this category was even higher in September.

net social benefits (mainly pension payments) increased by £0.9 billion, or 5.4%, to £17.0 billion,

A fiscal stimulus?

I have analysed this issue before where the publicly proclaimed austerity looks rather more like a pre-election stimulus if you ignore the hype and just look at the data. In today’s release there is a component which does add to this theme.

central government net investment (capital expenditure) increased by £3.3 billion, or 25.7%, to £16.4 billion, largely due to a £2.0 billion increase in gross capital formation.

If we move to wider public expenditure it is hard to make any sort of austerity case from these especially if we recall the economy’s growth rate.

Central government expenditure (current and capital) for the financial year-to-date 2014/15 was £344.1 billion, an increase of £10.1 billion, or 3.0%, higher than the same period in 2013/14.

With the falls in the annual rate of inflation such numbers would to a Martian look much more like a stimulus than austerity

The effect of these influences
In essence they are summarised by the numbers below.

PSNB ex was £11.8 billion in September 2014, an increase of £1.6 billion compared with September 2013.

In case you were wondering if this was some some sort of fluke here are the numbers for the fiscal year so far

Public sector net borrowing excluding public sector banks (PSNB ex) from April to September 2014 was £58.0 billion, an increase of £5.4 billion compared with the same period in 2013/14.

So up is indeed the new down in the world of “paying down the deficit”! If  we compare where we are now to where we were expected to be the disappointment mounts.

the public sector net borrowing excluding public sector banks (PSNB ex) was £58.0 billion for the financial year-to-date (April to September) 2014/15, while the full year OBR illustrative projection for 2014/15 was £86.6 billion.

It is true that we tend to borrow less in the second half of the fiscal year but not that much less!

There is much to consider here. I think that the best perspective is provided by going back just under a year to the 2013 Autumn Statement. Back then it looked as though the UK public finances were on the verge of a considerable improvement. Since then recorded economic growth has been as strong as one could reasonably have hoped back then. But rather than improving they have deteriorated. Whilst this has become a regular feature of many austerity programmes the rub here is that UK economic growth has arrived. So right now there is more evidence for a (pre-election) stimulus in the UK data than for any form of austerity.

On that basis the national debt will continue to mount.

Maastricht debt (General Government Gross Debt) at the end of September 2014 was £1,557.5 billion. (89.9% of UK GDP

We should be grateful that  the bond vigilantes are fast asleep and we can borrow extremelly cheaply by past standards. Perhaps our establishment thinks it can in extremis order the Bank of England to purchases any extra debt.

Still one form of tax revenue is booming in the fiscal year so far.

stamp duties (on shares, land & property) increased by £1.5 billion, or 25.2%, to £7.3 billion

Abenomics cannot escape the issue of Japan being trapped between a rock and a hard place

The last couple of years have seen me reviewing the progress of Abenomics or the economic policies of Japan’s Prime Minister Shinzo Abe. These were initially lauded by the media with the Financial Times and Paul Krugman leading the way. However I expressed many doubts about how expanding the money supply and depreciating the currency would lead to an economic transformation for the land of the rising sun. After all it had tried such policies previously without conspicuous success and we had already learnt by then from the UK and the Euro area that higher inflation was likely to hit real wage growth. Accordingly any economic heavy lifting was going to have to come from economic reform which seemed unlikely when Abe-san himself represents the vested interests of old Japan.

(Wo)men overboard

The next feature of pro-Abenomics propaganda was that it was beginning to institute reforms by increasing the number and role of women in the workplace. This morning has seen something of a reverse for that. From Reuters.

Trade and industry Minister Yuko Obuchi, 40, the daughter of a prime minister and tipped as a future contender to become Japan’s first female premier, told a news conference she was resigning after allegations that her support groups misused political funds.

Just hours later, Justice Minister Midori Matsushima also resigned.

This leads to fears that the women promoted by Shinzo Abe have exactly the same problems as the men with issues such as corruption. So rather than a hoped for change of direction it seems that the same group are in charge whatever their gender.

