The UK gets an upgrade and a downgrade in a single day

The weekend just past saw plenty of action but my concentration is on Friday. As you see there were two clear events which operated in opposite directions in terms of views on the UK economy.  Let me open with the one which was reported much less but is in line with one of the themes of this blog which is that economic statistics are much less reliable that many would have you believe. From the Office for National Statistics ( ONS) on Friday morning.

The impact of the new data is largest in 2015 due to forestalling in advance of an increase in tax on dividends; the dividends revision in 2016 will be published on 29 September 2017.

Okay if you recall we thought that was happening back then but wait until you see the new estimate of the impact.

In 2015, the indicative estimate of the household and NPISH (non profit institutions serving households) saving ratio is 9.2%, revised up from the latest published value of 6.5%. The indicative estimate for growth in real household and NPISH gross disposable income is 5.3%, revised up from the latest published value of 3.6%.

Let me start with the savings issue where an extra £41.6 billion of household savings have been found in 2015. In terms of light entertainment we see that “Improvements to Illegal Activities” were £1.6 billion of that where apparently people are doing these to build a savings nest egg. Also as rent and imputed rent total some £1.9 billion I am left wondering how much imputed rent which is of course never received as it is a theoretical construct is saved? Of course Sir Charles Bean will be disappointed as well because it previously looked as though people might have listened to his calls for people not to save whereas now it looks like he was ignored.

But more seriously this update changes the whole trajectory of the UK economy as on this ratio the savings ratio has been ~9% since 2011. This is rather different to the previous number of slightly under 9% declining to 6.1%! If we move to economics we see that those who do sectoral equations and assure us that they cannot be wrong have a problem as if one bit is larger another has to be smaller. For example the ONS now think that UK companies borrowed some £41.1 billion less than in 2015 than previously reported.

Also we should note that disposable income rose considerably more quickly than previously reported.

Surpluses everywhere!

If we move to trade we see yet another example of what would have Lindsey Buckingham singing ” I think I’m in trouble”. From the Financial Times.

 

Statisticians are investigating the delicate matter of why the trade balance between the UK and the US does not balance. At various times over the past decade, the UK and the US have both simultaneously recorded a trade surplus with each other.

Excellent isn’t it? Imagine a world where in football matches both teams win!

 

Last year, for example, the UK claimed a £10bn goods trade surplus with the US, according to official statistics, while the US said it had recorded a surplus of $1bn.

Actually the real problem is below and regular readers will be aware that I have pointed out time and time again that the UK services data leaves a lot to be desired.

 

In services, COMTRADE, the UN trade statistics database, shows that the US claims a services trade surplus of $13bn with the UK, which claims a services surplus of more than $34bn with the US.

Either the FT journalists are unaware of or chose not to report this.

The UK Statistics Authority suspended the National Statistics designation of UK trade on 14 November 2014.

Oh and the US figures may be as bad it is just that I have spent quite a bit of time looking at the problems in the UK.

Moodys

More publicised in spite of the fact it was not produced until late Friday evening UK time was this.

Moody’s expects weaker public finances going forward, partly linked to the economic slowdown under way but also reflecting the increasing political and social pressures to raise spending after seven years of spending cuts.

Which led according to their analysis to this.

Moody’s Investors Service, (“Moody’s”) has today downgraded the United Kingdom’s long-term issuer rating to Aa2 from Aa1 and changed the outlook to stable from negative.

It was a little awkward for them to forecast weaker public finances in a week which had seen better numbers released but some of the arguments seem sound. For example a minority government is likely to spend more than a majority one. Also they expect the UK economy to continue to be on a weaker trajectory.

Growth has slowed in recent months, with average quarterly growth of just 0.26% in the first two quarters, versus an average of 0.6% over the 2014-2016 period.

That puts them in conflict with the Bank of England which of course is now expecting a bit of a pick-up. If we look at track records we are left with problem that neither have a good track record, can they both be wrong? Also after the problems with statistics we have already looked at today can one state the sentence below with any confidence?

Private consumption has slowed sharply and business investment has been weak since 2016, most likely linked to the Brexit-related uncertainty.

In essence though the opinion and downgrade has been driven by this view.

Moody’s is no longer confident that the UK government will be able to secure a replacement free trade agreement with the EU which substantially mitigates the negative economic impact of Brexit.

Comment

Let us start with Moodys where there is some sense to be found in their view of public expenditure I think. The pattern looks set to be higher due to the consequences of minority government and that is consistent with ratings agencies often picking out useful bits of detail. Their problem is their tendency to be behind the times and of course the existence of a credit crunch driven by them labelling instruments as “AAA” which were anything but. If we move to financial markets we see something which shows what power they now have. If you project a worse fiscal position then you would expect bond yields to rise in response whereas at the time of typing this the UK 10 year Gilt yield has fallen to 1.33%. Or perhaps the currency to fall? Not that either as it has moved back above US $1.35 and Euro 1.13.

If we move back to economics the problems are very serious for those who base their work only on statistics and equations. You see it is not only the future which is uncertain it is the present and past too. There is no Dune style Bene Gesserit for the past nor a Muad-Dib for the future. Those who tell you that an economic variable has to be something because of what another is should be made to face a critique every time. This brings me to something which regularly comes back into fashion like a weed in a garden which is targeting nominal GDP ( Gross Domestic Product). This will require adjusting policy based on a variable which is often wrong and sometimes very wrong.

As to the specific data for the UK we saved more in the period up to 2015 which means that more recent figures come from a stronger base. How much the more recent ones will be revised is hard to say as you see some of the changes today have happened in the last month.

