The UK Public Finances give the UK economy a positive message

The focus returns to the UK economy today and as the sunshine pours through my windows let us remind ourselves of one of its strengths. From the BBC.

Ed Sheeran was the big winner at this year’s Billboard Awards, held in Las Vegas.

The singer took home four awards: top artist, top radio songs artist, top song sales artist and top hot 100.

Yes it was overall a good weekend for those of the ginger persuasion as we got a reminder of a successful part of our economy. From the UK Music website.

The UK music industry grew by 6% in 2016 to contribute £4.4 billion to the economy, a major new report reveals today…….Successful British acts including Ed Sheeran, Adele, Coldplay, Skepta and the Rolling Stones helped exports of UK music soar in 2016 by 13% to £2.5 billion.

Millions of fans who poured into concerts ranging from giant festivals like Glastonbury to small bars and clubs pushed the contribution of live music to the UK’s economy up by 14% in 2016 to £1 billion.

There was a time that the success of the industry was frittered away by the use of Columbian marching powder but of course in a masterstroke that is now added to the GDP numbers. Although exactly how to measure this is a mystery to me and when I have checked appears to be something of a mystery to our statisticians too. As Fleetwood Mac would put it “Oh Well!”

Bank of England

No doubt Governor Mark Carney will be cheered by this week;s headlines assuming of course he has spotted them. From Graeme Wearden of the Guardian

FTSE 100 hits record high as US and China call a trade war truce 🇺🇸🇨🇳

Perhaps he will take the opportunity when he gives evidence to Parliament today to claim yet more wealth effects from higher asset prices as following that headline yesterday the FTSE 100 has pushed even higher to 7868 this morning. This would be in not dissimilar fashion to the way that the Bank of England has done so with house prices after it made a policy switch back in the summer of 2012 to explicitly boost them with the Funding for Lending Scheme. Of course a full exposition of the state of play in the equity market would need to allow for dividends and inflation.

Meanwhile the last week has seen the Bank of England and Mark Carney hit troubled water again on this issue of what we might call “woman overboard”. This is where the intelligent one ( Kristin Forbes) did not want a second term and the much less intelligent one ( Minouche Shafik)  had to be made a Dame to cover up her early departure. That is before we get to this. From the BBC

Charlotte Hogg has spoken of learning lessons after the “mistake” that ended her career at the Bank of England.

A former deputy governor – and tipped to take the top job – she says in her first interview that the experience made her a “different kind of leader”.

Somehow the BBC economics editor Kamal Ahmed seems to have forgotten the way she broke the rules she had set and the implied effort to in essence ride it out in a manner suggesting such rules were not for “one of us”. Also it is hard to know where to start with this.

Since her resignation in March 2017, Ms Hogg has remained out of the public eye.

It is a lesson in the way the UK establishment operates as I note the daughter of a baroness and a Viscount has the chutzpah to tell us this.

As a leader of Visa, I want it to be a more diverse organisation.

This was combined with an even more important issue that her lack of knowledge about monetary policy was no barrier to being appointed to the Monetary Policy Committee (MPC) for what Sir Humphrey Appleby would no doubt call “One of Us”.

As to Governor Carney I do hope that the Treasury Select Committee will grill him on his Forward Guidance. Here he is from August 2013 on the BBC.

So that people watching this at home, so that people running businesses here across the United Kingdom can make decisions about whether they are investing or spending with greater certainty about what’s going to happen with interest-rates.

What this has meant in practice is that the Unreliable Boyfriend has regularly promised interest-rate rises but these have not turned up.However when the opportunity came to cut interest-rates he did so immediately. Even that went wrong and had to be reversed after long enough had been left to try to avoid it looking too embarrassing.

Oh and they could also ask how he seems so often to talk for the whole MPC when the other eight members are supposed to be of independent mind especially the four external members?

Public Finances

These have been performing pretty well recently and this morning’s data continued on this happier theme.

Public sector net borrowing (excluding public sector banks) decreased by £1.6 billion to £7.8 billion in April 2018, compared with April 2017; this is the lowest April net borrowing since 2008.

The last bit is of course going to be true every time now until the next downturn but behind it has been a consistent stream of improvements  which have contradicted some of the other data which have been weaker. For example receipts from Income Tax were strong rising from £11.4 billion last year to £12.8 billion this. Even VAT rose a little from £11.2 billion to £11.5 billion which may suggest that the more apocalyptic surveys on retail sales have been exaggerated. Also debt costs fell which seems likely to reflect the fading of the rate of inflation as the main player here will be the impact of the Retail Price Index on index-linked debt costs.

The good news continued if we look back for some more perspective although you may note not very everyone as my first rule of OBR club hits another winner.

Public sector net borrowing (excluding public sector banks) in the latest full financial year (April 2017 and March 2018) was £40.5 billion; that is, £5.7 billion less than in the previous financial year (April 2016 to March 2017) and £4.7 billion less than official (OBR) expectations; this is the lowest net borrowing since the financial year ending March 2007.

So we have passed the time which regular readers will recall saw the economy apparently improve but the public finances struggle to one where the tables have been reversed. If April was any guide then the Income Tax data suggests a better economic situation than we have seen elsewhere and was quite an improvement on 2017/18 when it struggled. But of course one month;s figures are unreliable.