If we move to the reform issue then this looks a bit like the first government of Shinzo Abe rather than a new dawn.

Abe’s first stint as prime minister in 2006-2007 was marred by scandals among his ministers – several quit and one committed suicide.

What about the economy?

A problematic piece of data was released in the middle of last week. This was industrial production for August which fell by 1.9% on July and was some 3.3% lower than a year before. The index where 2010=100 was only at 95.2. This report followed on a 2.9% year on year fall in July which replaced a period of positive growth.

This poses a problem as two of the three months of the third quarter are now accounted for and this part of Japan’s economy has shrunk in both. Whilst the business surveys are mildly positive for September (PMI was 51.7), I note that the Purchasing Managers Index in August was more positive at 52.2 and yet output fell. So this sector seems likely to be a drag on Japan’s economy in the third quarter of 2014.

Also we already have something of a correction to the claims that the economy would quickly bounce-back from the effects of April’s rise in the consumption tax.

What about Real Wages?

This has become an increasing issue in the credit crunch era as we have seen falls in real wages or at best stagnation spread. The (fairy) story told by Abenomics fans was that as inflation rose Japanese firms would increase pay to at least match it and the economic expansion would allow real wages to grow. Meanwhile the Ministry of Labour told us late last week that real wages in August were 3.1% lower than a year before. This was the fourteenth month in a row that annual real wage growth was negative. So on the evidence so far Abenomics has pushed real wage growth downwards rather than the upwards claimed.

Accordingly it is hard to see much of a boost to the Japanese economy coming from the domestic consumer as he/she faces up to lower wages in real terms. The irony here of course is that the rise in the consumption tax has pushed inflation up and real wages down.

Today’s Data

The Economic Statistics and Research Institute has published it surveys this morning and signals  a possible turning point. However as the coincident index fell from 109.9 in July to 108.5 in August and the leading index fell from 105.5 to 104.4 I am not sure where they get their optimistic tinge from.

We also saw modest year on year falls in department store sales and convenience store sales for September.

Financial Markets Surge

There is a grim theme of these times which is the decoupling of the real and the financial economy. This morning has seen an example of that as the Japanese Nikkei 225 equity index has surged by 578 points or a smidgen under 4% to 15,111. No doubt policymakers who have in my opinion an unhealthy obsession with equity market levels will be pleased. But once you look beyond the possible causes such as the improvement in other markets on Friday you also see this. From Japan Today.

Japan’s $1.2 trillion retirement fund will increase its allocation target for shares to about 25 percent from 12 percent, the Nikkei newspaper reported without attribution.

The Government Pension Investment Fund will also boost its holdings of foreign bonds and stocks to about a combined 30 percent from 23 percent,

No wonder the market surged! Has anybody asked the pensioners what they think of this? It makes me wonder two things. Firstly what equity market skills Shinzo Abe has and secondly why this is badged as a reform.

If you are wondering who will buy all the government debt that Japan is going to issue going forwards I guess we need to look at the Bank of Japan. There is certainly very little sign of panic in a ten-year bond yield of only 0.48%.

Oh and with the Bank of Japan buying Japanese equities too then we have a clear Goodhart’s Law issue. If you pressurize institutions to buy the equity market and force it higher then claiming higher equity markets are a sign of economic succession is at best a type of misrepresentation.

Shinzo Abe gets cold feet?

In an interview with the Financial Times Shinzo Abe is suggesting a type of Laffer curve being at play in Japan.

By increasing the consumption tax rate if the economy derails and if it decelerates, there will be no increase in tax revenues so it would render the whole exercise meaningless.

Such a situation will be familiar to those who have followed the travails of the periphery of the Euro area. Except here we are seeing a suggestion that 8% may be as high as the consumption tax can go which if you look at a VAT (Value Added Tax) rate of 20% for the UK seems odd to say the least. Also if you do believe that the Japan really does have a problem as it continues to have high fiscal deficits (7% of GDP in 2013) which only add to the issue of its national debt which is estimated by the IMF to be 243% of GDP in gross terms.