Knee Op

After the false dawn of a fortnight ago I am booked in for tomorrow morning for my ACL reconstruction so I will be taking a break of at least a couple of days. On that subject let me wish Billy Vunnipola  well as at least I managed more than 20 years between incidents.

 

 

 

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What is happening in the UK housing market?

There are always a multitude of factors to consider here but one has changed if the “unreliable boyfriend” can finally go steady. That is the Open Mouth Operations from various members of the Bank of England about a Bank Rate ( official interest-rate) increase in November presumably to 0.5%. This would be the first time since the summer of 2013 and the introduction of the Funding for Lending Scheme that there has been upwards pressure on mortgage rates. Indeed the FLS was designed to drive them lower ( albeit being under the smokescreen of improving small business lending) and if we throw in the more recent Term Funding Scheme the band has continued to play to the same beat. From Bank of England data for July.

Effective rates on new individual mortgages has decreased by 10bps from 2.05% to 1.95%, this is the first time the series has fallen below 2%;

The current table only takes us back to August 2015 but it does confirm the theme as back then the rate was 2.57%. Noticeable in the data is the way that fixed-rate mortgages (1.99%) have become closer to variable-rate ones (1.73%) and if we look at the combination it looks as though fixed-rate mortgages have got more popular. That seems sensible to me especially if you are looking beyond the term of office of the “unreliable boyfriend.” From the Resolution Foundation.

The vast majority (88%) of new loans are taken with fixed interest rates, meaning 57% of the stock of loans are now fixed.

Has Forward Guidance had an impact?

That depends where you look but so far the Yorkshire Building Society at least seems rather unimpressed.

0.89% variable (BoE Base rate + -3.85%) variable (YBS Standard Variable Rate -3.85%) fixed until 30/11/2019

There is a large fee ( £1495) and a requirement for 35% of equity but even so this is the lowest mortgage-rate they have even offered. You can get a fixed rate mortgage for the same term for 0.99% with the same fee if you have 40% of equity.

So we see that so far there has not been much of an impact on the Yorkshire Building Society! Perhaps they had a tranche of funding which has not yet run out, or perhaps it has been so long since interest-rates last rose that they have forgotten what happens next? If we move to market interest-rates Governor Carney will be pleased to see that they have taken more notice of him as the 2 year Gilt yield was as low as 0.15% on the 7th of this month and is now 0.45%. The 5 year Gilt yield rose from 0.39% on the 7th to 0.77% now.

Thus there should be upwards pressure on future mortgage rates albeit of course that funding is still available to banks from the Term Funding Scheme at 0.25%. But don’t take my word for it as here are the Bank of England Agents.

competition remained intense, driven by new market entrants and low funding costs

What about valuations?

There have been a lot of anecdotal mentions of surveyors lowering valuations ( which is a forward indicator of lower prices ahead) but this from the Bank of England Agents is the first official note of this.

There were more reports of transactions falling through due to surveyors down-valuing properties, reflecting concerns about falling prices.

This could also be considered a sign of expected trouble as they discuss mortgages.

However, this competition was mainly concentrated on customers with the cleanest credit history.

Affordability and Quality

This issue has also been in the news with the Resolution Foundation telling us this.

While the average family spent just 6 per cent of their income on housing costs in the early 1960s, this has trebled to 18 per cent. Housing costs have taken up a growing proportion of disposable income from each generation to the next. This is true of private and social renters, but mortgage interest costs have come down for recent generations. However, the proportion of income being spent on capital repayments has risen relentlessly from generation to generation thanks to house price growth.

As someone who can recall his maternal grandparents having an outside toilet and paternal grandmother not having central heating I agree with them that quality improved but is it still doing so?

millennial-headed households are more likely than previous generations to live in overcrowded conditions, and when we look at the distribution of square meterage we see today’s under-45s have been net losers in the space stakes

I doubt many are as overcrowded as the one described by getwestlondon below.

A dawn raid on a three-bedroom property in Brentt found 35 men living inside……..The house was packed wall-to-wall with mattresses, which the men living there, all of eastern European origin, had piled into every room except the bathrooms.

But their mere mention of overcrowded raises public health issues surely? As ever the issue is complex as millennials are likely to be thinking also of issues such as Wi-Fi connectivity and so on. Still I guess the era of smartphones and tablets may make this development more palatable albeit at a price.

More recent generations have also had longer commutes on average than previous cohorts, despite spending more on housing.

Recent Data

The news from LSL Acadata this week was as follows.

House price growth fell marginally in August (0.2%), which left the average England and Wales house price at £297,398. This is still 2.1% higher than this time last year, when the average price was £5,982 lower. In terms of transactions, there were an estimated 80,500 sales completed – an increase of 5% compared to July’s total, and up 6% on a seasonally adjusted basis.

Interesting how they describe a monthly fall isn’t it? The leader of that particular pack is below.

House prices in London fell by an average of 1.4% in July, leaving the average price in the capital at £591,459. Over the year, though, prices are still up by £4,134 or 0.7% compared to July 2016. In July, 21 of the 33 London boroughs saw price falls.

An interesting development

Bloomberg has reported this today.

More home buyers are resorting to mortgages to purchase London’s most expensive houses and apartments as rising prices drag them into higher tax brackets.

Seventy-four percent of homes costing 1 million pounds ($1.3 million) or more in the U.K. capital were bought with a mortgage in the three months through July, up from 65 percent a year earlier, according to Hamptons International. The figure was as low as 31 percent during the depths of the financial crisis in 2009.