More problems for the Bank of England

The 2017/18 financial year saw a rise in UK debt costs of £5.9 billion which will essentially be the rise in inflation ( RPI) triggered by the fall in the UK Pound £ after the EU leave vote. This is an actual cost often ignored of the Bank of England not only “looking through” the likely inflation rise but adding to it with its Bank Rate cut and Sledgehammer QE of August 2016.

Also there is something rather embarassing in terms of number-crunching.

n compiling debt estimates for March 2018, there was an error in the treatment of data for the Asset Purchase Facility (APF), which incorrectly recorded the data relating to two events in the compilation process:the closure of the Term Funding Scheme in February 2018….the maturation of a tranche of gilts held by the APF.

Okay so what?

However, correcting this error has reduced PSND ex as at the end of March 2018 by £11.0 billion, equivalent to 0.5 percentage points as a ratio of GDP.

Comment

The news from the UK Public Finances is good and was particularly so in April. In addition we were told that the last financial year was around £2 billion better than we had previously calculated. So we now qualify for the Stability and Growth Pact in something of an irony and face the issue of what happens next? We have seen economic stimulus via the ongoing deficits but also austerity for many as funds have been switched between areas and different groups sometimes hurting the poorest. Of course we are several years already behind the planned surplus.

Maybe the numbers tell us we are doing better economically than some of the others although there is a catch and that is the way the numbers have been manipulated. Many of you will recall the Royal Mail pension fund saga where adding future liabilities supposedly improved the public finances and the housing associations who have blown into and then out of the numbers like tumbleweed in the wild west. More recently there is the issue of Bank of England involvement.

Public sector net debt (excluding both public sector banks and Bank of England) was £1,583.2 billion at the end of April 2018, equivalent to 75.8% of GDP, a decrease of £10.5 billion (or 2.8 percentage points as a ratio of GDP) on April 2017.

Meanwhile over at the Treasury Select Committee

 

 

 

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Trade what is it good for?

Yesterday brought news which financial markets have received warmly this morning. From the Financial Times.

The US has stepped back from the brink of a trade war with China after Washington halted plans to impose tariffs on up to $150bn of imports, according to the US Treasury secretary.  “We’re putting the trade war on hold,” Steven Mnuchin said in a television interview on Sunday.

My first thought is one of simple relativity which is how important numbers for the world economy get dwarfed these days when we look at central bank balance sheets. Moving back to the trade issue we have been facing this situation.

 Chinese negotiators resisted a Trump administration push to make a commitment to increase purchases by $200bn annually.

Such numbers fascinate me as in the nice round number mostly seems to ignore what will be bought and what would be done with them as the detail falls rather short.

Mr Mnuchin said. But he said the US side had very specific “industry by industry” targets in mind, raising the possibility of a 35-40 per cent increase in agricultural imports this year and an additional $50bn-$60bn in annual US energy exports over the next three to five years.

For example the agricultural numbers are a “possibility” even in the rhetoric. Whilst we could see more shale oil production how much more food can the US grow and produce? This seems much more a nod to the support base for President Trump that a real plan. If we move on the real issue is driven by this though.

Critics in the US are also concerned that its main emphasis appears to be on meeting Mr Trump’s goal of reducing the US’s annual $337bn trade deficit with China rather than tackling more difficult structural issues in the Chinese economy, such as Beijing’s subsidisation of key industries and systemic theft of US intellectual property.

Yes the trade deficit as we get a reminder that one of the global imbalances which the so-called great and the good told us needed fixing has not been fixed. Or as the Bureau for Economic Analysis puts it for the first three months of 2018.

Year-to-date, the goods and services deficit increased $25.5 billion, or 18.5 percent, from the same period in 2017. Exports increased $39.2 billion or 6.8 percent. Imports increased $64.7 billion or 9.1 percent.

Trade is good

It is not often put this way but let me point out that there are good elements here. For example the United States is boosting economic output in the rest of the world both with its purchases and its larger deficit. Most countries are of course poorer than the US but some more so and thereby benefit. The numbers below are the deficits for March

China ($35.4),Mexico ($7.0),India ($1.4)

Trade is very badly measured

Numbers are bandied about in this area implying far more accuracy than in fact exists. As I looked at the numbers I noted for example that the US had a small deficit with Canada in March whereas I recall a while back both thought they were in surplus. From Bloomberg.

Canadian officials tend to use U.S. data to make their case and the Bureau of Economic Analysis has calculated the U.S. had a $7.7 billion surplus in 2016. But Statistics Canada data show it’s Canada with the surplus in goods and services, totaling C$18.8 billion ($14.6 billion) last year.

As Hot Chocolate put it “Everyone’s a Winner” except of course they cannot be in a zero-sum game. Actually you might think it would make everyone happy in the mirage but of course we do not seem to be. An example of the problems and issues here was provided by the UK statistical office on the 8th of this month.

The £9.8 billion upward revision to the total trade deficit in 2016 means the deficit has been revised from £40.7 billion to £30.9 billion (Table 2). The main driver of the revision in 2016 came from improvements made to methods used to estimate net spread earnings, which feed into exports of services. The net spread earnings improvement revised trade in services exports back to 2004.

