What use is central bank Forward Guidance?

This week has seen a type of Forward Guidance by the UK Chancellor George Osborne and also by the Office for Budget Responsibility or OBR. Not only did the OBR decide that the outlook for the UK economy was somewhat brighter in spite of the fact that year on year economic growth has been slowing (2.9% to 2.3%)  it also found a pot of money down the back of its economic modeling sofa.

This reflects higher expected receipts from income taxes, corporation tax and VAT – some of which result from modelling changes to our NICs (National Insurance Contributions) and VAT deductions forecasts.

The change to the VAT model was considerable as the BBC points out.

The effect of correcting this error was considerable: it means an extra £11.5bn by 2020-21,

This brought things pretty much to the status of a farce as the “independent” OBR found that its economic model could finance the U-Turn on tax credits. But if we return to the OBR its Forward Guidance on the UK public finances is used as a benchmark officially and in the media without the skepticism I provide. They seem to miss the fact that it has provided mistake after mistake. These have been on fundamental matters such as the path of wages and the fact that we should have a fiscal surplus now rather than a likely deficit of over £70 billion. Accordingly its Forward Guidance only has one use which is to describe a situation which are incredibly unlikely to experience.

The Bank of England

A fundamental problem with Forward Guidance from the Bank of England is the same problem that the OBR has which is a sequence or litany of forecasting errors. Plainly guidance is of much more use if provided by those with seer like skills rather than those who have often been hopeless! But they continue to believe that they can sing along with Roger Daltrey and the Who.

I can see for miles and miles and miles and miles and miles
Oh yeah

Reality was once a friend of mine and all that. After all as it expected that unemployment would fall slowly it thought it would be safe to use an unemployment rate of 7% as a signal for Forward Guidance 1.0. You can argue as to how much of a threshold that 7% was but as unemployment rapidly declined through 7% then 6.5% then 6% then 5.5% the credibility of Forward Guidance fell with it. Along the way 1.0 got replaced by 2.0 after only 7 months. Actually you could argue 3.0 came in as well as the plan for reversing QE (no sniggering at the back please….) got revised further away. Actually that has been revised even further away recently as the Bank Rate threshold has shifted to 2% whilst the promises of a Bank Rate rise have remained just promises. I think everybody can see the problem with Forward Guidance that continually changes often fundamentally! We are at around version 9.0 now depending how you count each change.

On that road Bank of England Governor Mark Carney has since his Mansion House speech of June 2014 told us several times that Bank Rate will rise soon or in that instance “sooner than markets expect”. There have been two obvious problems with this which start with the fact that they haven’t and continue with the fact that he seems to alternate with saying low-interest rates will remain for a while. So they might go up or they might not Mark? Those who followed his advice about higher interest-rates and if you look at the remortgaging figures quite a few did may have food for thought next week if the ECB follows up its promises of a policy easing.

What does the Bank of England think?

Its underground blog has offered some thoughts today so it is time for us to hum along to The Jam.

I’m going underground, (going underground)

You may not be entirely surprised to learn that it offers a more favourable picture of Forward Guidance.

In this post we summarise results from our ongoing research on `Threshold-Based Forward Guidance’, whereby the policymaker links their decision to raise the policy rate from the lower bound to outturns for particular macroeconomic variables.

Interesting as of course this left rather a lot of egg on Governor Carney’s face when he tried it! Nonetheless apparently it is a triumph?

 We show that TBFG can improve welfare at the lower bound by increasing expected future inflation and, unlike forward guidance based purely on calendar time, by shrinking the variance of possible outcomes for inflation around the target.

There are quite a few warning lights flashing on the dashboard but let them continue.

Relative to forward guidance policies that only involve calendar time, TBFG performs much better because it builds in a commitment to provide additional stimulus should the economy turn out worse than expected and to remove stimulus should it turn out better.

Unless they can find someone who has been on the dark side of the moon for the past 7 years then I cannot think of anyone who would doubt the commitment of central banks to more stimulus. Also the latter commitment to remove stimulus has the unfortunate problem that nobody has actually removed stimulus yet in spite of many promises to do so. Maybe the US Federal Reserve really means it this time about December 16th but in 2015 it has cried wolf so far.

Also there is the issue of this.

improve welfare at the lower bound by increasing expected future inflation

They are of course free to offer to pay more for the goods and services they purchase but they can count me out! Actually in the UK “welfare” or real wages at the lower bound has been improved by inflation falling. This is the exact opposite of the scenario proposed. Awkward that.

Indeed reading the analysis it covers inflation rather than growth with something of an implicit assumption that they come together. Whereas the UK experience along with many others has recently been that a period of growth has come with both lower inflation and inflation expectations.

Oh and if we move from the world of economic models to the real one then the excerpt below found itself completely undermined by the fall in oil and commodity prices which began in late summer 2014.

by shrinking the variance of possible outcomes for inflation around the target.

How is that going with UK official CPI at -0.1%?


Earlier this year there was the debate over whether a dress was blue and black or white and gold which lit up the internet. The reality according to the BBC 4 documentary series on Colours is that our brains adjust what we see for consistency and that the dress saga was caused by that. For example the colour “banana yellow” is something of a misnomer as in fact they have a green tinge in the morning’s but our brains reject that. The trick with the dress was that what we thought we saw depended on the amount of light at that time.

Well central bankers see a white and gold dress all the time and that is their problem. Their economic models see inflation as a benefit pretty much everywhere and every time whereas the rest of us see a black and blue dress where inflation is in the vast majority of cases harmful. Or to put it another way it is pretty much the story of UK economic history. In that white and gold world Forward Guidance is a benefit and maybe there are  a few circumstances where the light is correct and they are right, but in general they are wrong as the dress is black and blue.




