What is happening to the UK housing market and house prices?

The last year of two has seen something of a change in the environment for UK house prices. The most major shift of all has come from the Bank of England which for the moment seems to have abandoned its policy where the music was “Pump it up” by Elvis Costello. This meant that when around 2012 it saw that even what was still considered an emergency Bank Rate of 0.5% plus its new adventure into Quantitative Easing was not enough to get house prices rising it introduced the Funding for Lending Scheme. This reduced mortgage rates by around 1% quite quickly and had a total impact that rose towards 2% on this measure according to Bank of England research. This meant that net mortgage lending improved and then went positive and the house price trend turned and then they rose.

The next barrage came in August 2016 with the “Sledgehammer QE” and the cut in Bank Rate to 0.25%. This was accompanied by the Term Funding Scheme (TFS) which was a way of making sure banks could access liquidity at the new lower Bank Rate and it rose to £127 billion. This was something of a dream ticket for the Bank of England as it boosted both the “precious” ( the banks) and house prices in one go,

However that was then as the Bank reversed the Bank Rate cut last November and the TFS ended this February. So whilst the background environment for house prices is favourable they have risen to reflect that and for once there are no new measures to keep the bubble inflated. Also we have seen real wages fall and then struggle in response to higher inflation.

Valuations

This morning has brought news about something which has not happened for a while now but is something which is destabilising for house prices. From the BBC.

There has been a “significant” rise in homes being valued at less than what buyers have agreed to pay, the UK’s largest mortgage advisers have said.

These “down valuations”, by lenders, can mean buyers having to pay thousands of pounds extra, up front, to avoid the sale collapsing.

Estate agents Emoov said it reflected surveyors predicting a financial crash.

UK Finance said lenders, which it represents, were right to ensure property values were realistic.

The organisation said borrowers also benefited from houses having an “independent valuation”.

Emoov are an interesting firm that have recently completed a crowdfunding program and perhaps want some publicity but for obvious reasons estate agents usually stay clear of this sort of thing. If we step back for a moment we note that whilst they are mostly in the background surveyors do play a role in price swings via their role in providing a base for mortgage valuations. They should know the local market and therefore have knowledge about relative valuations but absolute ones is a different kettle of fish. If they get nervous and start to be stricter with valuations then the situation can snowball though mortgage chains. As to the numbers the BBC had more.

Emoov, one of the UK’s largest digital estate agents, said one in five of its sales now resulted in a down valuation.

Two years ago, it was fewer than one in 20, it added.

This is the highest rate since the UK’s financial crash in 2008, according to agents from 10 mortgage adviser groups contacted by the Victoria Derbyshire programme.

There is a specific example quoted by the BBC.

Phil Broodbank, from Wirral, bought his house for £180,000 a few years ago and spent up to £25,000 renovating it.

When the time came to remortgage, a surveyor valued his house at £200,000 without visiting it in person – in what is known as a “drive by”.

This valuation was £20,000 lower than a local estate agent had valued the property.

One bonus is that “drive by” in the Wirral does not quite have the same menace as in Los Angeles. Also these have been taking place for quite some time now but there were fewer complaints when the bias was upwards. The response from UK Finance is fascinating.

“Although the valuation is carried out for the lender, borrowers also benefit from a realistic independent valuation as it could help them avoid paying over the odds for the property they are buying.”

How do they know it is “realistic” especially if it was a cursory observation from the road? Also as the valuation is for the lender there are always going to be more interested in downturns that rises as of course the bank is more explicitly vulnerable then. In case you are wonder who UK Finance are they took over the British Bankers Association.

Borrowing Limits

The Guardian pointed out over the weekend that some old “friends” seem to be back.

this week Clydesdale Bank said it will grant first-time buyers mortgages of 5.5 times a borrower’s income and lend up to £600,000 – and the buyer only needs a 5% deposit.

A little care is needed as this is for the moment only available to those classed as professionals by Clydesdale Bank who earn more than £40,000 a year. Also there is a theoretical limit in that according to Bank of England rules mortgage lenders are supposed to keep 85% or more of their business using a 4.5 times times a borrower’s income. But if history is any guide these things seem to spread sometimes like wildfire and this industry has a track record that even a world-class limbo dancer would be envious of in terms of slipping under rules and regulations.

This bit raised a wry smile.

But mortgage brokers said they were relaxed about Clydesdale’s new deal.

As it is a potential new source of business they are no doubt secretly pleased. Also I did smile at this from the replies.

 5.5 times of income is nothing unusual. In Australia this is very common and goes as high as 7 to 9 times. ( GlobalisationISGood )

This Australia?

Rising global interest rates are combining with bank caution on lending, via extreme vetting of loan applications in the wake of financial services Royal Commission revelations, to generate a mini-credit crunch.

That’s putting further pressure on house prices, whose falls are gathering pace. ( Business Insider )

What this really represents if we return to the UK is another sign that houses are unaffordable for the ordinary buyer. Another factor in the list is this.

While 25-year terms were the standard in the 1990s, 30 years is now the norm for new borrowers, with many lenders stretching to 35 years to make monthly payments more affordable. ( Guardian )

 

Comment

We do not know yet how the two forces described today will play out in the UK housing market but down valuations seem to be a stronger force. After all Clydesdale will only do a limited amount of its mortgages and fear is a powerful emotion. Mind you some still seem to be partying like its 2016.