We see that even Shinzo Abe is now facing the contradictions which were always inherent in the policy of Abenomics. Raising inflation was always likely to have a depressing influence on the economy via its impact on the level of real wages. Then adding an increase in indirect taxation to this was only giving it a further push. Perhaps he hoped that the international environment would be more favourable than it is and would cover this up.

The problems I have highlighted above return me to my image of a rock and a hard place. Japan is experiencing something of a fiscal crisis with deficits adding to its already large national debt. The theoretical solution suggested by the IMF of higher indirect taxes – how has that worked for the IMF elsewhere?!- seems to be already in trouble with the next proposed rise being questioned. If we then factor in the impact of Japans population which is both ageing and declining then we see that it is only going to get tougher going forwards. As Japan’s population holds the vast majority of Japan’s national debt a default will cause as many problems as it solves.

Perhaps the new passenger airliner unveiled by Mitsubishi is a hopeful step for an industrial regeneration. But for Japan’s establishment the replacement of the daughter of a previous Prime Minister with the nephew of one about sums it up really.

Why I think a Base Rate cut in the UK is as likely as a rise going forwards

Today’s blog post title goes against quite a lot of conventional wisdom in the UK where we are continually promised that Base Rate rises are just around the corner. So far however we have found ourselves on a straight road and the chances of that continuing have moved higher. It was only last Thursday that I pointed out on here that the Bank of England was moving away from its promises of a Base Rate rise which continued a theme I had opened on the 27th of December last year.

So should we see any slowing of the UK economy in 2014 and the exchange rate of the pound continues to be strong there are factors pointing towards a base rate cut. This would be reinforced if the pound strength actually pushed inflation to below its target. The MPC would be likely to ignore the years of inflation being above target and concentrate myopically on the immediate figures in such a situation.

Okay so what grounds might there be for a Base Rate cut?

Some of these have been established this morning in a speech given by Bank of England Chief Economist Andy Haldane in Kenilworth.

So far, then, so bad. On this evidence, the UK economy is as weak as at any time in the recent or distant past. It is firmly on the back foot.

Okay Andy so what ground do you have for thinking in such a way? The emphasis below is mine.

Annual real wage growth in the UK – average weekly earnings growth adjusted for consumer price inflation – is currently running at close to minus 1%. Growth in real wages has been negative for all bar three of the past 74 months. The cumulative fall in real wages since their pre-recession peak is around 10%. As best we can tell, the length and depth of this fall is unprecedented since at least the mid-1800s.

Regular readers will be aware of this issue but I thought the sentence I emphasised a fresh way of looking at it. Some of you may already have spotted that he has missed a trick as the real wages data would look worse if he had used the Retail Price Index. As he is using data supplied by the Trade Union Congress for their Britain Needs A Pay Rise campaign I suspect they have missed a trick too. Oh and using an index (CPI) only just over a decade old to go back more than a century has its dangers.

Next up we got this.

Productivity – GDP per hour worked – was broadly unchanged in the year to 2014 Q2, leaving it around 15% below its pre-crisis trend level. The level of productivity is no higher than it was six years ago. This is the so-called “productivity puzzle”. Productivity has not flat-lined for that long in any period since the 1880s, other than following demobilisation after the World Wars.

Okay so a further problem and particularly troubling that it has not picked up as our economy has pushed forwards and had a better spell.

There is something of a departure for a Bank of England official in this next section which I wholeheartedly welcome. It is considering the effect of the credit crunch on savers.

Annual real interest rates – for example, rates earned by households on time deposits adjusted for consumer price inflation – are around zero. They have been near-zero for close to four years. Real deposit rates have not been that low since the 1970s, when inflation was in double digits.

This is something of a change as I can remember Deputy Governor the aptly named Charlie Bean telling us this back in September 2010. He replied “Yes” to this question posed by Channel four news.

This bad news for savers is the point of what you are doing?