What are the prospects now for buy to let property investment in the UK?

One of the features of the UK property price boom which was triggered by the Bank of England in July 2012 has been a shift from people buying to own to buying to rent. The changes were highlighted on the 10th of this month in a speech given by Jon Cunliffe of the Bank of England.

And it is growing quickly now, by around 9% a year.  Buy to let now represents 16% of the overall mortgage stock and accounted for 80% of net lending over the past year.

The attraction was two-fold but came from this development driven by the start of the Funding for (Mortgage) Lending Scheme (FLS) which drove this.

But over the past three years, as banks’ funding costs have reduced and as competition in the mortgage market has intensified, on average mortgage interest rates have fallen by 2 percentage points.

So the opening attraction was lower mortgage rates which began to turn the mortgage market around and this led to the second factor which was the expectation of higher house prices. So costs were cheaper and expected returns were higher especially if you figured that the Bank of England was really determined to fire the market up again. After all FLS followed some £375 billion of Quantitative Easing and the slashing of Bank Rate to 0.5%. This all looks bit like the “whatever it takes” expressed back that same summer of 2012 by Mario Draghi of the European Central Bank.

Buy To Let had been on the march anyway

The longer-term situation had been as shown below.

The private rental sector in the UK has been growing rapidly over the past 15 years partly due to structural reasons.  The stock of mortgage lending for buy to let has increased from £65bn to £200bn over the last decade.  And it is growing quickly now, by around 9% a year.

Thus we see that an existing trend was given a shove by the Bank of England and it was not alone. Back in July another policy change was highlighted by the Financial Stability Report.

The buy-to-let market could receive an additional stimulus from recent pension reforms, which give retirees more flexibility over how they use their defined contribution (DC) pension pots.

We simply do not know the longer-term impact of the change to pension rules. Perhaps the strongest impact may well be the perception that a type of “Greenspan/Bernanke/Yellen Put” is being applied, as measure after measure boosts house prices. For those unfamiliar which the concept then listen to “The only way is up,baby” from Yazz for a musical theme. In this arena “down” is definitely a four-letter word.

Why did buy to let boom relative to house purchases?

There are several factors at play here and the most obvious was tucked away in the Bank of England FSR.

higher house prices relative to incomes.

Whilst the reductions in mortgage-rates have improved affordability of course real incomes have fallen whilst house prices have risen. There are different measures of this but house prices are up by around 18% and real wages are down by around 6% in the credit crunch era. It would be an irony if it is the continual hints and promises of interest-rate increases  from Bank of England Governor Mark Carney that have deterred people but whatever the reason prospective mortgagees who face ever longer terms may wonder how long low interest-rates will last for?

Also there is something else which seems to have encouraged a change and it is also something which the Bank of England may want to lock away in a dark cupboard.

But there are signs of growing risk appetite spreading to underwriting standards. …….the number of advertised buy-to-let mortgage products at LTV ratios of 75% and above has increased since mid-2013………Looser lending standards in the buy-to-let sector.

Criteria for buy-to-let mortgage lending are different to ordinary mortgage lending but we are left with the view that its rise has been partly due to the fact that it has been easier to borrow.

How much of a problem is this?

Let me use the words of the Bank of England to describe it.

Buy-to-let borrowers are potentially more vulnerable to rising interest rates because loans are more likely to be interest only and extended on floating-rate terms, and affordability tends to be tested at lower stressed interest rates than owner-occupied lending.

You may be surprised by the “interest-only” bit as one only has to recall around 2009 when our political class were telling us that these were not far off evil and would not be a feature of the UK system going forwards in the words of Taylor Swift

Like, ever…

In reality we find that they have simply metamophosed, changed form and been expanding in another area. Still don’t be afraid as our valiant “great and the good” are on the case.

HM Treasury will consult on tools for the FPC related to buy-to-let lending later in 2015, with a view to building an in-depth evidence base on how the operation of the UK buy-to-let housing market may carry risks to financial stability. The FPC will continue to monitor this sector closely.

A bit like the sheriff in the film Smokey and the Bandit I think.

Tax changes

If you have a boom then governments and establishments immediately see scope to tax it. This is now in process for the buy-to let boom. Back in the summer Budget there were plans laid for the future.

Currently, individual landlords can deduct their costs – including mortgage interest – from their profits before they pay tax, giving them an advantage over other home buyers. Wealthier landlords receive tax relief at 40% and 45%. This tax relief will be restricted to 20% for all individuals by April 2020.

A trim for some although the obvious critique is that it is “So Far Away” (Carole King).

Yesterday we saw a change in that the tax raising became more immediate.

From 1 April 2016 people purchasing additional properties such as buy to let properties and second homes will pay an extra 3% in stamp duty.

So we have a classic establishment move which was estimated to raise around £1 billion a year in an area where the tax take has risen a lot in recent times. It was a bit over £6 billion in 2011/12 rising to £10.8 billion in 2014/15. Thus the UK Treasury has been very grateful for the house price boom and no doubt gives an appreciative nod to the “independent” Bank of England which triggered it.


Firstly let me make it clear that I have no beef with individual’s making a choice to buy and let a property. It is the collective issue and the way that the UK economy has been twisted towards it which has meant that money and effort has flowed to it as opposed to other others such as manufacturing. The consensus for house prices that “The only way is up” has twisted our expectations and has consequences for the flow of funds and entrepreneurial effort elsewhere. It is a factor in us moving towards a rentier society. Also by driving house prices higher it makes them ever more unaffordable for first time buyers which means that more are pushed towards renting and the cycle becomes more like a fly-trap than an economic choice.