The good part is that they are working on the data and there is specific good news for the UK. But the catch is that it opens a window onto matters which are missed or badly measured. I have long argued on here that this is a serious issue for the UK as we have little detail on our services exports which is an important factor in our economy and seems likely to be something which would reduce our trade deficit it it was measured properly. These are difficult areas for statisticians as numbers from financial markets are unreliable as for example if you had a “good thing” you would want to keep it quiet in the way that the Prudential rather famously wrong-footed the rest of the UK Gilt market back in the early days of my career. Also this is true.

This collection of NSE has proved challenging as it is not something the reporting units are required to report under financial regulations.

World Trade Growth

Last year was a good year. From the World Trade Organisation.

Trade volume growth in 2017, the strongest since 2011, was driven mainly by cyclical factors, particularly increased investment and consumption expenditure. Looking at the situation in value terms, growth rates in current US dollars in 2017 (10.7% for merchandise exports, 7.4% for commercial services exports) were even stronger, reflecting both increasing quantities and rising prices.

In general world trade growth is around 1.4/1.5 times world GDP growth although of course even here we hit trouble. From Luis Martinez of the University of Chicago

The results indicate that yearly GDP growth rates are inflated by a factor of between 1.15 and 1.3 in the most authoritarian regimes. Correcting for manipulation substantially changes our understanding of comparative economic performance at the turn of the XXI century.

The catch is that we in the west have been getting more authoritarian and of course there is the possibility that they do not leave their lights on all night as some do in the west.

I show that the elasticity of official GDP figures to nighttime lights is systematically larger in more authoritarian regimes.

Comment

There is a lot to consider here and the headline comes from Trump Town with a protectionist agenda based on America First. Of course before that came other moves such as the way China subsidises industries to crowd out competition and the way that Germany got a lower exchange-rate via membership of the Euro.

Next comes the issue of whether it will provide yet another signal of an economic slow down? So far the outlook seems good as the Harpex shipping index has been rising and is now at 657.

As to trade itself the issue is complex as the issue of US energy production reminds us. This is because whilst the US Energy Information Agency reports the quote below the issue is not that simple.

The United States has been a net energy importer since 1953, but AEO2018 projects the United States will become a net energy exporter by 2022 in the Reference case.

You see that is different from self-sufficiency as the US will export more than it imports but due for example to the different types of crude oil will still be importing. In a way that is a reminder of the intricate links in trade these days as few products are now entirely from one country as so many have lots of links in their chain.

Chains keep us together (run into the shadows)
Chains keep us together (run into the shadows)
Chains keep us together (run into the shadows)
Chains keep us together (run into the shadows)
Chains keep us together (run into the shadows) ( Fleetwood Mac)

Is there a shortage of US Dollars and if so why?

At the moment we are seeing quite a few trends combined which look as though they are returning us to a position where there is a shortage of US Dollars. This is troubling as this was an issue in the genesis of the credit crunch as back then it affected banks and particularly European and Japanese ones. It seems odd as the foreign exchange market is very liquid but maybe it is not liquid enough or at least at the right price. Back in March Pictet Bank provided something of an explainer.

The problem is a spike in the differential between LIBOR and the Overnight Index Swap, or the premium over the risk-free rate non-US banks pay to borrow dollars outside of the US.

The spread has risen to 42 basis points, the highest since February 2012, and up from 25 basis points at the start of last month and just 10 basis points in November.

While the rise does not pose a systemic risk, it has nevertheless raised the cost, and reduced the availability, of dollar-denominated loans for non-US banks by a considerable margin and in short space of time.

It is pretty much back to that level (43) after going above 60 and just for clarity that is 0.6%. Here is the first lesson  of this saga in that in our present world some interest-rates do not seem to have much impact at all as for example I did warn on the third of this month that a rise in Argentinian ones would backfire. Some 9.75% higher later I guess my point has been made for me. However here we have a 0.6% or so at the peak looks in terms of Carly Rae Jepson that it “really,really,really,really” matters. This appears to be driven by two factors the first is that it affects the “precious” otherwise known as the banks and is in US Dollars. Of course the official story is rather different as the excerpt below from the May Inflation Report of the Bank of England shows.

In the years following the crisis, funding spreads narrowed as banks repaired their balance sheets and became more resilient.

I am resilient, we are resilient , it has unexpectedly collapsed ….

US Dollar

This has been a factor as we note that recently the US Dollar has been what we might call King Dollar again. If we use the US Dollar Index or DXY for this we see that it has rallied four points since mid April from over 89 to over 93 now. The bigger turn came at the opening of June 2014 when it has dipped below 80. So the price of the US Dollar has risen too over this phase. Whilst the DXY is now out of date in trade terms as for example the Chinese Yuan is missing it does a job for this sort of analysis as the Yen and Euro are there.

US Interest-Rates and Yields

This has been a case of singing along with Jackie Wilson.

You know your love (your love keeps lifting me)
Keep on lifting (love keeps lifting me)
Higher (lifting me)
Higher and higher (higher

The US Federal Reserve has increased its official interest-rate to between 1.5% and 1.75% and nearly as importantly has been raising the rhetoric about there being more (3/4) increases this year. I am not convinced by this but if we look around markets seem to be accepting it perhaps on the grounds that unlike other central banks the Fed has at least been reasonably consistent.

Also there have been rises in bond yields with the media concentrating on 3% for the ten-year Treasury Note and then 3.1%. But for this purpose more significant is what has taken place at the shorter maturities. The chart below gives us a handle on what has been taking place there.