Perhaps they too think that over time it will be good to lock in what are historically low interest-rates although that comes with the assumption that they are taking a fixed-rate mortgage.

Comment

As we look at 2017 so far we see that  rental inflation has both fallen and according to most measures so has house price inflation although the official measure bounced in the spring . We have seen some monthly falls especially in London but so far the various indices continue to report positive inflation for house prices on an annual basis. Putting it another way it has been higher priced houses which have been hit the most ( which is why the official data has higher inflation). In general this has worked out mostly as I expected although I did think we might see negative inflation in house prices. Perhaps if Governor Carney for once backs his words with action we will see that as the year progresses. The increasing evidence of “down valuations” does imply that.

If we look at the overall situation we find ourselves arriving at one of the themes of my work as I am not one of those who would see some house price falls as bad. The rises have shifted wealth towards existing home owners and away from first-time buyers on a large-scale and this represents a factor in my critiques of central bank actions. Yes first time buyers see cheaper current mortgage costs but we do not know what they will be for the full term and they are paying with real wages which have fallen. On the other side of the coin existing home owners especially in London have been given something of a windfall if they sell.

Are improving UK Public Finances a sign of austerity or stimulus?

One of the features of the credit crunch era is that it brought the public finances into the news headlines. There were two main reasons for this and the first was the economic slow down leading to fiscal stabilisers coming into effect as tax revenues dropped. The second was the cost of the bank bailouts as privatisation of profits turned into socialisation of losses. The latter also had the feature that establishments did everything they could to keep the bailouts out of the official records. For example my country the UK put them at the back of the statistical bulletin hoping ( successfully) that the vast majority would not bother to read that far. My subject of earlier this week Portugal always says the bailout is excluded before a year or so later Eurostat corrects this.

The next tactic was to forecast that the future would be bright and in the UK that involved a fiscal surplus that has never turned up! It is now rather late and seems to have been abandoned but under the previous Chancellor of the Exchequer George Osborne it was always around 3/4 years away. This meant that we have had a sort of stimulus austerity where we know that some people and at times many people have been affected and experienced cuts but somehow the aggregate number does not shrink by much if at all.

If we move to the economy then there have been developments to boost revenue and we got a clear example of this yesterday. Here is the official retail sales update.

Compared with August 2016, the quantity bought increased by 2.4%; the 52nd consecutive month of year-on-year increase in retail sales.

As you can see we have seen quite a long spell of rising retail volumes providing upward momentum for indirect taxes of which the flagship in the UK is Value Added Tax which was increased to 20% in response to the credit crunch. Actually as it is levied on price increases too the development below will boost VAT as well.

Store prices increased across all store types on the year, with non-food stores and non-store retailing recording their highest year-on-year price growth since March 1992, at 3.2% and 3.3% respectively.

There is one cautionary note is that clothing prices ( 4.2%) are a factor and we are at a time of year where the UK’s statisticians have got themselves into a mess on this front. In fact much of the recent debate over inflation measurement was initially triggered by the 2010 debacle on this front.

Public Sector Pay

One area of austerity was/is the public-sector pay cap where rises were limited to 1% per annum, although we should say 1% per annum for most as we saw that some seemed to be exempt. However this seems to be ending as we start to see deals that break it. In terms of the public finances the Financial Times has published this.

 

The IFS has estimated that it would cost £4.1bn a year by 2019-20 if pay across the public sector were increased in line with inflation from next year rather than capped at 1 per cent……….Figures published in March by the Office for Budget Responsibility, the fiscal watchdog, suggest that if a 2 per cent pay rise were offered to all public sector workers rather than the planned 1 per cent cap, employee numbers would need to be reduced by about 50,000 to stay within current budgets.

Today’s Data

The UK data this week has been like a bit of late summer sun.

Public sector net borrowing (excluding public sector banks) decreased by £1.3 billion to £5.7 billion in August 2017, compared with August 2016; this is the lowest August net borrowing since 2007.

This combined with a further upgrade revision for July meant that we are now slightly ahead on a year on year basis.

Public sector net borrowing (excluding public sector banks) decreased by £0.2 billion to £28.3 billion in the current financial year-to-date (April 2017 to August 2017), compared with the same period in 2016; this is the lowest year-to-date net borrowing since 2007.

Revenue

There was good news on the income tax front as the self-assessment season was completed.

This month, receipts from self-assessed Income Tax were £1.3 billion, taking the combined total of July and August 2017 to £9.4 billion; an increase of £0.4 billion compared with the same period in 2016. This is the highest level of combined July and August self-assessed Income Tax receipts on record (records began in 1999).

So we had an increase of over 4% on a year on year basis. This seems to be the state of play across overall revenues.

In the current financial year-to-date, central government received £280.4 billion in income; including £209.4 billion in taxes. This was around 4% more than in the same period in the previous financial year.

There is one area which continues to stand out and in spite of the talk and comment about slow downs it remains Stamp Duty on land and property. So far this financial year it has raised some £5.9 billion which is up £0.9 billion on the same period in 2016. A factor in the increase will be the rise in Stamp Duty rates for buy-to lets.

Expenditure

This rose at a slower rate which depending on the measure you use close to or blow the inflation rate.

Over the same period, central government spent £302.7 billion; around 3% more than in the same period in the previous financial year.

The subject of inflation remains a topic in another form as the UK’s inflation or index linked debt is getting expensive. This is due to the rises in the Retail Price Index which will be the major factor in UK debt interest rising by £3.8 billion to £26.3 billion in the financial year so far. So much so there is an official explainer.