What happens next? In the short-term (until April 2016) we may see a flurry of purchases ahead of the tax change. After then I am not so sure. If we look at the gains from buy to let then I have been looking at a few yields around London and the gross yield seems to be of the order of 5%. I know that there are costs and void periods but they may not be far off covering a mortgage. Should that be so then the Stamp Duty needs to be compared to the prospect of a capital gain which have been?

UK house prices increased by 6.1% in the year to September 2015

Ah so six months worth of capital gain? We need to look back longer for a better perspective. The UK ONS has a mixed-adjusted measure for pre owned house prices which started at 100 in February 2002 and as of September was at 220.9. So if we add 3% to the 100 we are left mulling the words of Newt in the film Aliens.

It won’t make any difference.

So whilst a couple of tax nudges to the buy-to-let market are welcome and indeed likely to be popular there are clear and present dangers. The first is that they look good but in reality change things only at the margin. The second is that they are all about tax or as Steve Winwood put it.

While you see a chance take it,





Is the government “fixing a hole” in the UK public finances?

Today sees or if you are reading this later has seen the Autumn Statement which is a spending planning and review set piece event for the UK government. This is always of particular interest in economic terms but these year it is especially so. After all if a government is going to put on a hair shirt or tighten its belt ( and by its really of course they mean ours) the logical time to do it is as far away from the next General Election as it can. Thus comes a major plank in what is sometimes called electoral cycle economics where there is a contractionary effort after an election replacing the expansionary one before it.

We also know that the current Chancellor George Osborne has set out his stall as someone who plans to cut the fiscal deficit and also promises to cut the national debt. In musical terms he sees this as described by the Beatles below.

I’m fixing a hole where the rain gets in

In this summer’s Budget he was in full flow on this subject.

That means more than just eliminating the deficit, it means running a surplus to get our dangerously high levels of debt down.

Some of you may already be thinking that he had veered into Alice Through The Looking Glass territory but wait for it as we were also told this.

this Charter commits us to keeping debt falling as a share of GDP each and every year– and to achieving that budget surplus by 2019-20.

Thereafter, governments will be required to maintain that surplus in normal times – in other words, when there isn’t a recession or a marked slowdown.

The Present Situation

A problem for the hype is that the UK public finances continue to misbehave. This was illustrated again only on Friday when we received the numbers for October.

Public sector net borrowing excluding public sector banks increased by £1.1 billion to £8.2 billion in October 2015 compared with October 2014.

Whilst the numbers can be erratic on a monthly basis a higher deficit in an economy which is recording solid economic growth figures poses a question as to what is happening? So let us look at the fiscal year so far for some perspective.

Public sector net borrowing excluding public sector banks decreased by £6.6 billion to £54.3 billion in the current financial year-to-date (April 2015 to October 2015) compared with the same period in 2014.

So disappointing progress especially if we note that revenues have been quite good.

Central government receipts for the financial year-to-date (April 2015 to October 2015) were £354.8 billion, an increase of £10.5 billion, or 3.0%, compared with the same period in 2014.

We get a confirmation of the improved position for wages by the fact that income-tax receipts have risen by 4.5% and against the theme of the times Corporation Tax has risen by 5.3%. I am pointing this out because quite a few places reported trouble with October revenues when in fact it was a change in payments from the Bank of England’s QE operations and “round-tripping” of the public finances.

interest & dividends decreased by £2.0 billion, or 40.5%, to £2.9 billion

So if revenues are solid and the deficit is struggling spending must have risen.

Central government expenditure (current and capital) for the financial year-to-date (April 2015 to October 2015) was £402.6 billion, an increase of £4.5 billion, or 1.1%,

Thus we return to what is austerity? After all the economic recovery with its falls in unemployment and consequent welfare benefits should be helping to reduce spending.  As we are told that in effect there is no or 0% inflation all of this is a real-terms spending increase. For newer readers the subject of what austerity actually means is a regular topic as we are told of “cuts,cuts,cuts” and do not misunderstand me I know that there have been losers but overall spending is up. In a way we return to the electoral cycle as a major factor in higher spending these days is the “triple-lock” guarantee for the basic state pension which if I recall correctly was supported by every major political party at the General Election. As we look forwards I note that next year’s figures will be affected by it too as we that a promised increase of 2.9% when inflation will begin the year at 0% looks likely to again be a solid real terms increase.

Putting it all together

At the summer Budget we were told this.

In March the OBR forecast we would borrow less than half that, or £75.3 billion, this year. In this Budget, they have revised borrowing down this year, to £69.5 billion.

Borrowing then falls to £43.1 billion next year, £24.3 billion in 2017/18 and down to just £6.4 billion the year after that.

There are various official bodies which compete for the job of worst forecasting organisation in the world but the OBR has an almost unparalleled record of success if it is aiming for this! Unless of course its original effort back in the summer of 2010 is actually true.

public sector net borrowing (PSNB) to fall from 11.0 per cent of GDP in
2009-10 to 1.1 per cent in 2015-16;

Along the way they have given us a lesson in applying conventional economic modelling to the credit crunch era as after a delay we were supposed to revert to mean.

Wages and salaries growth rises gradually throughout the forecast,
reaching 5½ percent in 2014

This preference of theory over reality is something which has afflicted the Bank of England too as it too makes forecasting error after error but then has the bare faced cheek to offer us Forward Guidance.