The billionaire founder of Phones4u John Caudwell has claimed his Mayfair property development will be “the world’s most expensive and prestigious apartment block”.

The entrepreneur, who turned to property after selling his mobile phone company for £1.5bn in 2006, plans to convert a 1960s multi-storey car park in the heart of Mayfair into 30 luxurious flats.  ( City-AM).

As to hype well there is this.

“I see London as the epicentre of the world and I see Mayfair as the epicentre of London. Therefore, I see my building site as the epicentre of the world,” Caudwell told City A.M. “I can’t think of anywhere better for people to live.”

Meanwhile I am grateful to Henry Pryor for drawing my attention to this. From the Independent in August 2000.

Roger Bootle, who predicted the death of inflation five years ago, says Britain has seen the last of extreme gyrations in house prices…………Nationwide, Britain’s largest building society, reported yesterday that the price of the average home fell 0.2 per cent, or £319, to £81,133 between June and July.

As of this June it was £215,844.

 

 

 

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Austerity is improving the UK Public Finances

As we head towards the weekend we have the opportunity to not only look at an area  where there has been good news but also inject a little humour. The latter was unintentionally provided by the OBR or Office for Budget Responsibility earlier this week.

second, we look at the potential fiscal impact of future government activity, by making 50-year projections of all public spending, revenues and significant financial
transactions, such as government loans to students.

No your eyes do not deceive you it really has forecast our fiscal future out towards 2068. This is from an organisation that in its eight years of existence has shown amazing consistency in being wrong. Sometimes it has been wrong pretty much immediately and at other times we have has to wait but usually not for too long. If we look back to its early days then let me give you two examples of its forecasting arrows not only missing the target but soaring out of the stadium with the crowd ducking for cover. Wage growth was forecast to be around 4.5% now and that is being nice to them as you see they got unemployment wrong too and so if we apply their “output gap” style analysis they would have wage growth at 5% or more. Also they would have Gilt yields up towards 5% as well whereas all are below 2% and the ten-year yield is 1.24%.

For newer readers that is the road which led to this.

The first rule of OBR Club is that the OBR is always wrong.

Putting it another way here is how something which is very good what is called the Whole of Government Accounts which as you can see below is sadly converted into laughing-stock status.

The net present value of future public service pension payments arising from past employment was £1,835 billion or 92 per cent of GDP. This is £410 billion higher than a year earlier, with the rise more than explained by the use of a lower discount rate to convert the projected flow of future payments into a one-off net present value and by other changes to assumptions underpinning the value of the liabilities.

The saga starts really well as I regularly get asked for an estimate of the UK’s pension liabilities but as you can see an enormous change has happened due to “a lower discount rate” . So the interest-rate or more specifically yield has been changed by an establishment that has consistently got yields not only wrong but very wrong. This also happened in the insurance world where this sort of blundering in the dark caused a lot of changes and costs.

The NHS

The OBR weighed in on this subject earlier this week and as a reminder this is the issue as described by the BBC.

Last month, the Prime Minister announced that the NHS in England would get an extra £20bn a year by 2023.

The £114bn budget will rise by an average of 3.4% annually.

In itself this is simple as government’s plan to spend more all the time and actually the OBR feels it needs to do so as the demographics of an ageing population bites. Yet we ended up with more heat than light and I could write a whole post on the “Brexit Dividend” so let us instead look at the overall position. There are three ways this can be paid for.

The easiest is that the economy grows by enough to finance it via higher taxes and lower social spending. After all we live in an era of Black Swan events but even in these days they happen only from time to time so the other choices are higher taxes or borrowing more. As you are about to see the public finances data have been pretty good over the past 18 months or so ( something else the OBR got wrong as it predicted a pretty substantial rise for the fiscal year just gone). So as we stand we could borrow the money quite easily and as I explained earlier we can do so cheaply in fact extremely cheaply in historical terms. Just for clarity as these issues get heated I am not advocating such a move simply saying that as we stand we could and probably quite easily. That seems to have got lost as at least some of the media looks for examples of higher taxes in response to the extra spending.

This whole issue makes me look back over the last issue and something stands out so let me put it in italics.

Over the credit crunch era we have borrowed a lot when it has been (relatively) expensive and not it is cheaper we are borrowing much less.

Some of that was forced on us but not all of it.

Today’s data

This continues to be good.

Public sector net borrowing (excluding public sector banks) decreased by £0.8 billion to £5.4 billion in June 2018, compared with June 2017;

As is the picture with a little more perspective

Public sector net borrowing (excluding public sector banks) in the current financial year-to-date (April 2018 to June 2018) was £16.8 billion; that is, £5.4 billion less than in the same period in 2017; this is the lowest year-to-date (April to June) net borrowing since 2007.

So we are back to pre credit crunch levels in this regard and the trajectory is lower. If we look into the detail then we see this about revenues.

In the current financial year-to-date, central government received £169.4 billion in income, including £125.0 billion in taxes. This was around 3% more than in the same period in 2017.