Both the uplift on coupon payments and the uplift on the redemption value are recorded as debt interest paid by the government, so month-on-month there can be sizeable movements in payable government debt interest as a result of movements in the RPI.

The next area where there has been something of a surge raises a wry smile. Contributions to the European Union have risen by £1 billion to £4.6 billion this financial year so far.

Comment 

We can see the UK’s journey below.

Current estimates indicate that in the full financial year ending March 2017 (April 2016 to March 2017), the public sector borrowed £45.6 billion, or 2.3% of gross domestic product (GDP). This was £27.6 billion lower than in the previous full financial year and around one-third of that borrowed in the financial year ending March 2010, when borrowing was £152.5 billion or 10.0% of GDP.

We seem so far this year to be borrowing at the same rate as last year. So you could easily argue we have had a long period of stimulus ( fiscal deficits). Yet only an hour after today’s numbers have been released we seem to have moved on.

Chancellor should have room to ease austerity in November Budget, says John Hawksworth

Oh and remember the first rule of OBR ( Office of Budget Responsibility) Club? From the Guardian.

Back in March, the OBR forecast that the budget deficit would rise to around £58 billion this year, but the latest data suggest that it may be similar to the £46 billion outturn for 2016/17.

So let us enjoy a week where the data has been better as we mull the likely consequences of a minority government for public spending. Meanwhile here are the national debt numbers and as I pointed out earlier they omit £300 billion ( RBS).

Public sector net debt (excluding public sector banks) was £1,773.3 billion at the end of August 2017, equivalent to 88.0% of gross domestic product (GDP), an increase of £150.9 billion (or 4.8 percentage points as a ratio of GDP) on August 2016.

Oh and £108.8 billion of the increase is the “Sledgehammer” QE of Mark Carney and the Bank of England. On that subject here is Depeche Mode.

Enjoy the silence

Me on Core Finance TV

http://www.corelondon.tv/central-banks-infinity-beyond/

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Can QE reductions co-exist with the “To Infinity! And Beyond! Critique?

Today looks set to take us a step nearer a change from the world’s major central bank. Later we will here from the US Federal Reserve on its plans for a reduction in its balance sheet. If we look back to September 2014 there was a basis for a plan announced.

The Committee intends to reduce the Federal Reserve’s securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal on securities held in the SOMA.  ( System Open Market Account).

Okay so what will this mean?

The Committee expects to cease or commence phasing out reinvestments after it begins increasing the target range for the federal funds rate; the timing will depend on how economic and financial conditions and the economic outlook evolve.

So we learnt that it planned to reduce its balance sheet by not reinvesting bonds as they mature. A sensible plan and indeed one I had suggested for the UK a year before in City AM. Of course back then they were talking about doing it rather than actually doing it. Also there was a warning of what it would not entail.

.The Committee currently does not anticipate selling agency mortgage-backed securities as part of the normalization process, although limited sales might be warranted in the longer run to reduce or eliminate residual holdings. The timing and pace of any sales would be communicated to the public in advance

Thus we were already getting the idea that any such process was likely to take a very long time. This was added to by the fact that there is no clear end destination.

The Committee intends that the Federal Reserve will, in the longer run, hold no more securities than necessary to implement monetary policy efficiently and effectively, and that it will hold primarily Treasury securities.

This was brought more up to date this June when we were told that any moves would be in what are baby steps compared to the US $4.5 trillion size of the balance sheet.

For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month.

They will do the same for mortgage-backed securities except US $ 4 billion and US $20 billion are the relevant amounts. But as you can see it will take a year to reach an annual amount of US $0.6 trillion. Thus we reach a situation where balance sheet reduction can in fact be combined with another chorus of “To Infinity! And Beyond!” Why? Well unless they have ended recessions then the reduction seems extremely unlikely to be complete until it is presumably being expanded again. Indeed for some members of the Federal Reserve this seems to be the plan. From the Financial Times.

 

Mr Dudley has said he expects the balance sheet to shrink by roughly $1tn to $2tn over the period, from its current $4.5tn. This compares with an increase of about $3.7tn during the era of quantitative easing.

The ECB

There was a reduction in monthly QE purchases from the European Central Bank from 80 billion Euros to 60 billion which started earlier this year. But so far there has been no announcement of more reductions and of course these are so far only reductions in the rate of increase of its balance sheet. Then yesterday there was a flurry of what are called “sauces”.

FRANKFURT (Reuters) – European Central Bank policymakers disagree on whether to set a definitive end-date for their money-printing programme when they meet in October, raising the chance that they will keep open at least the option of prolonging it again, six sources told Reuters.

Of course talk and leaks are cheap but from time to time they are genuine kite flying. Also there is some potential logic behind this as the higher level of the Euro has reduced the likely path of inflation and the ECB is an institution which takes its target seriously. Now the subject gets complicated so let me show you the “Draghi Rule” from March 2014,

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

So the Euro rally will have trimmed say 0.3% off future inflation. However some are claiming much more with HSBC saying it is 0.75% and if so no wonder the ECB is considering a change of tack. Mind you if I was HSBC I would be quiet right now after the embarrassment of how they changed their forecasts for the UK Pound £ ( when it was low they said US $1.20 and after it rallied to US $1.35 they forecast US $1.35!).

This is something of a moveable feast as on the 9th of this month Reuters sources were telling us a monthly reduction was a done deal. But there is some backing from markets with for example the Euro rising above 1.20 versus the US Dollar today and it hitting a post cap removal high ( remember January 2015?) against the Swiss Franc yesterday.