It is often forgotten but the world of low interest-rates and yields has provided the UK with quite a windfall each year as we issue debt at such prices and yields.

Four years away

I remember the days when De La Soul informed us that ” 3 That’s the Magic Number” but in the world of UK public finances they were on shy I think. If you look at the original forecasts of the coalition government the land of milk and honey (surpluses) was four years or so away and four years later it was four years or so away! To maintain that theme the can is likely to be kicked forwards a year or so today.

Current Problems

We have seen recently several areas where there is upwards pressure on spending. For example we do not know how much of the defence spending promises will happen but we do know that extra fighter squadrons are not free and that ISIS and Putin seem unlikely to disappear. There are hints of changes to the plans for tax credits. Also for those of us who wondered if at this stage of the electoral cycle plans like Help To Buy for the housing market might fade away then others seem less sure. From Steve Hawkes on Twitter.

And shares in Britain’s biggest housing developers go through the roof – Persimmon up 5%, Barratt 4%, Bovis 4.5%, Taylor Wimpey 4%

Of course there are hints about us building more houses but they have been true for over a decade now and governments of various hues but the common theme has been inaction.


As you can see it is possible to make a case for austerity ( we know that areas of public spending are being squeezed and a fiscal stimulus as we have a real terms increase in spending at the same time! We are also perpetually on the cusp of a surplus and reducing the national debt. Perhaps the establishment are fans of the Beatles.

And it really doesn’t matter if
I’m wrong I’m right
Where I belong I’m right
Where I belong
Silly people run around
They worry me and never ask me
Why they don’t get past my door

Meanwhile as the plans and forecasts rush around please remember the wise words of Alice In Wonderland.

Why, sometimes I’ve believed as many as six impossible things before breakfast.

He even provided a theme for OBR forecasts.

It’s no use going back to yesterday, because I was a different person then.

For those who prefer a verbal exposition of what is happening I will be on Share Radio from 1:30 pm offering analysis of today’s events.

Is the economy of Italy still the girlfriend in a coma?

Today I wish to take a look again at the state of play in the Italian economy and see if it remains “the girlfriend in a coma” as described by Bill Emmott who used to be editor of the Economist. The documentary he made especially the interview with Silvio Berlusconi who you may not be surprised to read promised quite a bit in an interview and the delivered nothing! Was revealing and sad. As to the concept let me give you an illustration from my article on the subject from the 18th of May.

between 2001 and 2013 GDP shrank by 0.2%. (The Economist)

Very thin pickings from the Euro area and it gets worse if we move from the aggregate number to try to get an idea of the individual experience as I did back then.

That statistic gets even worse when you allow for the fact that the Italian population was expanding over that period by around 7% so per person the situation was even worse.

Once you look at it like that it is a surprise that there has not been more protests in Italy about the state of play.This is because a weak aggregate performance becomes quite a decline per person or capita. Let us bring everything up to date.

The latest economic growth

Form Istat Italy.

In the third quarter of 2015 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.2 per cent with respect to the second quarter of 2015 and by 0.9 per cent in comparison with the third quarter of 2014.

Firstly let us welcome the fact that Italy has economic growth and the fact that it has had it for each quarter of 2015 now. However there is a rather ominous pattern for 2015 so far as it has gone 0.4%,0.3% and now 0.2% which is a clear trend. Of course there is spurious accuracy at play but it is hard not to at least wonder about it.

What the economic growth in 2015 has done is wipe out the 12 year decline the Economist pointed out as the latest quarter had GDP of 387.2 billion Euros and 2013 was oddly extremely consistent with each quarter in the 385 billion Euros (these numbers are based on 2010).

Thus as we stand the Euro era has provided economic stagnation for Italy on an aggregate level and declines per person.

Shouldn’t 2015 have been better?

On Friday ECB President Mario Draghi was busy slapping himself on the back for his monetary policies but it is hard not to think of Italy reading the quotes below.

We cannot say with confidence that the process of economic repair in the euro area is complete……..this is the weakest euro area rebound since 1998; and the recovery remains very protracted in historical perspective…..If our current assessment is correct, it will take the euro area 31 quarters to return to its pre-crisis level of output – that is, in 2016 Q1.

These words echo in Mario’s home country as if we stay with the last point when will Italy return to its pre crisis level of output? If we look at it in annual terms the peak was in 2007 when annual GDP was 1.688 trillion Euros. After the initial hit Italy bounced back but sadly the Euro area crisis saw it sink again and GDP in 2014 was 1.535 trillion Euros or 9% lower which at current growth rates will take quite some time to recover. That is on the optimistic assumption that the outlook is bright and to coin a phrase “the only way is up baby”.

Also whilst Mario was slapping himself on the back and proclaiming the success of his policies Italy will have benefited from the fall in oil and commodity prices that began in the late summer of 2014. Of course around a third of that has been offset by the fall in the value of the Euro- Mario is a bit less clear on this consequence of his actions.

Thus we have a lower exchange rate, lower input prices, negative official interest-rates and as of the end of October purchases of some 61.3 billion Euros of Italian government bonds. This has led to a situation that seems unrelated to either the Italian economy or its public finances as Mario Draghi pointed out to Il Sole 24 Ore at the end of October.

The interest rate on two-year Italian securities is near zero;

Should Forward Guidance have any impact on the real economy then we are plainly being signalled a cut in the main ECB interest-rate below -0.2% plus more QE next month. With the Euro below 1.07 versus the US Dollar we can see that there has already been an impact on the financial one.