Looked at like that we get a confirmation of the slowing of the housing market as Stamp Duty revenues have fallen by £300 million to £3.1 billion and the QE operations of the Bank of England contributed £600 million less.

But on the other side of the ledger we do for once see some outright austerity.

Over the same period, central government spent £184.2 billion, around 1% less than in the same period in 2017.

Before we get too excited debt interest fell by £2.2 billion which will be mostly if not entirely the impact of lower ( RPI ) inflation on index-linked Gilts. Also the numbers for local councils have swung too so allowing for that we do not have outright austerity but we do on the measure compared with inflation.

National Debt

There is good news here too at least in relative terms.

Public sector net debt (excluding public sector banks) was £1,792.3 billion at the end of June 2018, equivalent to 85.2% of gross domestic product (GDP), an increase of £33.0 billion (or a decrease of 1.0 percentage points as a ratio of GDP) on June 2017.

There are also numbers excluding the Bank of England but sadly the numbers published are inconsistent. This happened a few months ago as well, There are also wider numbers for what previously I would have said was something of a gold standard but after the pension revision we looked at above I will merely say they are worth a look.

The overall net liability in the WGA was £2,421 billion or 122 per cent of GDP at the end of March 2017, up £435 billion on the previous year’s restated results ( OBR)

Comment

We have been on quite a journey with the UK public finances and to some extent it has been this sort of Journey.

It goes on and on and on and on

We have also seen that

Some will win some will lose

Because until this phase a lot of the austerity has been from one group to another as for example comparing the Triple Lock for the Basic State Pension with its 2.5% minimum with the 1% per annum for other social benefits and pay rises. But with the better news can we say this?

Don’t stop believing
Hold on to that feeling

We can to some extent but that does not mean the sky is pure blue. The clouds come from all the efforts to manipulate the numbers which would take an article in their own right and also the way the national debt has risen. Which allows me one more example of OBR Club unless of course we find an alternative universe where the national debt peaked at below 70% of GDP and then fell primarily due to us being in surplus for the last couple of years……

 

 

 

 

 

 

The economic impact of the King Dollar in the summer of 2018

One of the problems of currency analysis is the way that when you are in the melee it is hard to tell the short-term fluctuation from the longer-term trend. It gets worse should you run into a crisis as Argentina found earlier this year as it raised interest-rates to 40% and still found itself calling for help from the International Monetary Fund. The reality was that it found itself caught out by a change in trend as the US Dollar stopped falling and began to rally. If we switch to the DXY index we see that the 88.6 of the middle of February has been replaced by 95.38 as I type this. At first it mostly trod water but since the middle of April it has been on the up.

Why?

If we ask the same question as Carly Simon did some years back then a partial answer comes from this from the testimony of Federal Reserve Chair Jerome Powell yesterday.

Over the first half of 2018 the FOMC has continued to gradually reduce monetary policy accommodation. In other words, we have continued to dial back the extra boost that was needed to help the economy recover from the financial crisis and recession. Specifically, we raised the target range for the federal funds rate by 1/4 percentage point at both our March and June meetings, bringing the target to its current range of 1-3/4 to 2 percent.

So the heat is on and looks set to be turned up a notch or two further.

 the FOMC believes that–for now–the best way forward is to keep gradually raising the federal funds rate.

One nuance of this is the way that it has impacted at the shorter end of the US yield curve. For example the two-year Treasury Bond yield has more than doubled since early last September and is now 2.61%. This means two things. Firstly if we stay in the US it is approaching the ten-year Treasury Note yield which is 2.89%. If you read about a flat yield curve that is what is meant although not yet literally as the word relatively is invariably omitted. Also that there is now a very wide gap at this maturity with other nations with Japan at -0.13% and Germany at -0.64% for example.

At this point you may be wondering why two-year yields matter so much? I think that the financial media is still reflecting a consequence of the policies of the ECB which pushed things in that direction as the impact of the Securities Markets Programme for example and negative interest-rates.

QT

QT or quantitative tightening is also likely to be a factor in the renewed Dollar strength but it represents something unusual. What I mean by that is we lack any sort of benchmark here for a quantity rather than a price change. Also attempts in the past were invariably implicit rather than explicit as interest-rates were raised to get banks to lend less to reduce the supply of Dollars or more realistically reduce the rate of growth of the supply. Now we have an explicit reduction and it has shifted to narrow ( the central banks balance sheet) money from broad money.

 In addition, last October we started gradually reducing the Federal Reserve’s holdings of Treasury and mortgage-backed securities. That process has been running smoothly.  ( Jerome Powell).

You can’t always get what you want

It may also be true that you can’t get what you need either which brings us to my article from March the 22nd on the apparent shortage of US Dollars. This is an awkward one as of course market liquidity in the US Dollar is very high but it is not stretching things to say that it is not enough for this.

Non-US banks collectively hold $12.6 trillion of dollar-denominated assets – almost as much as US banks…….Dollar funding stress of non-US banks was at the center of the GFC. ( GFC= Global Financial Crisis). ( BIS)

The issue faded for a bit but seems to be on the rise again as the Libor-OIS spread dipped but more recently has risen to 0.52 according to Morgan Stanley. What measure you use is a moving target especially as the Federal Reserve shifts the way it operates in interest-rate markets but they kept these for a reason.