Let me be clear here this is a financial markets thing rather than a real economy thing but these do have a way of leaking across and tripping up the unwary. Adding to this we are seeing real world effects too as I note this from Reuters.

Interest rates on U.S. 30-year fixed-rate mortgages rose to the highest in seven years as a bond market selloff this week propelled 10-year yields to the highest since July 2011, Freddie Mac said on Thursday………Thirty-year mortgage rates averaged 4.61 percent in the week ended May 17, matching the level last seen in May 2011.

Of course they affect the banks from another route.

Quantitative Tightening

One way that the supply of US Dollars is being reduced is quite basic as the US Federal Reserve has set out to do that explicitly. From a balance sheet which just passed US $ 4.5 Trillion we now see that it has fallen to US $4.36 trillion which put like that may not seem a lot but that is US $140 billion or so. The pace is also picking up a bit so in terms of narrow money or what central bankers have loved to call “high-powered money” there is less of it to go around from this source at any rate.

Crude Oil

This too seems to have been a factor in the recent moves and there is some logic to this as of course the vast majority of oil business is settled in US Dollars. Not all of it anymore but a large proportion. Thus the rise in the price exemplified by the fact that the price of a barrel of Brent Crude Oil is now just below US $80 or some 52% over the past year has also sucked US Dollars out of the system. This is my view is of course mostly a timing thing as the oil producers will then spend them as for example one of the ways the money gets recycled is by the Gulf States buying weapons but we know that timing matters in the credit crunch era. Supposedly because we are more resilient as I look up that particular page in my financial lexicon for these times.

There are many views on this but here is one from a social media exchange I was involved in.

My thesis is the $/oil correlation is a consequence of oil market design/paradigm shift. This began 1st July 2017 & completed a couple of months ago. ie the dollar is now on an If I’m right, when (not if) oil falls the $ will fall with it ( @cjenscook )

Comment

Let us now look at it the other way from the point of view of the central bankers. Let me take you to the US Federal Reserve website where with something of a fanfare it declared this back in the day.

In May 2010, the FOMC announced that in response to the re-emergence of strains in short-term U.S. dollar funding markets it had authorized dollar liquidity swap lines with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank.

They had been gone for all of three months and were supposed to go as my emphasis below returns us again to my financial lexicon for these times.

 In October 2013, the Federal Reserve and these central banks announced that their existing temporary liquidity swap arrangements–including the dollar liquidity swap lines–would be converted to standing arrangements that will remain in place until further notice.

Very little is being used right now as one European bank has taken 80 million US Dollars worth in revolving 6 day credit or there are more than one. But this reminds me of the old wartime analogy of President FD. Roosevelt and loaning your neighbour a hose in case he has a fire. Meanwhile the emerging markets have started to be called the submerging ones.

The Italian economic job has led us to the current mess

After looking at the potential plans of the new Italian coalition government, assuming it gets that far yesterday let us move onto the economic situation. Let us open with some news from this morning which reminds us of a strength of the Italian economy. From Istat.

The trade balance in March 2018 amounted to +4.5 billion Euros (+3.8 billion Euros for non EU area and +0.7
billion Euros for EU countries).

There is an immediate irony in having joined a single currency ( Euro ) to boost trade and find that your main surplus is elsewhere. However some 55.6% of trade is with the European Union and 44.4% outside so there is a sort of balance if we note we are not being told the numbers for the Euro area itself. If we do an annual comparison then it is not a good day for economics 101 either as the relatively strong Euro has not had much of an effect at all as the declines are mostly within the European Union.

Outgoing flows fell by 2.2% for non EU countries and by 1.5% for EU countries. Incoming flows increased by 0.4% for EU area and decreased by 0.5% for non EU area.

Actually both economic theory and Euro supporters will get some more cheer if we look at the year so far for perspective as exports with the EU ( 5.5%) have grown more quickly than those outside it (0,5%). The underlying picture though is of strength as in the first quarter of 2018 a trade surplus of 7.5 billion Euros has been achieved. If we look back and use 2015 as a benchmark we see that exports are at 114.1 and imports at 115.9 so Italy is in some sense being a good citizen as well by importing.

The main downside is that Italy is an energy consumer ( net 9.4 billion Euros in 2018 so far) which is not going to be helped by the current elevated oil price.

Inflation

This is an intriguing number as you might think with all the expansionary monetary policy that it was a racing certainty. But reality as so often is different. If we look at the trading sector we see this.

In March 2018 the total import price index decreased by 0.1 % compared to the previous month ; the total twelvemonth
rate of change increased by 1.0%.

So quite low and this is repeated in the consumer inflation data series.

In April 2018, according to preliminary estimates, the Italian harmonised index of consumer prices (HICP) increased by 0.5% compared with March and by 0.6% with respect to April 2017 (it was +0.9% in the previous month).

Just for clarity that is what we call CPI in the UK and is not called that in Italy because it has its own measure already called that. Apologies for the alphabetti spaghetti. Such a low number was in spite of a familiar influence in March.

The increase on monthly basis of All items index was mainly due to the rises of prices of Non-regulated energy products (+1.1%) ( from the CPI breakdown).