Now Andy Haldane is implying that this is one of the things which have weakened the economy. Oh and Charlie Bean was displaying his usual anti-prescience skills back in September 2010.

At the current juncture, savers might be suffering as a result of bank rate being at low levels, but there will be times in the future — as there have been times in the past — when they will be doing very well.

So far some four years later such a situation has yet to arrive Charlie! Still I suppose that having retired with a pension fund valued at £3.96 million he has hardly noticed.

The Agony Index

Andy Haldane uses the concepts and data above to create an agony index which is not especially pleasant reading.

The agony index is currently at painfully low levels.
It has been around 5 percentage points below its 1970-2014 average since 2008. Such an extended period of agony is virtually unprecedented going back to the late 1800s, with the exception of the aftermath of the World Wars and the early 1970s.

Bank of England Forecasting Accuracy

The emphasis is mine.

And if you believe the MPC’s growth forecasts, that recovery is set to continue in the period ahead.

Indeed one of my themes has been confirmed here and it is nice to see some refreshing honesty for a change.

These suggest that the MPC, in common with every other mainstream forecaster, has been forecasting sunshine tomorrow in every year since 2008 – that is, rising real wages, productivity and real interest rates. The heat-wave has failed to materialise. The timing of the upturn has been repeatedly put back. Downside surprises have been correlated.

The future does not look especially bright

In the UK, real interest rates are now expected to remain negative for at least the next 40 years. An alternative hypothesis is that these developments reflect pessimistic expectations about future growth prospects, which are mirrored in expected policy rates needing to remain lower for much longer.

You may note that the “lower for longer” mantra of Forward Guidance has found the word “much” added to it. Yet another change? Perhaps and maybe soon we will be following the Bank of Canada and moving away from Forward Guidance completely.

Some care is needed here as we have just concluded that forecasts are not far off hopeless right now but the summary of wages and the labour market is also somewhat ominous.

Taken together, this paints a picture of a widening distribution of fortunes across the labour market – a tale of
two workers. The upper peak of the labour market is clearly thriving in both employment and wage terms. The mid-tier is languishing in both employment and real wage terms. And for the lower skilled, employment is up at the cost of lower real wages for the group as a whole.

Let us cut to the chase

Here is the implied policy judgement from Andy Haldane.

And recent evidence, in the UK and globally, has shifted my probability distribution towards the lower tail. Put in rather plainer English, I am gloomier.


There is a fair bit to consider here and let me open by pointing out that Andy Haldane has got gloomier over a period where the UK economy has apparently grown strongly again (0.7% according to the NIESR). Also the ESA 10 revisions have left our economy somewhat larger in recorded terms but little solace seems to have been gained from that. Perhaps he is not much of a fan of them either!

Also I wish to point out that there was another side to the speech as you might guess from the title of “Twin Peaks”. There was an ecstasy alternative to the agony. But I have the feeling that we are being feed a policy shift in what might be called bite-sized chunks. As I have argued before the chances of a future Base Rate cut are much higher than you are likely to read elsewhere. Please do not misunderstand me as I would not vote for it but the possibility is edging up on the horizon.

If we move to an international perspective then the United States may be edging in the same direction. Here is James Bullard of the St.Louis Federal Reserve on Bloomberg.

Inflation expectations are declining in the U.S…… “That’s an important consideration for a central bank. And for that reason I think that a logical policy response at this juncture may be to delay the end of the QE.

Now who is left raising interest-rates? Oh and did the markets or the central bankers move first?

What interest-rates do governments and central banks control?

Yesterday was a day of wild swings in financial markets and one which makes me miss the days when I used to put on a trading jacket in the open outcry markets of LIFFE. Something about old warhorses and the sniff of battle I guess! However the moves in one area did highlight a fundamental issue which is rarely discussed either properly or in depth so I will explain it today. The issue can simply be expressed as who sets interest-rates? You may note the fact that I use a plural here. Also I guess you are already figuring that it is much wider than the conventional somewhat stereotypical answer which is that the interest-rate is set by the central bank of the respective country. This is particularly relevant at a time when central banks have intervened in so many areas and markets and are considered by some to be giants in a land reminiscent of Lilliput.