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

Impact on the US economy

The situation here was explained by Federal Reserve Vice-Chair Stanley Fischer back in November 2015.

To gauge the quantitative effects on exports, the thick blue line in figure 2 shows the response of U.S. real exports to a 10 percent dollar appreciation that is derived from a large econometric model of U.S. trade maintained by the Federal Reserve Board staff. Real exports fall about 3 percent after a year and more than 7 percent after three years.

Imports are affected but by less.

The low exchange rate pass-through helps account for the more modest estimated response of U.S. real imports to a 10 percent exchange rate appreciation shown by the thin red line in figure 2, which indicates that real imports rise only about 3-3/4 percent after three years.

And via both routes GDP

The staff’s model indicates that the direct effects on GDP through net exports are large, with GDP falling over 1-1/2 percent below baseline after three years.

The impact is slow to arrive meaning we are likely to be seeing the impact of a currency fall when it is rising and vice versa raising the danger of tripping over our own feet in analysis terms.

What happens to everyone else?

As the US Dollar remains the reserve currency if it rises everyone else will fall and so they will experience inflation in the price of commodities and oil. This is likely to have a recessionary effect via for example the impact on real wages especially as nominal wage growth seems to be even more sticky than it used to be.

Comment

Responses to the situation above will vary for example the Bank of Japan will no doubt be saying the equivalent of “Party on” as it will welcome the weakening of the Yen to around 113 to the US Dollar. The ECB is probably neutral as a weakening for the Euro offsets some of its past rise as it celebrates actually hitting its 2% inflation target which will send it off for its summer break in good spirits. The unreliable boyfriend at the Bank of England is however rather typically likely to be unsure. Whilst all Governors seem to morph into lower Pound mode of course it also means that people do not believe his interest-rate hints and promises. Meanwhile many emerging economies have been hit hard such as Argentina and Turkey.

In terms of headlines the UK Pound £ is generating some as it gyrates around US $1.30 which it dipped below earlier. In some ways it is remarkably stable as we observe all the political shenanigans. I think a human emotion is at play and foreign exchange markets have got bored with it all.

Another factor here is that events can happen before the reasons for them. What I mean by that was that the main US Dollar rise was in late 2014 which anticipated I think a shift in US monetary policy that of course was yet to come. As adjustments to that view have developed we have seen all sorts of phases and we need to remember it was only on January 25th we were noting this.

The recent peak was at just over 103 as 2016 ended so we have seen a fall of a bit under 14%

Back then the status quo was

Down down deeper and down

Whereas the summer song so far is from Aloe Blacc

I need a dollar, dollar
Dollar that’s what I need
Well I need a dollar, dollar
Dollar that’s what I need

Me on Core Finance

 

 

 

Lower house price inflation adds to the headache at the Bank of England

Today is inflation day in the UK where we receive the latest data but before we get to that there were some developments on the issue of how we measure it. This took place at the Economic Affairs Committee of the House of Lords where its ongoing enquiry into the Retail Price Index  or RPI continued and took evidence from the National Statistician John Pullinger. Regular readers will be aware that I have been making the case for the RPI for more than six years now as the UK establishment set a plan to try to get rid of it and more recently attempting to let it wither under a policy of neglect where they do not update it even if the changes required are ones which are easy to do because the data is already collected for other indices. Actually they have not even been consistent in that policy as they did make a change last year to bring in a new house price index as the previous one had been discovered to be incorrect.

For newer readers this matters because put simply it is the indices that give the higher readings for inflation which seem to come under official challenge. The pensioners index went about five years ago and the RPI has been under fire for most of this decade. The measure they would like to replace it with called CPIH has in its relatively short life consistently given the lowest reading. The latest numbers go RPI ( 3.4%) which of course was replaced by the CPI ( 2.4%) and then CPI (2.3%). I am sure you can see the trend for yourself but in case you think this is arcane it mattered a lot yesterday as with total wage growth being 2.5% then we get quite different answers for real wage growth. Another impact is on GDP growth where the statistician Mark Courtney has estimated that the use of CPI rather than RPI has raised recorded growth by something of the order of 0.5%. At times of low growth like now that gets even more significant.

Moving to yesterday John Pullinger said this.

The RPI is not a good measure of inflation ( slight delay) as captured by prices that capture the impact on the consumption of goods and services, it is not a good measure of inflation if you look at the impact of prices on households.

Even this opening salvo represents a change as the previous position was the bit before the slight delay whereas now room for manoeuvre is being created. As the meeting developed there was a shift to this as reported by the Financial Times.

Mr Pullinger had previously refused to consider reforms to the RPI, saying it was a legacy index that could not be changed.But in response to insistent questions by committee members, he said the statistics agency had now changed its mind, but needed to get the Treasury and the Bank of England on board before it would act.

So just like the Financial Times itself where the economics editor Chris Giles argued for some years against the RPI before mellowing recently. Let me cut to the two main issues here which are owner-occupied housing costs and the formula effect. The UK establishment have campaigned in favour of inflation measures which exclude owner occupied housing costs ( CPI) or use fantasy rents which are never paid in reality to do so ( CPIH). In some ways I think the latter is worse as it flies under a false flag as cursory readers may only read the headlines which say it covers housing costs. In reality it has been an embarrassment which I have covered many times.