Looking Forwards

We find as we assess things that there have already been disappointments for 2015 and by that I mean that only in October the Bank of Italy told us this.

Economic activity in Italy has been expanding since the beginning of 2015, at an annualized rate of about 1.5 per cent.

Yet I note that it suggested overall economic growth would be less than 1% in 2015 which in the circumstances is not good and if we return to the recovering ground lost point means not this decade.

If we look to the business surveys then they are managing some optimism as shown below.

Italian manufacturers registered a solid start to the fourth quarter, with output and new orders both rising at robust and accelerated rates in October……Italian service sector activity rose for the eighth consecutive month in October, supported by solid and accelerated growth in inflows of new business.


A consequence of the economic difficulties has been persistently elevated unemployment.

At the same time, the unemployment rate fell to 11.8%. The drop was associated with an increase of inactive people rather than with employees.

Let us take the good news first which is that employment has risen and unemployment has fallen which is nice to see. However it remains high and is falling only slowly plus there are concerns if the recent improvement is merely a category shift from unemployed to inactive.

There has also been consistent wage growth which feeds into real wages with inflation so low. Although care is needed as these only cover formal agreements which cover about 60% of the situation.

Compared with October 2014 the hourly index and the per employee index increased by 1.2 per cent.


The Girlfriend in a Coma theme came from someone who plainly likes Italy and was sad to see that its economic growth pattern was so poor. Let me echo that as I like Italy too. A subtitle was Good Italy:Bad Italy and the former is easy to see if you visit the place with the latter shown by today’s article. Whilst it would be great to proclaim that there has been a fundamental change there it is hard to see many signs.

A consequence of this has been that the debt burden of the Italian state has risen and risen. It seemed symbolic when it rose above 2 trillion Euros in the spring of 2013 and is more like 2.2 trillion now. If the economy struggles then the ratio to GDP rises which is has done and is now 132.8% according to the Bank of Italy. Due to the exertions of the ECB with its QE purchases there is no financial crisis and Italy has the benefit of borrowing cheaply. But kicking the debt can via QE only works in the longer-term if Italy grows at a decent rate.

A more hopeful thought is that the shadow economy is helping out considerably. Back in 2013 the IEA estimated it as just under 22% of the economy although oddly they thought it had shrunk in the Euro area from 27%. This means that Italy’s Euro era performance is even worse! Of course since then some of the shadow economy (drugs and prostitution) have become formal economic agents. Is there an Italian equivalent for “hard-working families”? So we are left hoping that in recent times the Italian shadow economy has seen a boom. Otherwise it has been in quite a long lasting depression.

Russia faces another round of its economic crisis

The last few days have given us an old-fashioned indication of an economy in distress which is that regimes often look to cast a smokescreen over economic problems at home and potential unrest by indulging in military action and wars. An example of this has been kindly provided this morning by Russia Today.

Russian airstrikes have torched more than 1,000 tankers taking stolen crude oil to Islamic State refineries. This blow against the jihadists comes as the Russian Air Force has hit 472 terrorist targets in two days in Syria, making 141 sorties.

The Russian bear has a sore head and is flexing its muscles in response. Along the way it is sending hints elsewhere as for example by the way that its Backfire bombers have skirted UK airspace on their way to Syria and made the RAF’s day by giving them the opportunity to scramble in response. Indeed if the rumours prove true that today’s defence review will give the RAF 2 extra fighter squadrons then its messes tonight may echo to Vladimir Putin’s name. Of course in terms of economic consequences such a situation is only likely to cause further issues for the UK’s troubled public finances which continue to underperform.

Oil and commodity Prices

Another way of looking at the economic crisis for Russia is provided by the oil price. This morning the price of a barrel of Brent Crude Oil has fallen by 2% to below US $44. Now lets us add in how much oil Russia produces which Bloomberg has provided.

Output from January to October averaged about 10.7 million barrels a day, a 1.3 percent increase over the same period in 2014, the data show. That’s in line with the Russian Energy Ministry’s full-year forecast for production of 533 million tons, or 10.7 million barrels a day.

If we look back to 2011,12,13 and the first half of 2014 the oil price acted as if a tractor beam was keeping it at around US $108 per barrel as we have discussed on here in the past. So if we take these numbers forwards we see a loss to the Russian economy of the order of US $680 million per day. Now I doubt it gets the full oil price and some prices will be different to Brent Crude but this is clearly in broad terms a quantum shift for a commodity producer.

From the domestic point of view this will be insulated for a while by the fall in the Ruble which provides a short-term period of “money illusion” but as the consequent inflation washes through the system the effects will then spread. Also as Otkritie Capital point out the public finances take a large hit.

Through the tax framework, the government took the brunt of the blow, just as it used to take most of the windfall profits.

If we move to the other commodities that Russia mines and produces we see a similar story. This morning’s news on Bloomberg is like a list of things produced by Russia.

Copper fell through $4,500 a metric ton for the first time since 2009, while nickel dropped to the lowest level since July 2003. Zinc lost 2.5 percent as of 8:13 a.m. in London,

Russia is also the world’s main producer of palladium and last week we were told this.

Palladium, also mostly used in pollution-control devices, has plunged 32 percent, and prices are near a five-year low set in August.

Completing the series comes a reminder that Russia is a substantial gold producer as well and the drum beat continues. From Emirates 24/7 today.

Gold extended losses on Monday, falling towards a near-six-year low reached last week…….Spot gold had dropped 0.7 per cent to $1,070.36 an ounce.