Although there was also a reduction in regulated energy prices. But in essence the theme here is not much and personally I welcome this as I think that driving inflation up to 2% per annum would be likely to make things worse if we note the sticky nature of wage growth these days.

If we move to an area where we often see inflation after expansionary monetary policy which is asset prices we again see an example of Italy being somewhat different.

According to preliminary estimates, in the fourth quarter of 2017: the House Price Index (IPAB) increased by 0.1% compared with the previous quarter and decreased by 0.3% in comparison to the same quarter of the previous year (it was -0.8% in the third quarter of 2017);

The numbers are behind the others we have examined today but the message is loud and clear I think. Putting it another way Mario Draghi is I would imagine rather disappointed in the state of play here as it would help the struggling Italian banks by improving their asset base especially as such struggles draw attention to the legal basis for them known as the Draghi Laws which have been creaking.

Growth

The good news is that there is some as you see there is a case to be made that the trend rate of growth for Italy is zero which is not auspicious to say the least.

In the first quarter of 2018 the seasonally and calendar adjusted, chained volume measure of Gross
Domestic Product (GDP) increased by 0.3 per cent with respect to the fourth quarter of 2017 and by 1.4 per
cent in comparison with the first quarter of 2017.

If we stick with what Chic might call “Good Times” then Italy beat the UK and drew with Germany and France in the quarter just gone. However it was more their woes than Italian strength sadly as I note that even with this economic growth over the past four years has been 4.3%. This is back to my theme that Italy grows at around 1% per annum in the good times that regular readers will be familiar with and the phrase girlfriend in a coma. Less optimistic is how quarterly GDP growth has gone 0.5% (twice), 0.4% (twice) and now 0.3% (twice).

Labour Market

Here is where we get signs of real “trouble,trouble,trouble” as Taylor Swift  would say.

unemployment rate was 11.0%, steady over February 2018…..Unemployed were 2.865 million, +0.7% over the previous month.

The number has fallen by not by a lot and is still a long way above the 6-7% of the pre credit crunch era. So whilst it is good news that 190,000 more Italians gained jobs over the preceding 12 months that is very slow progress. Also wage growth seems nothing to write home about either.

At the end of March 2018 the coverage rate (share of national collective agreements in force for the wage setting aspects) was 65.1 per cent in terms of employees and 62.1 per cent in terms of the total amount of wages.

In March 2018 the hourly index and the per employee index increased by 0.2 per cent from last month.

Compared with March 2017 both indices increased by 1.0 per cent.

So a very marginal increase in real wages.

Comment

One thing that has struck me as I have typed this is the many similarities with Japan. Let me throw in another.

According to the median scenario, the resident population for Italy is estimated to be 59 million in 2045 and 54.1 million in 2065. The decrease compared to 2017 (60.6 million) would be 1.6 million of residents in 2045 and 6.5 million in 2065.

A clear difference can be seen in the unemployment rate and of course even Italy’s national debt is relatively much smaller although not as the Japanese measure such things.

The bond yield is somewhat higher especially after yesterday’s price falls and the ten-year yield is now 2.12% but here is another similarity from a new version of the proposed coalition agreement.

I imagine this would mean asking banks to hold less capital for the loans they give to SMEs. This would make banks more fragile and – in the 5 Star/League world – could lead to more “public gifts” to private banks. ( @FerdiGuigliano )

The Bank of Japan had loads of such plans and of course the Bank of England modified its Funding for Lending Scheme in this way too. Neither worked though.

Meanwhile we cannot finish without an apparent eternal  bugbear which is the banks.

League and 5 Star also have plans for Monte dei Paschi, which has been recently bailed out by the Italian government. They want to turn it into a utility, where the State (as opposed to an independent management) decides the bank’s objectives.

Me on Core Finance TV

 

 

Will Italy get a 250 billion Euro debt write-off from the ECB?

Up until now financial markets have been very sanguine about the coalition talks and arrangements in Italy. I thought it was something of calm before the storm especially as these days something which was a key metric or measure – bond yields – has been given a good dose of morphine by the QE purchases of the European Central Bank. However here is a  tweet from Ferdinando Guigliano  based on information from the Huffington Post which caught everyone’s attention.

1) Five Star and the League expect the to forgive 250 billion euros in Italian bonds bought via quantitative easing, in order to bring down Italy’s debt.

My first thought is that is a bit small as whilst that is a lot of money Italy has a national debt of 2263 billion Euros or 131.8% of its GDP or Gross Domestic Product according to Eurostat. So afterwards it would be some 2213 billion or 117% of GDP which does not seem an enormous difference. Yes it does bring it below the original 120% of GDP target that the Euro area opened its crisis management with but seems hardly likely to be an objective now as frankly that sank without trace. Perhaps they have thoughts for spending that sort of amount and that has driven the number chosen.

Could this happen?

As a matter of mathematics yes because the ECB via the Bank of Italy holds some 368 billion Euros and rising of Italian government bonds and of course rising. However this crosses a monetary policy Rubicon as this would be what is called monetary financing and that is against the rules and as we are regularly told by Mario Draghi the ECB is a “rules based organisation”. Here is Article 123 of the Lisbon Treaty and the emphasis is mine.

Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.

Now we hit what Paul Simon would call “troubled water” as the ECB has of course been very close to the highlighted part. The argument for QE purchases rested on the argument that buying in the secondary market was indirect and not direct or as the ECB puts it.