The “formula effect” is more complex and many of you will have read the eloquent arguments in  favour of what was called RPIJ  by Andrew Baldwin in the comments section here which in essence is RPI without it. The UK establishment took that line for a few years then dropped it as you have to calculate it yourself now ( or wait for Andrew to do it for you). The bone of contention here is that some of it at least is due to changes in the way clothing prices were measured in 2010 which caused as Taylor Swift would put it “trouble,trouble,trouble”. You see until then there were arguments CPI under measured inflation not RPI being over. If I was in charge there would be a major project into investigating and reforming this area as before then the formula effect was smaller. It is a matter for the UK authorities as to why such work began but then stopped. Research was replaced by rhetoric.

Today’s numbers

We dodged a little bit of a bullet I think.

The all items CPI annual rate is 2.4%, unchanged from last month

What I mean by that is that there were upwards pressure as three utilities raised domestic energy costs and the comparison for petrol prices was with 115.3 pence last year. Having written what I have above it was hard not to have a wry smile at what held inflation down.

where prices of clothing fell by 2.3% between May and June this year compared with a fall of 1.1% between the same two months a year ago. Prices usually fall between May and June as the summer sales season begins but the fall in 2018 is the largest since 2012.

Fortunately in some ways this was not the reason why the RPI went the other way.

The all items RPI annual rate is 3.4%, up from 3.3% last month.

Looking Ahead

There continues to be a tug higher from the producer price numbers.

The headline rate of inflation for goods leaving the factory gate (output prices) was 3.1% on the year to June 2018, up from 3.0% in May 2018. Prices for materials and fuels (input prices) rose 10.2% on the year to June 2018, up from 9.6% in May 2018.

These do not impact on a one for one basis by any means as the effect weakens from input prices to output prices and even more so to consumer inflation. The input number is mostly ( ~70%) the impact of the oil price and changes in the value of the UK pound £.

House Prices

Finally the official data series is catching up with the other measures that we look at.

Average house prices in the UK have increased by 3.0% in the year to May 2018 (down from 3.5% in April 2018). This is its lowest annual rate since August 2013 when it was also 3.0%.

This means that the other measures seem to be working well as a leading indicator although it is also true that there remain challenges to the new series ( there is still some debate about its treatment of new builds)

Comment

There is good news today in that inflation at least on the official measures did not rise and there is hope for something of an official rethink on how it is measured. Let me give some credit to the Economic Affairs Committee which did challenge the National Statistician yesterday. For purposes of transparency I did contact them last month to point out they should widen their evidence base and to invite them to the Royal Statistical Society meeting on the RPI at which I was one of the speakers. Sadly their Lordships were otherwise engaged but staff members did attend I am told. I note that they were also willing to reflect evidence that the CPI measure has under recorded inflation ( housing costs for a start).

Moving to today’s numbers we see that upwards pressure remains on consumer inflation but that there is plenty for the Bank of England to consider. We saw yesterday that wage growth has dipped albeit only by a small amount and now inflation has remained static. Some may consider that its eyes will be on the fall in house price inflation especially should its mood be of behaving like an unreliable boyfriend.

But even so let me compare house price growth’s 3% with this which is a basis of the CPIH housing costs section.

Private rental prices paid by tenants in Great Britain rose by 1.0% in the 12 months to June 2018; unchanged since April 2018.

UK employment looks strong but wage growth less so

Today brings us a consequence of yesterday;s discussion as we analyse the latest wages numbers which are entwined with the productivity situation. These days the causality is invariably assumed to be from productivity to wages but there is this about Henry Ford from National Public Radio in the US.

 $5 a day, for eight hours of work in a bustling factory.

That was more than double the average factory wage at that time, and for U.S. workers it was one of the defining moments of the 20th century.

Which led to this.

”It was an absolute, total success,” Kreipke says. “In fact, it was better than anybody had even thought.”

The benefits were almost immediate. Productivity surged, and the Ford Motor Co. doubled its profits in less than two years. Ford ended up calling it the best cost-cutting move he ever made.

Some combination of positive and lateral thinking led Henry Ford to quite a triumph as we mull whether anyone would have that courage today. Perhaps some do but they are on a smaller scale and get missed.

Also there is the issue that some advances take us backwards in some respects as research from Princeton in the US quoted by regis told us this.

In their aggressive scenario, the world stock of robots will quadruple by 2025. This would correspond to 5.25 more robots per thousand workers in the United States, and with our estimates, it would lead to a 0.94-1.76 percentage
points lower employment to population ratio and 1.3-2.6 percent lower wage growth between 2015 and 2025.

This type of analysis is usually nose to the grindstone stuff however or if you like a type of micro economics where the measured effects are likely to look bad as robots replace people and the loss of usually skilled jobs leads to lower average wages. PWC have given a more macro style analysis a go. From the Guardian.

Artificial intelligence is set to create more than 7m new UK jobs in healthcare, science and education by 2037, more than making up for the jobs lost in manufacturing and other sectors through automation, according to a report.

A report from PricewaterhouseCoopers argued that AI would create slightly more jobs (7.2m) than it displaced (7m) by boosting economic growth. The firm estimated about 20% of jobs would be automated over the next 20 years and no sector would be unaffected.