As we stand the ECB QE programme amounts to 2.2 trillion Euros and of course rising.

The Bank of England

We see something of a different tack from the Bank of England as it increased its QE programme last August and that is over. But it is working to maintain its holdings of UK Gilts at £435 billion as highlighted below.

As set out in the MPC’s statement of 3 August 2017, the MPC has agreed to make £10.1bn of gilt purchases, financed by central bank reserves, to reinvest the cash flows associated with the maturities on 25 August and 7 September 2017 of gilts owned by the Asset Purchase Facility (APF).

Today it will purchase some £1.125 billion of medium-dated Gilts as part of that which may not be that easy as only 3 Gilts are now eligible in that maturity range.

However tucked away in the recent purchases are an intriguing detail. You see over the past 2 weeks the Bank of England has purchased some £1.36 billion of our longest dated conventional Gilt which runs to July 2068. So if Gilts only ever “run off” then QE will be with us in the UK for a very long time.

The current Bank of England plan such as it is involves only looking to reduce its stock of bond holdings after it has raised Bank Rate an unspecified number of times. I fear that such a policy will involve losses as whilst the rises in the US have not particularly affected its position there have been more than a few special factors ( inflation, North Korea, Trumpenomics…), also we would be late comers to the party.

The MPC intends to maintain the stock of purchased assets at least until the first rise in Bank Rate.

Will that be like the 7% unemployment rate? Because also rise from what level?

at least until Bank Rate has been raised from its current level of 0.5%.

Comment

As you can see there is a fair bit to consider and that is without looking at the Bank of Japan or the Swiss National Bank which of course has if its share price is any guide has suddenly become very valuable. We find that any reduction moves are usually small and much smaller than the increases we saw! Some of that is related to the so-called Taper Tantrum but it is also true that central banks ploughed ahead with expansions of their balance sheets without thinking through how they would ever exit from them and some no doubt do not intend to exit.

The future is uncertain but not quite as uncertain as central banks efforts at Forward Guidance might indicate. So if we address my initial question there must be real fears that the next recession will strike before the tapering in the case of the ECB or the reductions of the US Federal Reserve have got that far. As to my own country the Bank of England just simply seems lost in its own land of confusion.

 

 

 

 

 

The issue of house prices in both Australia and China

Earlier today there was this announcement from Australia or if you prefer the south china territories.

Residential property prices rose 1.9 per cent in the June quarter 2017, according to figures released today by the Australian Bureau of Statistics (ABS)……..Through the year growth in residential property prices reached 10.2 per cent in the June quarter 2017. Sydney and Melbourne recorded the largest through the year growth of all capital cities, both rising 13.8 per cent followed by Hobart, which rose 12.4 per cent.

So we see something which is a familiar pattern as we see a country with a double-digit rate of inflation in this area albeit only just. Also adding to the deja vu is that the capital city seems to be leader of the pack.

However there is quite a bit of variation to be seen on the undercard so to speak.

“Residential property prices, while continuing to rise in Melbourne and Sydney this quarter, have begun to moderate. Annual price movements ranged from -4.9 per cent in Darwin to +13.8 per cent in Sydney and Melbourne. These results highlight the diverse housing market and economic conditions in Australia’s capital cities,” Chief Economist for the ABS, Bruce Hockman said.

The statistics agency seems to be implying it is a sort of race if the tweet below is any guide.

“Sydney and Melbourne drive property price rise of 1.9%” – how did your state perform?

Wealth

There was something added to the official house price release that will lead to smiles and maybe cheers at the Reserve Bank of Australia.

The total value of Australia’s 9.9 million residential dwellings increased $145.9 billion to $6.7 trillion. The mean price of dwellings in Australia rose by $12,100 over the quarter to $679,100.

Central bankers will cheer the idea that wealth has increased in response to the house price rises but there are plenty of issues with this. Firstly you are using the prices of relatively few houses and flats to give a value for the whole housing stock. Has anybody made an offer for every dwelling in Australia? I write that partly in jest but the principle of the valuation idea being a fantasy is sound. Marginal prices ( the last sale) do not give an average value. Also the implication given that wealth has increased ignores first-time buyers and those wishing or needing to move to a larger dwelling as they face inflation rather than have wealth gains.

This sort of thinking has also infested the overall wealth figures for Australia and the emphasis is mine.

The average net worth for all Australian households in 2015–16 was $929,400, up from $835,300 in 2013–14 and $722,200 in 2005-06. Rising property values are the main contributor to this increase. Total average property values have increased to $626,700 in 2015–16 from $548,500 in 2013–14 and $433,500 in 2005-06.

If we look at impacts on different groups we see it driving inequality. One way of looking at this is to use a Gini coefficient which in adjusted terms for disposable income is 0.323 and for wealth is 0.605 . Another way is to just simply look at the ch-ch-changes over time.

One factor driving the increase in net wealth of high income households is the value of owner-occupied and other property. For high wealth households, average total property value increased by $878,000 between 2003-04 and 2015-16 from $829,200 to $1.7 million. For middle wealth households average property values increased by $211,200 (from $258,000 to $469,200). Low wealth households that owned property had much lower growth of $5,600 to $28,500 over the twelve years.

As you can see the “wealth effects” are rather concentrated as I note that the percentage increase is larger for the wealthier as well of course as the absolute amount. Those at the lower end of the scale gain very little if anything. What group do we think central bankers and their friends are likely to be in?

Debt

This has been rising too.

Average household debt has almost doubled since 2003-04 according to the latest figures from the Survey of Income and Housing, released by the Australian Bureau of Statistics (ABS).