The Bank of England

Martin Weale

Martin Weale gave a speech yesterday evening and as he is a voting member of the Monetary Policy Committee you might think that UK interest-rate markets would be hanging on his every word. So let us examine what he had to say.

An increase in Bank Rate of ¼ point would be unlikely to slow that process to a halt immediately but there is a risk that, if the increase were delayed, inflation would be pushed above target or a rather sharper increase in Bank Rate would be needed subsequently.

This represents his view that a nudge higher in UK Base Rates is required right now to combat future upside inflation risks. A bit awkward for a man who “looked through” rises in consumer inflation to over 5% you might think! He did briefly vote for a Base Rate rise then but changed his mind (something which may yet repeat). Also you may be intrigued by this bit.

The margin of spare capacity is shrinking rapidly and all logic suggests that that ought to lead to an increase in inflationary pressures over the two to three year horizon which concerns the Committee.

Whilst he is making his case he has nudged the policy horizon from 2 years to 2/3 years. I guess the vaguer you make it the easier it is to dodge responsibility when things go wrong as they so regularly have.

Let me add here a real problem for inflation targeting which is that right now seeing the future more than a few months ahead is as difficult as it has ever been. On those grounds alone lengthening the policy horizon is not a little dim.

What did the financial markets actually do?

As I have already hinted at yesterday was a day of big moves in interest-rate markets and also high volumes. For instance by I saw reports that the US Treasury market had passed the previous days total volume by 10 am. Let us examine some moves in the UK.

If we go to one of the UK’s longest dated conventional GIlts (2060) I note that it rallied more than 3 points and that its yield fell from 2.83% to 2.73%. Those with personal pensions will be grateful that it is no longer compulsory to buy an annuity because should such yields persist we will see even poorer value from conventional annuities. If we move down the maturity curve to the ten-year yield used as a benchmark then this fell below 2% (and is there as I type this) which contrasts significantly with the (just over) 3% with which 2014 began.

There are also interest-rate futures markets which for the UK are rather confusingly called short sterling. A price rise here indicates a lower path for expected interest-rates in the UK and prices have been rising. We do not have to look back very far to see quite a change as since the end of last week the December 2015 has priced in a future with interest-rates 0.24% lower and the March 2016 contract has priced in interest-rates some 0.29% lower. Just to confirm that these are lower interest-rates and not the higher ones Martin Weale is voting for.

The combination of all these factors will be felt in various areas as for example some mortgage rates (fixed ones in particular) and corporate borrowing rates will respond to the new situation should it remain like this. So the UK is seeing a monetary loosening of policy right now -especially if we also add in the recent decline of the value of the UK Pound- just as two members of the MPC are calling for higher Base Rates. Other countries have more direct formal relationships here as for example yesterday saw lower fixed rate mortgages being offered in the United States in response to the plunge in US Treasury Bond yields which took place.

What about Quantitative Easing?

This has been an attempt to reduce longer-term interest-rates via bond yields by several of the worlds major central banks. You would think that such large purchases (some £375 billion) would have an effect on the price. Except that yesterday UK Gilt prices surged and yields fell without there being any new QE purchases. The only action these days is the rolling over of maturing bonds (which just to be clear I would stop). Whilst there is a stock of UK QE we have to question if UK Gilt yields would have dropped anyway leading to the possibility of it being a waste of time and a failure.

As it did exist in the UK we need to look elsewhere for clues. Germany is currently an interesting test case as its bonds continue to surge with its five-year yield now a mere 0.11%. It does not have QE and yet if we move to Japan long considered the home of QE and currently deploying it with kamikaze enthusiasm we see a five year yield of 0.14%. The circumstances of the two countries are of course by no means exactly the same but the country without QE has lower shorter maturity bond yields. Also with longer-dated bonds surging in price in Germany again today they could not be catching up much faster.