In essence it comes down to this assumption.

as real incomes rise

Some may be wondering if “as society becomes richer” necessarily leads to that especially after a period where policies like QE have led to wealth rising via higher asset prices but real incomes have struggled in many places and real wages in the UK have fallen. The truth is that we are unsure and analysis on both sides mostly depends on the assumptions behind it. You pretty much get the answer you looked for.

What are wages doing?

Actually UK wage growth has been if we allow for the margin of error looks to have been pretty stable so far in 2018.

Between March to May 2017 and March to May 2018, in nominal terms, regular pay increased by 2.7%, slightly lower than the growth rate between February to April 2017 and February to April 2018 (2.8%).

Between March to May 2017 and March to May 2018, in nominal terms, total pay increased by 2.5%, slightly lower than the growth rate between February to April 2017 and February to April 2018 (2.6%).

Whilst there is a small fall on this basis we see that from February to May total pay growth has gone 2.6%, 2.5%, 2.6% and now 2.5%. By the standards of these numbers that is remarkably stable. This poses a question for the Bank of England as there is not much of a sign of annual wage growth there.

If we move to real wages we find that most of the change we have seen has come from falling inflation.

Between March to May 2017 and March to May 2018, in real terms (that is, adjusted for consumer price inflation), regular pay for employees in Great Britain increased by 0.4% and total pay for employees in Great Britain increased by 0.2%.

Actually they are being a little disingenuous there as people might think that this refers to the CPI inflation measure whereas later they explain that it is CPIH ( H=Housing) with its fantasy imputed rents. This flatters the numbers as the latter keeps giving lower inflation readings and this is before we get to the Retail Price Index or RPI which would have real pay still falling.

The output gap

Today’s quantity numbers for the UK labour market were good again.

There were 32.40 million people in work, 137,000 more than for December 2017 to February 2018 and 388,000 more than for a year earlier…….The employment rate (the proportion of people aged from 16 to 64 years who were in work) was 75.7%, higher than for a year earlier (74.9%) and the highest since comparable records began in 1971.

Also whilst we do not have a formal measure of underemployment like the U-6 measure in the United States it looks as though it is improving too as Chris Dillow points out.

Big drop in the wider measure of joblessness in Mar-May (unemp+part-timers wanting f-t work + inactive wanting a job) – down from 4.51m to 4.35m

Yet the continuing good news does not seem to be doing much for wages. We get surveys telling us they are picking up but the official data is either missing it or it is not happening. If we go through that logically then is wage growth is taking place it must be in the ranks of the self-employed or smaller companies ( the various official surveys only go to companies with a minimum of ten or in some cases 20 employees).

Productivity

This looks to have improved because the economy was growing through this period albeit nor very fast but hours worked did this.

the number of people in employment increased by 137,000  but total hours worked fell slightly (by 0.3 million) to 1.03 billion. This small fall in total hours worked reflected a fall in average weekly hours worked by full-time workers.

An odd combination in some ways as why take on more staff whilst reducing hours? But the optimistic view is that employers were expecting a rise in demand and were getting ready for it. Whatever the reason recorded productivity looks to have risen.

Comment

There is quite a bit to consider here. If we look back to 2007 we see total pay growth fluctuating around 5% and making a heady 7.3% in February. But before that there were plenty of 4% numbers. Now we occasionally break the 3% barrier but the last time if we use the three-month average was in the summer of 2015. So much for “output gap” style analysis so beloved by the Ivory Towers and the Bank of England.

As to the possible Bank of England move in August today’s numbers are unlikely to change your mind. Those arguing for a rise will look at the strong employment situation and those against will note the slight fading of wage growth. Which will an unreliable boyfriend go for?

What we need are better data sources and let me ask for two clear changes. We need wages data which at least tries to cover the self-employed and smaller businesses. We also need to be much clearer about what full-time employment is. As we stand we are in danger of failing the Yes Minister critique.

Sir Humphrey Appleby: If local authorities don’t send us the statistics that we ask for, then government figures will be a nonsense.

James Hacker: Why?

Sir Humphrey Appleby: They will be incomplete.

James Hacker: But government figures are a nonsense anyway.

Bernard Woolley: I think Sir Humphrey want to ensure they are a complete nonsense. ( The skeleton in the cupboard via IMDb)

 

 

 

 

Can robots rescue the UK from its productivity problem?

This is an issue which bedevils economists especially those who project straight lines into the future and their forecasts were left at a dizzying altitude by the impact of the credit crunch. The Bank of England puts it like this.

From 2007, 10-year average productivity growth was negative for the first time in almost a century.  Overall, it was the worst decade since the late 18th century.

What it goes onto say is that for the first 3-4 years things were normal in terms of a recession but it was after this that the change happened in that it did not then recover and go forwards. There are a couple of times ( 1761 & 1781 ) where we did worse but as I have pointed out before if I had data telling me things were going badly in the industrial revolution I would keep rechecking the data. Such as we understand it here is the past.

10-year productivity growth averaged 0.7% in the 19th century and 1.4% in the 20th

That research was from April but earlier this month the Bank Underground blog returned to the subject again.