The Ruble

This has fallen this morning so that it again requires some 66 Rubles to buy one US Dollar. If we look back to the better times for the Russian economy we see that it was in the low 30s so in essence the shift from the commodity boom to commodity disinflation and for Russia deflation has halved its currency. Quite chilling when put like that isn’t it?

We have seen quite a lot of volatility in 2015 as there was a rally to around 50 in May and a couple of times it has rumbled around 70. So we learn two things. Firstly how can Russian industry and businesses possibly plan in such a volatile environment? Secondly that rather than being a short sharp shock followed by a recovery this is something which to quote the Stranglers is “Hanging Around”. This leads to quite a different set of economic influences especially as we wonder if it will persist for long enough to be described as “temporary”?

Inflation Inflation Inflation

The September Monetary Report of the Bank of Russia summed it up like this.

Therefore, given the ruble depreciation in July-August 2015 and the elevated inflation expectations, consumer price growth in 2015 will be higher than expected – 12.0-13.0%.

This compares to a developed world average inflation rate that is in essence zero per cent and if we look to see the components we are told this.

the contribution of exchange rate dynamics to annual inflation in August was roughly 7 pp and lower demand reduced inflation by about 1 pp.

So the former tells us of  an inflationary burst and the latter tells us of a consequence of deflation. A combination which Britney has helpfully described for us.

Don’t you know that you’re toxic?

Two consequences

The first is that something which low inflation is helping in many countries which is real wages is seeing a doppelgänger in Russia. From Danske Bank today.

real wages growth (-10.9% y/y) shrank the most in 16 years

They also give us a clear consequence of this.

pushing retail sales to their lowest level since 1998 (-11.7% y/y)

Also I note that it is not a good time to be poor in Russia as a basic staple so basic in fact that central bankers describe it as “non-core” has done this.

High food inflation is weighing heavily on private consumers, posting 18.4% y/y in October and 21.2% y/y in the ten months so far.

The second consequence is much closer to home from my point of view as we note this from Bloomberg on the state of play in London’s property market.

Russian buyers acquired 4.2 percent of homes sold in central London’s best districts in the third quarter, compared with 10 percent a year earlier, according to broker Knight Frank LLP.

In Ruble terms UK property has doubled in price over the last 15/18 months as again it nudges 100 Rubles to the UK Pound £.  Russians who invested heavily in the UK in central London such as Roman Abramovich have played a bit of a blinder although it is probably best to hide such matters from Vladimir Putin.


Central banks especially ones subject to the whims of Vladimir Putin tend to have an optimistic bias so let us touch base with the Bank of Russia.

The Bank of Russia estimates GDP to contract by 3.9-4.4% in 2015…….According to the Bank of Russia forecast, GDP will fall by 0.5-1.0% in 2016 and the economic growth rates are expected to be 0.0-1.0% in 2017 and 2.0-3.0% in 2018.

As you can see things are not so good when even those with a clear incentive to get out the rose tinting can only forecast a return to growth in a period which fans of Carole King would describe as “So Far Away”.

If we move to other issues we see that Russia has quite a lot of the inflation that central bankers are trying to create on a smaller scale elsewhere and via the route (currency depreciation) which some are trying to get it albeit on a smaller scale. I think you would find that Russian consumers and workers would offer quite a critique of the effect on them.

If we move wider there is the ongoing issue of paying US Dollar denominated debt with ever more Rubles and that being deflationary in itself. Of course with interest-rates as shown below there is hardly much incentive to borrow in Rubles either.

the Bank of Russia decided to limit its key rate reduction to 50 basis points in July and cut it to 11.00% p.a.,

Added to these economic factors are the political and military which are intertwined with it. I discussed the military interventionism earlier and we also see Europe extending its sanctions but in economic terms the disruption is highlighted by this from the Wall Street Journal.

State of emergency declared in Crimea after pylons supplying energy from Ukraine are blown up.

Are we seeing inflation in states of emergency too?



What if the ECB cuts interest-rates will the US Fed then raise them?

One of the themes of these times has been the concept of “currency wars” as various nations and currency blocs have sought to gain a competitive advantage. However yesterday evening and this morning have reminded us of the fact that we are being promised interest-rate wars in December. Last night saw the Vice Chair of the US Federal Reserve Stanley Fischer pump out the party line and indulge in some Open Mouth Operations on the subject of an interest-rate rise.

we have done everything we can to avoid surprising the markets and governments when we move, to the extent that several emerging market (and other) central bankers have, for some time, been telling the Fed to “just do it.”

Well this first bit is untrue as of course many people ( but not us) have been surprised by the fact that the Federal Reserve has not already raised interest-rates this year. Also “when we move” is intriguing for an institution where only one member has voted that way so far and nine including Stanley voted for unchanged. Perhaps Jeffrey Lacker is the persuasive sort. Thus we are left with Yazz on the prospects for interest-rates.

The only way is up, baby
For you and me now

However there was more and Bank of England watchers may have noted the use of the plural here.

What lies ahead? In the relatively near future probably some major central banks will begin gradually moving away from near-zero interest rates.

No doubt he does speak to Bank of England Governor Mark Carney regularly although he may not be fully away of his propensity for “spinning around” and his own version of Open Mouth Operations.

The Mario Draghi version

Rather intriguingly ECB President Draghi has latched onto the the Fischer theme last night and decided he is in complete agreement with “begin gradually moving away from near-zero interest rates.” So let us examine the speech to to the European Banking Congress he has just given.

The level of the deposit facility rate can also empower the transmission of APP (Asset Purchase Program or QE), not least by increasing the velocity of circulation of bank reserves.