Putting it another way QE is now generally expected in Italy for example and maybe rather soon. Yet its government bonds are falling in price and the ten-year yield is up by 0.34% to 2.74% today alone. It was not so long ago that the discussion was around Spanish yields were below the UK, er not now and by a fair margin and yet QE is expected there too….

What does the central bank control?

It controls the official interest-rate and these days there may be more than one occupying this mantle. Let us look at the UK Base Rate. This is an interest-rate that is for overnight borrowing only. if we are generous we might add that it usually holds for one month until the next MPC meeting.

Accordingly the impact is then implied onto a range of other interest-rates. Some are explicit as there are mortgage rates which are tied to the Base Rate. Others are not so explicit but are expected to respond. What if increasingly they did not? We have seen that sort of behaviour in parts of the Euro area.


I hope that this has clarified matters on this subject. As ever we do not have a laboratory and some test tubes to do a controlled experiment. But two members of the MPC are currently voting for Base Rate rises and Mark Carney has hinted at future rises. Yet right now the financial markets are apparently approving of the recent reforming of Fleetwood Mac.

You can go your own way
Go your own way
You can call it another lonely day
You can go your own way
Go your own way

The Royal Statistical Society

I raised the issue of the treatment of UK inflation with respect to rail fares ( CPI or RPI) with the RPICPI User Group. In response the Chairman has written to the head of the UK Statistics Authority requesting clarification. The details of the exchanges can be found below.


The UK has falling real wages and oil prices but a rising price of football

Over the past week or so the pace of action in financial markets has really picked up. It was only yesterday that I was discussing disinflationary trends and this morning I note that the price of a barrel of Brent Crude Oil has fallen below US $84 per barrel. Since the peak of US $115.71 on June 19th it has fallen by some 27% and the pace has accelerated over the past 24 hours. The report from the International Energy Agency reducing oil demand forecasts for this year and next and telling us that supply exceeds demand right now certainly put the skids under the oil price! We are now back to levels last seen in the latter part of 2010 so some care should be taken as we have fallen very far very fast and must be vulnerable to a short-covering rally.

Also I would like readers to take a step back from the media coverage which will involve panic over disinflation and deflation in some confused combination. Whilst a falling oil price does signal issues with the current state of the world economy it is also a strong reflationary influence and so many economies will get a much needed boost from it. Indeed it will be oil importers who most benefit and there is a long list of them. For once there is some good news for the Euro area although it comes with a problem for the European Central Bank which will get lower inflation before the growth boost. Imagine the panic if Euro area consumer inflation should have a print below zero. Let me wish Mario Draghi good luck in explaining that one.

However we are seeing consequences of this oil price fall in more and more places with China adding itself to the list today. From the National Bureau of Statistics via Google Translate.

2014 years 9 months, the national consumer price index rose 1.6%

So the disinflationary trend is clearly in evidence (it was 3.1% this time last year) there with some already wondering if we will see before long a number less than 1%. With the producer price numbers negative that may yet happen. Of course Chinese consumers and workers will welcome the reduction in inflation and may choose to avoid reading the experts who will tell them it is bad for them.

The UK

As we switch to the UK we see that it will be receiving a boost from the falling oil price and maybe even a small one to the trade figures as it is now a net importer. Adding to this is the recent fall in the value of the UK Pound which has dipped below US $1.59 today. Whilst this will offset some of the oil price fall it should in theory give the economy a boost although the lesson of the 2007/08 depreciation was to weaken expectations for such effects.

We are seeing lower fuel prices at the pump at least. According to the official data petrol prices are some 5.2 pence per litre cheaper and diesel some 8.1 pence cheaper. As I driver of a diesel may I add a little hurrah to the narrowing of the gap? It used to be cheaper but that was before many of us in the UK were persuaded to switch fuel type. Let us hope that more price falls are on their way.

What about today?

Employment has continued its recent growth phase.