 In its latest Inflation Report, the Monetary Policy Committee forecasts productivity growth to be a little faster than its average in recent years, as increases in investment begin to feed through, but still only half the rate seen before the financial crisis.

That reads rather like the MPC ( Monetary Policy Committee) taking out a bit of an each way bet. Or maybe a response of sorts to the Labour party proposal to give it a target for productivity growth.

Bank’s Agents

For those unaware these are the employees of the Bank of England who do their best to keep it in touch with the state of play in the economy.

In total, about 30 Agents have discussions with around 9000 businesses per annum, including most of the UK’s largest companies, as well as thousands of SMEs, covering all sectors of the economy.

They may not realise the significance of their opening salvo.

companies chose recruitment over business investment.

Those familiar with my work will know that these leads into two themes of mine. One is that labour productivity was very likely to have been affected by the way that employment has performed so well in the credit crunch era and pretty much by definition in the period when it rose before output did. Second comes something inconvenient for the economics profession in that it wanted the UK to be more like Germany in maintaining employment in a recession which happened. The latter is rather awkward for the idea of the Bank of England Ivory Tower being tasked with improving productivity.

Along the way I note an implication for the immigration debate in this below.

Strong growth of labour availability was associated with low real wages growth. Many of our contacts recruited additional staff, sometimes to handle sales growth but often to improve non-price competitiveness – for example to raise levels of service and marketing. Low real wages growth made these actions affordable

There are other factors at play as well as the picture is complicated as for a start correlation does not prove causation but the Ivory Towers seem to reject any such thought out of hand. Whatever the cause this is one of the stories of the credit crunch.

 So we observed that the composition of the economy and workforce pivoted towards lower value-added services and jobs, resulting in downward pressure on average wages and productivity levels

What about investment?

In essence this was often put on the back burner but now things seem to be changing according to the Bank Agents.

The Bank’s Agents’ recent experience is that, increasingly, the focus of many companies is turning to investment in labour-saving plant and machinery to raise productivity and alleviate resource bottlenecks.

Why might this be?

Often the benefits from investment in new plant and machinery include a reduction in the need for labour.  Higher labour costs shorten the payback period and incentivise such investment.

I find this intriguing because if we look at the current situation we see that real wages have until recently been falling and are currently flat at least in broad terms. So what we are seeing here if the Agents are right is employers expecting higher wages in the future and therefore responding with what we might call labour-saving investment. This includes an area where up until now the UK has been regarded as weak.

 Robotic technologies in particular are being deployed in a mix of manufacturing and service industries, at relatively low-cost and often with payback periods of less than five years. Usually, the working life of the equipment being deployed is greater than five years, making the investment extremely attractive.

We are given many examples of the use of robotics although I think that self-service tills are stretching the point somewhat. Also what could go wrong with the example below?

Looking into the future, restaurant and bar staff may be gradually replaced through automation and self-service beer pumps.

But on other side of the coin some reviewing their investment and pension savings may be grateful for any signs of intelligence at play.

an example being the use of artificial intelligence to assist institutional investors.

Comment

It is nice to see a part of the Bank of England being upbeat about the UK economy especially as it is the part that has its nose to the ground as opposed to in the clouds.

 However, the frequency of cases where contacts are looking to address rising costs and poor productivity suggests to us that whole-economy productivity growth should soon start to recover.

Lets hope so although in my opinion things were not as bad as some claimed due to this.

The fact that examples are becoming more common across sectors suggests that the recent slowdown of labour supply growth may be followed by a sustained productivity recovery

I have argued plenty of times that the strong employment performance of the UK economy has affected productivity and further that in many areas I do not think you can measure it at all. But higher labour supply does look like it reduced both productivity growth and real wage growth as well as reducing investment.

Also there is a very powerful reply to the post which I can only echo 100%.

One comment I heard recently was “Why would you invest in business when housing returns 8%”. ( Ed Mackenzie )

This of course will be like red-hot cinders for the Bank of England as its modus operandi in the credit crunch era has been to get house prices rising again via a litany of policies. On this road to nowhere it has contributed to a fall in UK productivity.

The implication being that the high returns on assets were dwarfing returns from capital investment.

Whatever happens next there are considerable advances in robotics to be seen.

 

What is the scale of the Turkish economic problem?

Recently I watched a BBC Four documentary series on the House of Osman or as we call it the Ottoman Empire which extended into south-east Europe as well as around the Mediterranean into North Africa. Now we associate it with decline and the phrase “young Turks” which oddly seems to have given inspiration to Rod Stewart but back in time it was a thriving Empire managing to rule parts of the world that we now consider not only as hot-spots but maybe too hot to handle. Now we find that the subject of a possible empire is in the news yet again.

Investors have been unnerved by Mr Erdogan’s decision to place his son-in-law in charge of the economy brief while sidelining familiar and respected former ministers. ( Financial Times)

Promoting family members is something of an in thing as is some of the language used.

Berat Albayrak, who is also Mr Erdogan’s son-in-law, said the central bank would be effective “like never before” and promised to bring soaring inflation down into the single digits “in the shortest time possible”.
“Speculation about the independence and decision-making mechanisms of the central bank is unacceptable,” he added. “A central bank that is effective like never before will be one of the fundamental aims of the policies of the new era.”