ABS Chief Economist Bruce Hockman said average household debt had risen to $169,000 in 2015-16, an increase of $75,000 on the 2003-04 average of $94,000.

The ABS analysis tells us this.

Growth in debt has outpaced income and asset growth since 2003-04. Rising property values, low interest rates and a growing appetite for larger debts have all contributed to increased over-indebtedness. The proportion of over-indebted households has climbed to 29 per cent of all households with debt in 2015-16, up from 21 per cent in 2003-04.

They define over-indebtedness as having debts of more than 3 years income or more than 75% of their assets. That must include rather a lot of first-time buyers.

Younger property owners in particular have taken on greater debt.

Also the statistic below makes me think that some are either punting the property market or had no choice but to take out a large loan.

“Nearly half of our most wealthy households (47 per cent) who have a property debt are over-indebted, holding an average property debt of $924,000. This makes them particularly susceptible if market conditions or household economic circumstances change,” explained Mr Hockman.

So something of an illusion of wealth combined with the hard reality of debt.

Ever more familiar

Such situations invariably involve “Help” for first-time buyers and here it is Aussie style.

In Australia every State government provides first home buyer with incentives such as the First Home Owners Grant (FHOG) ( FHBA)

In New South Wales you get 10,000 Aussie Dollars plus since July purchases up to 650,000 Aussie Dollars are free of state stamp duty.

China

If we head north to China we see a logical response to ever higher house prices.

Local governments are directly buying up large quantities of houses developers haven’t been able to sell and filling them with citizens relocated from what they call “slums”—old, sometimes dilapidated neighborhoods. ( Wall Street Journal).

We have discussed on here more than a few times that the end game could easily be a socialisation of losses in the property market which of course would be yet another subsidy for the banks.

The scale of the program is large, accounting for 18% of floor space sold in 2016, according to Rosealea Yao, senior analyst at Gavekal Dragonomics, and is being partly funded by state policy banks like China Development Bank. ( WSJ)

Will they turn out to be like the Bank of Japan in equity markets and be a sort of Beijing Whale? Each time the market dips the Bank of Japan provides a put option although of course there are not that many Exchange Traded Funds for it to buy these days because it has bought so many already.

Comment

There is a fair bit to consider here so let me open with a breakdown of changes in the situation in Australia over the last decade or so.

This growth in household debt was larger than the growth in income and assets over the same period. The mean household debt has increased by 83% in real terms since 2003-04. By comparison, the mean asset value increased by 49% and gross income by 38%.

Lower interest-rates have oiled the difference between the growth of debt and income. But as we move on so has the rise in perceived wealth. The reason I call it perceived wealth is that those who sell genuinely gain when they do so but for the rest it is simply a paper profit based on a relatively small number of transactions.

If we move to the detail we see that if there is to be Taylor Swift style “trouble,trouble, trouble” it does not have to be in the whole market. What I mean by that is that lower wealth groups have gained very little if anything from the asset price rises so any debt issues there are a problem. Also those at the upper end may be more vulnerable than one might initially assume.

High income households were also more likely to be over-indebted. One quarter of the households in the top income quintile were over-indebted compared to one-in-six (16%) low income households (in the bottom 20%).

Should one day they head down the road that China is currently on then the chart below may suggest that those who have rented may be none too pleased.

Never Tear Us Apart ( INXS )

I was standing
You were there
Two worlds collided
And they could never ever tear us apart

Can Portugal trade its way out of its lost decade?

The weekend just gone has brought some good news for the Republic of Portugal. This came from the Standard and Poors ratings agency when it announced this after European markets had closed on Friday.

On Sept. 15, 2017, S&P Global Ratings raised its unsolicited foreign and local currency long- and short-term sovereign credit ratings on the Republic of  Portugal to ‘BBB-/A-3’ from ‘BB+/B’. The outlook is stable.

Bloomberg explains the particular significance of this move.

Portuguese Finance Minister Mario Centeno expects greater demand for his nation’s debt from a broader array of investors to spur lower borrowing costs both for the government and corporations, after the country’s credit rating was restored to investment grade status by S&P Global Ratings.

So the significance of their alphabetti spaghetti is that Portugal has been raised from junk status to investment grade. I will deal with the impact on bond markets later but first let us look at the economic situation.

Portugal’s economy

The key to this move is an upgrade to economic prospects.

We now project that Portuguese GDP will grow by more than 2% on average between 2017 and 2020 compared to our previous forecast of 1.5%.

This is significant because one of my themes on the Portuguese economy is that if we look back over time it has struggled to grow by more than 1% per annum on any sustained basis. This has led to other problems such as its elevated national debt to economic output level and makes it very similar to Italy in this regard. So should it be able to perform as S&P forecast it will be a step forwards for Portugal in terms of looking forwards.

If we look for grounds for optimism there is this bit.

We expect Portugal will maintain its strong export performance over the forecast horizon, reflecting solid growth in external demand and an uptick in exports.

Export- led growth is of course something highly prized by economists.

A solid external performance is likely to bring goods and services exports to around 44% of GDP in 2017, from below 29% just seven years ago.

Portugal has done well on the export front but S&P may have jointed the party after the music has stopped as this from Portugal Statistics earlier this month implies.

In July 2017, exports and imports of goods recorded year-on-year nominal growth rates of +4.6% and +12.8%
respectively (+6.7% and +6.6% in the same order, in June 2017)…….The deficit of trade balance amounted to EUR 1,057 million in July 2017, increasing by EUR 446 million when compared with July 2016.