There will be no primary market purchases under the PSPP, regardless of the type of security, as such purchases are not allowed under Article 123 of the Treaty on the Functioning of the European Union.

It is a bit unclear as to when they become available but if I recall correctly as an example the Bank of England limit is one week.

The reason for this is to stop a national government issuing debt and the central bank immediately buying it would be a clear example of round-tripping. The immediate implication would be a higher money supply raising domestic inflation dangers  although there would be an initial boost to the economy. We did look at an example of this a couple of years ago in the case of Ghana and whilst we never get a test tube example in economics the Cedi then fell a substantial amount and inflation rose . Thus the two worrying implications are inflation and a currency plunge on a scale to cause an economic crisis.

Would this happen in the case of Italy? That depends on how it plays out. Inside the boundaries of the Euro maybe not to a  great extent initially but as it played out there would be an effect as Italy would not doubt be back for “More,More,More” once Pandora’s Box was open and of course others would want to get their fingers in the cookie jar.

Oh and if we go back to the concept of the ECB being a “rules based organisation” that is something that is until it breaks them as we have learnt over time.

Fiscal Policy

You will not be surprised to learn that they wish to take advantage of the windfall. Back to the tweets of Ferdinando Guigliano

5) The draft agreement would see the Italian government spend 17 billion euros a year on a “citizens’ income”. The European Commission would contribute spending 20% of the European Social Fund

That raises a wry smile as we mull the idea of them trying to get the European Commission to pay for at least some of this. Perhaps they are thinking of the example of Donald Trump and his wall although so far that has been more of a case of a “Mexicant” than a “Mexican.”

Next came this.

According to , the 5 Star/League draft document says there would be a “flat tax”… but with several tax rates and deductions

So flat but not flat well this is Italy! Also we see what has become a more popular refrain in this era of austerity.

Italy’s pension reform would be dismantled: workers would be able to retire when the sum of their retirement age and years of contribution is at least 100.

Over time this would be the most damaging factor as we get a drip feed that builds and builds especially at a time of demographic problems such as an aging population.

So a fiscal relaxation which would require some changes in the rules of the European Union.

The two parties want to re-open European Treaties and to “radically reform” the stability and growth pact. The coalition would also want to reconsider Italy’s contribution to the EU budget.

Market Response

That has since reduced partly because the German bond market has rallied. Partly that is luck but there is an odd factor at play here. You might think that as the likely paymaster of all this Germany would see its bonds hit but the reality is that it is seen as something of a safe haven which outplays the former factor. On that road it issued some two-year debt yesterday with investors paying it around 0.5% per annum. Also I think there is such a shock factor here that it takes a while for the human mind to take it in especially after all the QE anaesthetic.

The Euro has pretty much ignored all of this as I use the rate against the Yen as a benchmark and it has basically gone “m’eh” as has most of the others so far.

Comment

There are quite a few factors at play here and no doubt there will be ch-ch-changes along the way. But the rhetoric at least has been raised a notch this morning.

We are in favor of a consultative referendum on the euro. It might be a good idea to have two euros, for two more homogeneous economical regions. One for northern Europe and one for southern Europe. ( Beppe Grillo in Newsweek)

I do not that the BBC and Bloomberg have gone into overdrive with the use of the word “populists” as I mull how you win an election otherwise? If we stick to our economics beat this is plainly a response of sorts to the ongoing economic depression in Italy in the Euro era. Also it was only on Monday when the Italian head of the ECB was asking for supra national fiscal policy. For whom exactly? Now we see Italy pushing for what we might call more fiscal space.

Meanwhile if we look wider we see yet more evidence of an economic slow down in 2018 so far.

Japan GDP suffers first contraction since 2015

Very painful for the Japanese owned Financial Times to print that although just as a reminder Japan is one of the worst at producing preliminary numbers.

UK real wages fell again in March

Today brings us to an area of the UK economy where the trend has remained positive and frankly amazingly so. Regular readers will be aware that back in the “triple-dip” ( hat tip to Stephanie Flanders then of the BBC now of Bloomberg for the phrase) days of 2011/12 that the employment data moved first and was followed by GDP in 2013. Thus employment trends have become something of a leading indicator as again we face a phase where they tell us one thing whereas other signals head south.

An example of other signals was seen only yesterday.

Much could be made of the adverse impact on April’s footfall of Easter shifting to March, but even looking at March and April together – so smoothing this out – still demonstrates that footfall has plummeted.  A -3.3% drop in April, following on from -6% in March, resulted in an unprecedented drop of -4.8% over the two months. (Springboard)

They then made a somewhat chilling comparison and the emphasis is mine.

 Not since the depths of recession in 2009, has footfall over March and April declined to such a degree, and even then the drop was less severe at -3.8%.

This added to this from KPMG a few days before.

April’s figures show retail sales growth falling off a cliff, with sales down -3.1 per cent on last year, but we must exercise caution and remember that the timing of Easter makes meaningful month-on-month comparisons difficult. That said, the three-month average is more helpful to assess, but this too points to sales only growing modestly

As you can see there are poor numbers there but two factors are at play. Firstly there is the impact of the period we have been through where real wages fell and I mean that in two senses. We have seen a recent dip which we have at best only begun to emerge from backing up an overall fall which again depends how you measure it but is more than 5%. Next is the decline of the high street which if the ones by me are any guide is ongoing.