There were 30.76 million people in work. This was 46,000 more than for March to May 2014………The proportion of people aged from 16 to 64 in work (the employment rate), was 73.0%,

So our quantity measure has performed extraordinarily well considering the economic distress that we have seen in the UK. However as it approaches all-time highs in terms of the ratio (73.2%) we do have a problem for projecting that forwards. Is this a type of (near) full employment? Personally I think that there is still room for reductions in the under employed sector but any such thoughts about nearing a maximum poses obvious issues.

The improvement in employment has followed through to the unemployment numbers.

There were 1.97 million unemployed people, 154,000 fewer than for March to May 2014 and 538,000 fewer than a year earlier. This is the largest annual fall in unemployment on record. Records for annual changes in unemployment begin in 1972.

The unemployment rate continued to fall, reaching 6.0% for June to August 2014, the lowest since late 2008.

Again these are very welcome figures and we should perhaps take a moment to let them percolate.

The hours worked numbers did show a clearer change of trend as they had been growing but now did this.

Total hours worked per week were 987.3 million for June to August 2014. This was:
• little changed on March to May 2014,
• up 24.5 million (2.5%) on a year earlier,

If we continue with our glass half full view there is a glimmer of a possible improvement in productivity there as our economy was growing then (h/t Chris Dillow).

What about real wages?

This remains a problematic area to say the least.

For June to August 2014, regular pay for employees in Great Britain was 0.9% higher than a year
earlier and total pay for employees in Great Britain was 0.7% higher than a year earlier.
Between August 2013 and August 2014, the Consumer Prices Index increased by 1.5%.

As you can see wages continue to be growing more slowly than the rate of inflation. The number for total pay growth in August alone was marginally better at 0.8% but the theme remains broadly the same. If you want an even grimmer measure then take a look at the Retail Price Index which was rising at an annual rate of 2.4% in August. So real wages were falling at an annual rate of 0.7% or 1.6% in August.

Breaking the numbers down

The detail of the average earnings numbers is not what you might expect. You might be surprised to learn that public-sector pay (excluding RBS etc..) was up by 1.6% in the year to August. Not quite the impression we are given is it? Pay in manufacturing was a bright spot but as the last three months have gone 2.2%,1.9% and now 1.3% that looks as though it is fading. My commiserations go to those who work in the retail hotel and restaurant sector as annual pay growth was negative in both July (-0.9%) and August (-1.1%). As it is a low paid sector this looks particularly grim and oddly considering our economic position it is reversing a better effort up to this spring.

If we put 3% economic growth into a computer model I would suggest it would react in the manner of HAL-9000 in the film 2001 A Space Odyssey if we put in overall current wage growth let alone the falls in some areas.


I wanted to widen the perspective today beyond the boundaries of the UK because that is the environment we need to judge our labour market statistics from. We should welcome the fact that the quantity measures are as strong as they are but also be troubled by the continued failure of wages to even keep up with inflation. How can this be with economic growth of 3%? Apparently in the new era quite easily.

I also welcome the fall in the oil price as it should give a boost and of course help the consumer. But it is not the only international trend right now as I observe that the government bond market of Germany has gone to further new highs today with its ten-year bond yield falling to 0.823%. I do not know about you but this makes asset prices (equities and houses) look very vulnerable to me right now. And yet we know that the establishment of political leaders and central bankers will do everything they can to stop any sustained falls. It could yet get very messy.

Of course there are places which could be forgiven for thinking that the credit crunch never existed. From the BBC.

Price of Football: Ticket increases outstrip cost of living

Market Update at 4:10 pm UK Time

It has been rather an extraordinary day with the US Dow Jones index falling some 350 points soon after opening and then swinging wildly. However the real moves -if you will forgive an old bond trader- have been found in the government bond markets. German 10 year bonds now yield a measly 0.77% which does not project much of an optimistic future does it? Also France saw Fitch move its outlook to negative last night and the response? Its government bonds have blasted higher too with the ten-year yield now 1.14%. Even children are old enough to remember days when adverse ratings moves led to upwards panic in bond yields not downwards ones!

Even the 10 year UK Gilt now yields less than 2%.