Okay so worse than last year. I often observe that monthly trade figures are unreliable so let us move to the quarterly ones.

In the quarter ended in July 2017, exports and imports of goods grew by 9.0% and 13.4% respectively, vis-à-vis
the quarter ended in July 2016.

If we look back we see that if we calculate a number for the latest quarter then we now have had a year of monthly data showing a deterioration for the trade balance. Just to be clear exports have grown but imports have grown more quickly. So the monthly trade deficits have gone back above 1 billion Euros having for a while looked like going and maybe staying below it.

If we move to the other side of the trade balance sheet we see that imports have surged which will be rather familiar to students of Portuguese economic history ( as in a reason why they have so frequently had to call in the IMF). This year the rate of growth ( quarterly) has varied between 12.2% and 15.9% in the seven months of data seen.

There is a clear tendency for ratings agencies to be a fair bit behind the news and the export success story would have fitted better a year or two ago. Let us wish Portugal well as we note the recent growth has been in imports and also note that in general in 2017 so far the Euro has risen putting something of a squeeze on exports which compete in terms of price. The trade weighted exchange-rate rose from 93 in April to 99 now in round terms. So the gains of the “internal devaluation” which involved a lot of economic pain are being eroded by a higher exchange rate.

Debt

If you look at the economy of Portugal then the D or debt word arrives usually sooner rather than later. This is why an improved trade performance is more important than just its impact on GDP ( Gross Domestic Product). This is how it is put by S&P.

Estimated at about 236% in 2017, we view Portugal’s narrow net external debt to CARs (our preferred measure of the external position) as being one of the highest among the sovereigns we rate, albeit on a steady declining trend.

There has been deleveraging but of course this drags on growth before hopefully providing a benefit.

Data from the Portuguese central bank, Banco de
Portugal, indicate that resident private nonfinancial sector gross debt on a nonconsolidated basis was still at a high 217% of GDP in June 2017, down from 260% at end-2012.

So far I think I have done well in avoiding mentioning the ECB ( European Central Bank) but this is an area where it has really stepped up to the plate.

The ECB’s QE has helped to further bring down the government’s and corporate sector’s borrowing costs.

Although it does pose a challenge to this assertion from S&P.

While we view the high level of public and private sector indebtedness as a credit weakness, we observe that external financing risks have declined significantly reflected in a substantial improvement in the government’s borrowing conditions.

Maybe but you cannot ignore the fact that the ECB has purchased some 29 billion Euros of Portuguese government bonds as part of its ongoing QE programme. To this you can add purchases of the bonds of Portuguese corporates and of course the 91 billion Euro rump of the Securities Markets Programme which also had Greek and Irish bonds. If you read about lower purchases of Portuguese bonds it is mostly because the ECB already has so many of them. Last time I checked large purchases of something tend to raise the price and lower the yield.

According to the latest ECB data, the central bank acquired €0.4 billion of Portuguese government bonds in August 2017, hitting a new low since the beginning of the
PSPP. The peak was in May 2016, at €1.4 billion.

The banks

Even S&P is none to cheerful here pointing out that the sector remains on life support.

It remains reliant on ECB funding.

Indeed the prognosis remains rather grim.

Banks’  earnings generation capacity also remains under significant pressure given the ultra-low interest rates, muted volume growth, and still large stock of
problematic assets (about 19% of gross loans) and foreclosed real estate assets (including restructured loans not considered in the credit-at-risk definition) as of mid-2017.

Internal Devaluation

If you improve your position via an internal devaluation involving lower wages and higher unemployment then moves like this are simultaneously welcome and risky.

In our opinion, consecutive increases in the minimum wage, most recently by 5.1% in January 2017, accompanied by measures to offset some of the additional cost for employers, are unlikely to have weakened the cost competitiveness of Portuguese goods and services.

Comment

Portugal is a lovely country so let us look at something which is really welcome.

As such, the jobless rate has almost halved from its peak of 17.5% during 2013 and is currently at 9.1% (July 2017), in line with the eurozone average and lower than in France, Italy, and Spain.

Good. However this does not change the fact that Portugal has travelled back to between 2004 and 2005. What I mean by that is that annual GDP peaked at 181.5 billion Euros in 2008 and after the credit crunch hit there was a recovery but then a sharp downturn such that GDP in 2013 was 167.2 billion Euros. The more recent improvement raised GDP to 173.7 billion Euros in 2016 and of course things have improved a bit so far this year to say 2005 levels.

Why is there an ongoing problem? Tucked away in the S&P analysis there is this.

we consider that Portugal’s fragile demographics, weakened by substantial net emigration and a declining labor force, exacerbate these challenges. Low productivity growth would likely stifle the economy’s growth potential (though this is not unique to Portugal), without further improvements in the efficiency of the public administration,
judiciary, and the business environment, including with respect to barriers in services markets (for example, closed professions).

Let me end by pointing out the rally in Portuguese bonds today with the ten-year yield now 2.5% although having issued 3 billion Euros of such paper with a coupon of 4.125% in January it will take a while for the gains to feed in. Also let me wish those affected by the severe drought well.

 

 

 

Can the “unreliable boyfriend” settle down in November?

On the face of it yesterday was an example of “the same old song” at the Bank of England in more than one respect. Firstly something that seemed to get ignored in the melee was that the vote was the same as the last time around which was to continue with the QE ( Quantitative Easing) programme and 7 votes to keep interest-rates unchanged with 2 for a 0.25% hike. The QE vote was apposite as it is currently ongoing with around £3.3 billion being reinvested earlier this week.