Germany

Another signal of a slow down that is much wider than in the UK was seen earlier as Germany reported this.

The Federal Statistical Office (Destatis) also reports that the gross domestic product (GDP) increased 0.3% – upon price, seasonal and calendar adjustment – in the first quarter of 2018 compared with the fourth quarter of 2017.

For perspective there is also this.

This is the 15th quarter-on-quarter growth in a row, contributing to the longest upswing phase since 1991. Last year, there were higher GDP growth rates (+0.7% in the third quarter and +0.6% in the fourth quarter of 2017).

So the slow down is much more than just the UK and we will have to see what develops next. I would remind you of yesterday’s subject which was hints of a fiscal stimulus in the Euro area as it becomes clearer why that might be doing the rounds. Also as I had started with leading indicators I am afraid it is yet another bad day for the Markit business surveys or PMIs which told us this in January.

“If this level is maintained over February and March,
the PMI is indicating that first quarter GDP would rise
by approximately 1.0% quarter-on-quarter”

That was for the Euro area and Germany had a higher reading so for them to have been right the German economy shrank in February and March.

UK Real Wages

There are signs of trouble here so let us go straight to the numbers.

Latest estimates show that average weekly earnings for employees in Great Britain in nominal terms (that is, not adjusted for price inflation) increased by 2.9% excluding bonuses, and by 2.6% including bonuses, compared with a year earlier.

In the rather odd world of Mark Carney and the Bank of England those are excellent figures especially if you look at the March figures alone which showed 3% growth on a year before. Let us continue on that sort of theme for a moment.

Latest estimates show that average weekly earnings for employees in Great Britain in real terms (that is, adjusted for price inflation) increased by 0.4% excluding bonuses, but were unchanged including bonuses, compared with a year earlier.

This has been copied and pasted across the media as showing real wage growth yet that is somewhat misleading. This is because if you actually look at what people get in they pay packets March actually showed a slowing to an annual rate of 2.3%. Now at absolute best the UK inflation rate was 2.3% according to the CPIH measure but that of course relies on imputed rents to bring it down from the 2.5% of CPI and is lower than the 3.3% of the RPI. According to the official data which you have to look up as it is not ready for copy and pasting real wages fell by 0.1% on the most friendly measure which is using CPIH.

Let me put this another way UK single month wage growth has now gone 3.1%, 2.8%, 2.6% and now 2.3%. I will not insult you by pointing out the trend here but will show you how this is being reported with the one strand of hope being that February has been revised up by 0.3% and fingers crossed for March on that front. From @katie_martin_fx

ING: “Rising UK wage growth points to summer rate hike”

Meanwhile the back picture is along the lines of this.

Actually it is worse than that in the longer-term because for some reason they use an inflation measure with imputed rents in it ( CPIH) which lowers the numbers. Secondly they are using regular pay which as I have explained above flatters wage growth at the moment.

Employment

This is the ying to the yang above as the numbers remain very good.

There were 32.34 million people in work, 197,000 more than for October to December 2017 and 396,000 more than for a year earlier………..Between October to December 2017 and January to March 2018, total hours worked per week increased by 6.6 million to 1.03 billion.

There was a dip at the opening of this year in hours worked per person but that may be the ides of March. However there was further credence to the view that the productivity issue is being measured badly and is often just the flipside of employment growth especially when GDP growth is low.

Output per hour – The Office for National Statistics’ (ONS’) main measure of labour productivity – decreased by 0.5% in Quarter 1 (Jan to March) 2018.

Comment

As you can see the strong employment growth seen in the UK for some time has fed into strong wages growth which meant that the Bank of England raised interest-rates in May. Oh hang on………

Sorry there must have been some strands of the Matrix style blue pill in my tea this morning. Returning to reality the UK’s employment numbers are excellent and the improvement as in fall in unemployment has continued. But the simple truth is that the wages data relies on two types of cherry-picking to also be good. Firstly you have to ignore what people actually get and concentrate on regular pay which may seem sensible at the Bank of England as on its performance bonuses must be thin on the ground but many rely on them. Next you have to use the lowest measure of inflation you can find which relies on fantasy rents and except for this purpose is usually roundly ignored.

I hope the number for March is revised higher and we can expect some pick-up in public-sector pay but as we stand total pay growth is seems to be following the lower inflation data. Also there is the issue of whether European economies pick up after a slower first quarter for 2018.

 

An expansion of fiscal policy in the Euro area might help to keep Italy in it

After the action or in many ways inaction at the Bank of England last week there was a shift of attention to the ECB or European Central Bank. Or if you prefer from Governor Mark Carney to President Mario Draghi. This is because tucked away in a rather familiar tale from him in a speech in Florence was what you might call parking your tanks on somebody else’s lawn. It started with this.

One is the ECB’s OMTs, which can be used when there is a threat to euro area price stability and comes with an ESM programme. The other is the ESM itself.