So he is signalling a likely change but whilst he is moving away from zero and thereby agreeing with Stanley Fischer I am afraid that he is singing along with the Monkees.

Goin’ down. Goin’ down.

If we look at the stream of hints that President Draghi has given us in recent weeks then initial thoughts of a cut to -0.3% are being replaced by thoughts of a cut to 0.4%. The German bond market seems to humming that tune now. From @FerroTV

German 2year yield drops to a fresh record low

That is -0.39% now we see a theme of this blog, that negative interest-rates are on the march, increasingly comes to fruition.

Although it is hard not to smile as a past version of Forward Guidance implodes. At the European Banking Congress last year Mario told us this and the emphasis is mine.

The first step, as I said, was to lower overnight interest rates all the way to their effective lower bound – including below zero for the deposit facility.

What a difference a year makes! Are we now going to their ineffective lower bound?

Mario will have some “friends”

Such interest-rate hints from the ECB will put scowls on the face of a few central banks around Europe. A picture of his face is likely to go back on the dartboards of Sweden’s Riksbank, Denmarks Nationalbanken, and the Swiss National Bank as they mull having to cut interest-rates from -0.35% for the former and -0.75% for the latter two. Will we see someone cut to -1%?

Of course some of that is speculation but I doubt that many requests for leave on December the 3rd will be entertained at any of those institutions. It seems set to be a time for all hands on deck.

What else does Mario have in his locker?

One area where the ECB has been fairly consistent has been in its mantra that it can adjust its QE or APP program.

We consider the asset purchase programme to be a powerful and flexible instrument, as it can be adjusted in terms of size, composition or duration to achieve a more expansionary stance.

As we see more and more central bankers jawboning on the subject of market liquidity it is the size of QE that is the hardest to change on any large scale. Of course changing what is bought would be a help in that as for example Portugal has lots of debt the ECB could buy. But buying ever more government bonds would make those markets ever more illiquid and ever harder to shrug off protests that the lack of liquidity is caused by the same central bankers who pontificate on it. Accordingly an increase in the duration of the program seems likeliest to me beyond September 2016  as we mull the thoughts of a famous cartoon character.

On that subject you may be intrigued to note that the US Treasury Bond market seems to be setting itself for an interest-rate rise followed by QE 5 rolling down the slipway.

What else does Mario think?

The first message is a bit of back slapping and trumpet blowing.

Our measures have therefore clearly worked – in fact, they are probably the dominant force spurring the recovery that we see today.

So much for the falls in the price of oil and other commodities then. But Mario was determined to mine the same vein.

To give you a comparison, we estimate that in normal times our policy rate has to be instantaneously reduced by 100 basis points to see a similar impact on lending rates after such a short time period.

But more needs to be done and after all the hype comes a contradiction.

the present upswing which started in 2013 is the weakest euro area rebound since 1998.

Also we need to recall that the ECB is a central bank which prioritises its inflation target above all else.

The so-called core measures of inflation – which strip out volatile components – have also been drifting down since mid-2012 when the euro crisis hit its climax, and have been hovering around 1% for nearly two years………….Low core inflation is not something we can be relaxed about, as it has in the past been a good forecaster for where inflation will stabilise in the medium-term.

So at the cost of directly contradicting his predecessor Jean Clause Trichet Mario Draghi could not be clearer about his plans for December. Also by implication he is contradicting the words of Bank of England Governor Mark Carney when he told us that central banks do not make up their minds before policy meetings.


We have a potential clash of the titans on its way and of the two the likeliest move remains that of the ECB. After all it has backed up its rhetoric and promises with action whereas the US Federal Reserve has so far backed up its promises with more promises.  Also even the US central bank which is often insular may note the strength of the US Dollar.

Of course the ECB has the benefit of having the first move in the chess game as it meets a fortnight or so ahead of the US Federal Reserve. That might be a long time for the Fed to twiddle its thumbs for although they could spend it trying to find out where the interest-rate rise button is.

Ironically such prospects reverse what happened in 2011 when the ECB raised its policy interest-rate twice (to 0.75%) whilst the US was busying itself with QE 2 and then Operation Twist. What happened next? Well remind yourself of the current ECB interest-rate…

Meanwhile the two central banks must be singing this Diana Ross song to the other.

Upside down
Boy (Girl), you turn me
Inside out
And round and round
Upside down
Boy (Girl), you turn me
Inside out
And round and round


Can macroprudential policy control house prices?

One of the features of the credit crunch era has been something that would not have been expected beforehand which is that house prices in more than a few countries are running hot. If you think about it house prices should have fallen in response to the credit crunch as banks and economies retrenched and wages fell as I was discussing only yesterday. But something else was thrown into the mix which was the monetary easing of central banks where interest-rates were cut and plunged us into the ZIRP or Zero Interest Rate Policy era. This has been followed in the last year or so by NIRP as some countries have taken the policy interest-rate negative.

Also we have seen a range of extraordinary monetary policies such as Quantitative Easing which in the UK is being kept at £375 billion. Also if we look at the UK experience the Funding for Lending Scheme began in the summer of 2012 and look what even Jon Cunliffe of the Bank of England thinks happened next and the emphasis is mine.

But over the past three years, as banks’ funding costs have reduced and as competition in the mortgage market has intensified, on average mortgage interest rates have fallen by 2 percentage points.

We learned only on Tuesday the impact of that on house prices in the UK.

UK average house prices increased by 6.1% over the year to September 2015, up from 5.5% in the year to August 2015

Now as the economy has been in a recovery phase for a bit you might think that such a situation is okay but then you have to address this.