The next example of the “same old song” came with a somewhat familiar refrain in the official Minutes of the policy meeting.

All MPC members continued to judge that, if the economy were to follow a path broadly consistent with the August Inflation Report central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than current market expectations.

This has the familiar promise but as usual had “if” and “could” as part of it. But then there was something new.

A majority of MPC members judged that, if the economy continued to follow a path consistent with the prospect of a continued erosion of slack and a gradual rise in underlying inflationary pressure then, with the further lessening in the trade-off that this would imply, some withdrawal of monetary stimulus was likely to be appropriate over the coming months in order to return inflation sustainably to target.

As they are currently refilling the QE programme and in the past have said that they would raise Bank Rate before changing the QE total this was “central bankingese” for an interest-rate rise. There are obvious issues here but let us park them for now and look for an explanation of why?

The economy is doing better than expected

The initial explanation trips over its own feet.

Since the August Report, the relatively limited news on activity points, if anything, to a slightly stronger picture than anticipated. GDP rose by 0.3% in the second quarter, as expected in the MPC’s August projections,

So we simultaneously did better and the same as expected?! Let us move onto something where this may actually be true.

The unemployment rate has continued to decline, to 4.3%, its lowest in over 40 years and a little lower than forecast in August. Survey indicators are consistent with continued strength in employment growth.

Also no matter how often the output gap theories of the Ivory Towers are proved wrong they are given another throw of the dice just in case.

Overall, the latest indicators are consistent with UK demand growing a little in excess of this diminished rate of potential supply growth, and the continued erosion of what is now a fairly limited degree of spare capacity.

Problems with this view

If you take that as a case for a Bank Rate rise there are two immediate issues to my mind. Let us return to the “output gap”.

Evidence continues to accumulate that the rate of potential supply growth has slowed in recent years.

Actually if you look at the employment situation in the UK exactly the reverse has been true as I pointed out in my “the boy who cried wolf” article on Monday. We have been told that unemployment rates of 7%, 6-6.5%, 5% and then 4.5% are significant as the Bank of England theorists attempt to run in quicksand. If we look at the flip side of this potential supply growth in terms of employment has surged as we have moved to record levels.

Also there is the issue of wage growth which of course is interrelated to the paragraph above. We are told this.

Underlying pay growth had shown some signs of recovery, albeit remaining modest.

They have also looked into the detail and concluded this.

Empirical estimates by Bank staff suggested that these may have depressed annual growth of average weekly earnings by around 0.7 percentage points ( New data from the ONS suggested that compositional effects related to factors including the skills, industry and occupational mix of the workforce had pushed down average pay growth in the year to Q2. )

Let me bring this up to date as Gertjan Vlieghe is giving  a speech as I type this and he has reinforced this theme.

Wage growth is not as weak as it was earlier in the year: over the past 5 months, annualised growth in private sector pay has averaged just over 3%. And some pay-related surveys also suggest a modest rise in wage pressure in recent months.

Let me give you a critique of that firstly as shown below.

Actually that is the overall rather than just the private-sector picture but if we look at that and use Vlieghe’s figures it looks to me that he has not include the latest numbers for July where there was a dip in bonus payments as I pointed out on Wednesday. So total annualised wage growth fell from 3.2% to 1.4% and it is odd that Gertjan has apparently missed this as you see he was given the data early.

As to the possible compositional effects let me explain with an example sent to me on twitter.

Janet & John are each paid 100. After good year pay goes to 110; so good they employ Timmy and pay him 80. Ave pay (now for 3) unch at 100 ( @NelderMead ).

Nice to see I am not the only person who was taught to read with the Janet and John books! But the catch is that we keep being told this and then like a mirage it fades away as a different reality emerges. The Bank of England has been a serial optimist on the wages front and has been left red-faced time and time again.

Comment

One thing I welcome about the news flow over the past 24 hours from the Bank of England is the way that it has pushed the UK Pound £ higher. It has gone above 1.13 versus the Euro and 150 to the Japanese Yen and most importantly above US $1.35 which influences what we pay for most commodities. This response to a possible tightening embarrasses those who claimed the Bank of England easing did not weaken the Pound £ last summer. Not the best timing for those saying parity with the Euro was just around the corner either.

Moving onto the economics then there is something more than a little awkward in 9 supposedly independent people suddenly having the same thoughts. It is almost as if they are Carney’s cronies. It is hard not to sing along with Luther Vandross on their behalf.

I told my girl bye-bye
But I really didn’t mean it
Said, ?I met somebody new so fine?
But I really didn’t mean it

If you read the final part of the Gertjan Vlieghe speech there are grounds for him to change his mind.

If these data trends of reducing slack, rising pay pressure, strengthening household spending and robust global growth continue, the appropriate time for a rise in Bank Rate might be as early as in the coming months.

After all he told us this only in April.

I will argue that there is an important distinction to be drawn between good monetary policy and making accurate forecasts

Remember when Ben Broadbent told us he would pick and choose amongst the data ( just after being wrong yet again).

Also it is hard to forget these previous episodes.

Mark Carney Feb 2016 “the MPC judges that it is more likely than not that Bank Rate will need to rise over our forecast period”

He of course later cut Bank Rate and before that there was this.

Mark Carney June 2014 An interest-rate rise ” could happen sooner than markets currently expect. ”

So let us welcome a stronger Pound £ as we note that Forward Guidance has been anything but. Let me finish with some Friday music from Prince which has been removed from the Bank of England play list.

This is what it sounds like
When doves cry