Actually rather contrary to what Mario implies Outright Monetary Transactions or OMTs were never required as the ECB instead expanded its bond puchases via the Quantitative Easing programme which is ongoing currently at a flow of 30 billion Euros a month. One might also argue the European Stability Mechanism has caused anything but in Greece however the fundamental point is that via such mechanisms monetary policy has slipped under and over and around the border into fiscal policy. For example after the progress in the coalition talks in Italy the financial media has moved onto articles about the Italian national debt being un affordable when in fact the factor that has made it affordable is/are the 342 billion Euros of it that the ECB has purchased. The Italy of 7% bond yields at the time of the Euro area crisis would not have reached now in the same form whereas the current Italy of around 2% yields has.

But there is more than tip-toeing onto the fiscal lawn below.

So, we need an additional fiscal instrument to maintain convergence during large shocks, without having to over-burden monetary policy. Its aim would be to provide an extra layer of stabilisation, thereby reinforcing confidence in national policies.

As no doubt you have already recognised that particular lawn has been mined with economic IEDs as Mario then implicitly acknowledges.

And, as we have seen from our longstanding discussions, it is certainly not politically simple, regardless of the shape that such an instrument could take: from the provision of supranational public goods – like security, defence or migration – to a fully-fledged fiscal capacity.

The only one of those that is pretty non contentious these days is the security issue and that of course is because of the grim nature of events in that area. However the movement of ECB tanks onto the fiscal lawn continued.

But the argument whereby risk-sharing may help to greatly reduce risk, or whereby solidarity, in some specific circumstances, contributes to efficient risk-reduction, is compelling in this case as well, and our work on the design and proper timeframe for such an instrument should continue.

All of that is true and just in case people missed it then the ECB broadcasted it from its social media feeds as well.

Why has Mario done this?

One view might be that as he approaches the end of his term he feels that he can do this in a way he could not before. Another ties in with a theme of this website which is to use the words of Governor Carney that monetary policy may not be “maxxed out” but there are clear signs of fatigue and side-effects. Mario may well have had a sleepless night or two as he thinks of his own recent words about the Euro area economy.

When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

Where this fits in with my theme is that this is happening with an official deposit rate of -0.4% and not only an enormously expanded balance sheet but ongoing QE. Thus the sleepless nights will be when Mario wonders what  to do if this also turns out to be ongoing? The two obvious monetary responses have problems as whilst what economists call the “lower bound” has proved to be yet another mirage that is so far and plunging further into the icy cold world of negative interest-rates increases the risk of a dash to cash. The second response which ties in with the issue of policy in Germany is that the ECB is running out of German bunds to buy so firing up the QE operation again is also problematic.

Fiscal Policy

The problem puts Mario on an Odyssey.

And if you’re looking for a way out
I won’t stand here in your way.

In terms of economic theory there is a glittering prize in view here but sadly it only shows an example of what might be called simple minds. This is because at the “lower bound” for interest-rates in a liquidity trap  fiscal policy will be at its most effective according to that theory. So far go good until we note that the “lower bound” has got er lower and lower. There was of course the Governor Carney faux pas of saying it was at 0.5% and then not only cutting to 0.25% but planning to cut to 0.1% before the latter was abandoned but also some argued it was at 0% and of course quite a bit of the world is currently below that.

So Mario is calling for some fiscal policy and as so often all eyes turn to Germany which as I have pointed out before is operating fiscal policy but one heading in the opposite direction as I pointed out on the 20th of November.

Germany’s federal budget  surplus hit a record 18.3 billion euros ($21.6 billion) for the first half of 2017.

This poses various problems as I then pointed out.

With its role in the Euro area should a country with its trade surpluses be aiming at a fiscal surplus too or should it be more expansionary to help reduce both and thus help others?

As you can see Mario is leaving the conceptual issue behind and simply concentrating on his worries for 2018. This of course is standard Euro area policy where changes come in for an emergency and then find themselves becoming permanent. Although to be fair they are far from alone from this as I note that Income Tax in the UK was supposed to be a temporary way of helping to finance the Napoleonic wars.

Comment

This speech may well turn out to be as famous as the “Whatever it takes ( to save the Euro) one. In terms of his own operations Mario has proved to be a steadfast supporter of it but the monetary policy ammunition locker has been emptied. It is also true that it means he has been something of a one-club golfer because the Euro area political class has in essence embraced austerity and left Mario rather lonely. Now his time is running out he is in effect pointing that out and asking for help. Perhaps he is envious of what President Trump has just enacted in the United States.

There are clear problems though. We have been on this road before and it has turned out to be a road to nowhere in spite of many talking heads supporting it. In essence it relies in the backing of Germany and it has been unwilling to allow supranational Eurobonds where for example Italy and Greece could borrow with the German taxpayer potentially on the hook. If anything Germany seems to be heading in the direction of being even more fiscally conservative.

If we look wider we see that at the heart of this is something which has dogged the credit crunch era. If you believe one of the causes of it was imbalances well the German trade surplus has if anything swelled and now it is adding fiscal surpluses to that. Next if we look more narrowly there are the ongoing ch-ch-changes in Mario’s home country Italy. From the Wall Street Journal.

Both parties vowed to scrap or dilute an unpopular pension overhaul from 2011 that steadily raises the retirement age. Economists say the parties’ fiscal promises, if enacted in full, would greatly add to Italy’s budget shortfall, likely breaking EU rules that cap deficits at 3% of gross domestic product. Italy’s public debt, at 132% of GDP, is the EU’s highest after Greece.

So is it to save the Euro or to keep Italy in it?