He failed however to use the trump card of a “bigly”. Of course the Financial Times somehow still manages to believe in central bank independence whereas we abandoned such thoughts years ago. Whilst the example below is admittedly extreme the theme is familiar.

Turkey’s central bank announced three interest rate rises during the campaign for June 24 elections, with a cumulative total of 500 basis points. The bank’s benchmark lending rate stands at 17.75 per cent.

So up,up and indeed up and away whereas the rhetoric is rather different. This is Hurriyet Daily News quoting President Erdogan on the 11th of May

“My belief is that interest rates are the mother of all evils. Interest rates are the cause of inflation. Inflation is a result, not a cause. We need to push down interest rates,”

As we wonder if Bank of England Governor Mark Carney was taking notes it is time to switch to the economic impact of all of this. The first factor we have already noted which is an interest-rate of 17.75% which is out of kilter with the economic times by some distance. As opposed to the -0.4% of neighbouring Greece or the 0.1% of Israel if we look the other way. So a break is being applied.

The Exchange-Rate

We can switch quickly to this as we know we only get rises in interest-rates like this if the national currency is in what Taylor Swift would call “trouble,trouble,trouble”. The latest Central Bank of Turkey minutes puts it somewhat euphemistically.

exchange rate developments

Or as the Hurriyet Daily News puts it.

The lira weakened to a record low of 4.9767 against the dollar late on July 11. The currency opened the July 12 trading at around 4.83 against the greenback.

The lira has shed nearly 25 percent of its value against the U.S. currency so far this year.

If we look at the pattern we see that the rate has been heading south for some time as five years ago it was at 2.04. However an acceleration started at the end of April when it was 4.05. Or returning to Ms Swift.

And the haters gonna hate, hate, hate, hate, hate

If we stay with financial markets there is a familiar sequence of responses to this.

Fall-out from Turkey’s tumbling lira hammered banking shares on July 11, sending the Istanbul stock market to its biggest one-day fall in two years.

The main share index dropped more than 5 percent while bank stocks lost 9 percent in their worst day for five years.

The yield on Turkey’s benchmark 10-year bond rose to 18.48 percent from 17.36 percent at close on July 10.

Central bankers will be panicking at all the negative wealth effects here. Care is needed as in such volatile circumstances markets ebb and flow quickly although it has mainly been ebb. Also the official interest-rate and bond yield numbers remind me of my analysis of how to deal with a foreign exchange crisis on May 3rd. If you think that a currency is collapsing then even ~18% interest-rates do not help much and even worse via forward or futures calculations it makes it look like the currency will drop even further. At some point investors will think things have stabilised and especially in these times will pile in for a juicy yield but when?

I’ll never miss a beat, I’m lightning on my feet

The trouble is that in the meantime you have slammed the brakes on your domestic economy.

Inflation

This is a consequence of the lower currency as the price of imported goods and services rises. For a while existing contracts may be a shelter but then it hits home.

In May, consumer prices rose by 1.62 percent and annual inflation increased by 1.30 points to 12.15 percent. The uptick in inflation spread across subgroups in this period ( CBRT)

Last week we learned that the CBRT was right to expect more bad news.

Inflation rose to 15.39 percent year-on-year, the highest annual rate since 2004 after a new method of calculating price rises was introduced, and month-on-month CPI inflation leapt to 2.61 percent – nearly double the forecast in a Reuters poll.

It looks set to go higher still.

Trade

Whilst a lower currency boosts an economy as price competitive exports and imports respond this takes time. Before they do you are actually in a worse situation as your imports cost more as the J-Curve and Reverse J-Curve entwine. Thus we get this.

According to the data released on July 11, the current account deficit rose to $5.9 billion in May from $5.4 billion in the corresponding month last year, with a nearly 9.6 percent year-on-year increase. ( Hurriyet Daily News)…….The country’s 12-month rolling deficit reached $57.6 billion in May, the data also showed.

This compares to these.

Turkey’s annual current account deficit in 2017 was around $47.3 billion, compared to the previous year’s figure of $33.1 billion.

Comment

Much of this feels like the UK in the 1970s although to be fair Turkish inflation it has yet to hit the 26.9% seen in the summer of 1975. A sharp brake has been applied to the economy via the higher cost of imports and via higher interest-rates. If we move to the business sector there will also be an impact from this.

The Turkish energy sector is facing an increasingly unstable situation with a rapidly declining lira making it impossible to repay billions of dollars’ worth of loans accumulated over the past 15 years.

Since 2003 $95bn has been invested into the country’s energy sector, of which $51bn remains to be paid. This figure represents 15% of the $340bn owed by non-financial companies in overseas liabilities, according to data from the nation’s central bank. ( Power Technology)

This is also familiar as countries which are in danger of trouble make it worse by borrowing in a foreign currency because it is cheaper in interest-rate terms. After all what could go wrong? It is also reminiscent of the foreign currency mortgage crisis of parts of south-eastern Europe. At least they did not borrow in Swiss Francs.

A recession is a danger as this hits and we will have to wait and see what develops but as to the talk of plenty of measures that sounds a little like capital controls to me. However the official view echoes Ms. Swift again.

I shake it off, I shake it off
I shake it off, I shake it off