In September 2015, the UK mix-adjusted house price index increased 0.3% from the previous record level witnessed in August 2015 to reach a new record of 219.8 (Figure 2). The UK index is 18.5% higher than the pre-economic downturn peak of 185.5 in January 2008.

This has been driven but the cuts in official interest-rates which were followed by moves to push mortgage interest-rates even lower and the moves went on and on until house prices were driven higher. After all it wasn’t real wage growth was it?

However earlier this month Nemat Shafik of the Bank of England told BBC radio this.

Interest rates ‘not tool for housing market’

Contradiction city

There is the obvious issue that since 2008 the Bank of England has been doing exactly that! Perhaps the ability to overlook such things was not only a factor in her being parachuted in as a Deputy Governor but also in the award of a Dame hood  in June. Also as she is one of those who keeps telling us that the Bank of England is about to raise interest-rates why not simply let them that part of their job?

Dame Shafik has an alternative for house prices

It has tools to do things like put limits on the amount of indebtedness that households can take on, it can reduce banks’ ability to lend very risky loans, so for us we need to use the right tools for the right problem.

Okay but perhaps as she sits at the next meeting she could tell Jon Cunliffe who told us a different story.

I do not think that the role of the macroprudential authority should be to control asset prices including house prices.

It reminds me of one stage of the UK desert campaign in the second world war which came under the category “order,counter-order, disorder”.

Macroprudential policy

Back in the day this used to be called credit controls many of whom we scrapped back in 1979 when exchange controls were ended and we moved away from such policies. The problem back then was the economy was jerked forwards and backwards and indeed distorted as institutions moved to get around and subvert restrictions which were then changed. It was not a triumph although advocates of what is called macropru often ignore that.

In the UK we have seen an example of it when the Bank of England introduced MMR or the Mortgage Market Review in April 2014. This tightened the rules for lending at high income multiples and ended self-certification mortgages which had acquired the rather descriptive title of “liar loans”. There was an obvious initial issue for some as described by Mortgage Strategy.

The biggest problem created by the MMR has been mortgage prisoners. These are borrowers who took out a mortgage when affordability rules were more relaxed and are now unable to get a deal in the new environment.

How are things going?Not so well according to the Guardian at the end of October.

Sub-prime mortgages, widely blamed for causing the 2007-08 financial crisis, are making a surprise comeback in the UK, with several new lenders launching home loans for people with poor credit histories.

This bit raised a wry smile.

Matt Andrews, managing director of Bluestone Mortgages, said: “We don’t like the term sub-prime – it implies these customers are somehow inferior to prime borrowers, which they are not.

We see above two of the fundamental problems of macropru which happened in the past. One group is disadvantaged in getting credit and at the other end of the spectrum we see lenders getting around the rules and a group who not so long ago we decided shouldn’t have such easy access to credit get back in the game.

Bank of England research

A paper released this morning offers some insights into the problems of macropru.

But the effectiveness of these instruments may be compromised if banks and borrowers are able to avoid these measures via regulatory arbitrage or if the regulation is subject to `leakages’ whereby the activity migrates to institutions which are not covered by the instruments.

Those 43 words used to be covered by just one disintermediation. One issue may have been noted above as you see several of the subprime lenders above are Australian institutions.

Some macroprudential instruments – in the absence of reciprocal arrangements – cannot be applied to all financial institutions within a country.

Also there are issues with another sector which we have not heard mentioned for a while.

Much of the debate over leakages has focused on lending by ’shadow banks’ or non-bank financial institutions,

You will not be surprised to read that the paper comes out in favour of macropru overall as it would be quite an own goal otherwise. A literal personal one in a way as one of the authors works for the Macroprudential Strategy and Support Division at the Bank of England.


This is another issue for our valiant regulators as we have the issue of whether such policies are applied at the right time or whether they are always too late? We are seeing an example of this in Sweden right now where there is a house price boom which I would argue is a bubble and yet the Riksbank Minutes tell us that little has actually been done about it.

several members of the Executive Board again emphasised that there is a great need to promptly clarify mandates and tools within the area of macroprudential policy and to adopt measures to manage risks on the housing market and risks linked to household debt.

We are left with the impression that central bankers rather like the idea of the boom happening and then arriving too late like General Terry at the battle of Little Bighorn.


The problems with macropru described above are known so I can only conclude that central bankers are trying to redact them from history. As I have already pointed out this is especially odd in the UK as according to Forward Guidance rises in interest-rates are supposed to be  on their way. The hints are by now familiar “at the turn of the year” “sooner rather than later”.

There is another oddity because you see the Bank of England still has its foot on the mortgage market pedal via the Funding for Lending Scheme.

During the second quarter of 2015, the number of groups participating in the FLS Extension was 34.  Of these, 11 participants made drawdowns of £5.1bn in total. Participants also repaid £0.9bn, taking total outstanding drawings to £61.4bn.

This is supposed to be for small business lending these days but then of course it always was! Let us be nice and say it has flatlined but what about mortgage lending? From the BBC last week.

The CML said that gross mortgage lending totalled £61.4bn in the third quarter of the year. This was up 18% on the previous quarter and a 12% rise on the third quarter of 2014.

Oh and I do hope that the lending to small businesses is not a form of corporate buy to let funding. Oh buy to let! Surely that is not yet another hole in the net of our valiant macropru regulators?

So the answer to my question is no. At the moment that is because they do not want it to. Should they apply it the side-effects would quickly be so great it would be rapidly watered down or kicked into the long grass (assuming there is still some space in that crowded area). But they could at least claim to have done something…..