The issue of house prices in both Australia and China

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

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

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

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

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

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

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

Wealth

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

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

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

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

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

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

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

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

Debt

This has been rising too.

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

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

The ABS analysis tells us this.

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

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

Younger property owners in particular have taken on greater debt.

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

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

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

Ever more familiar

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

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

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

China

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

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

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

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

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

Comment

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

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

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

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

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

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

Never Tear Us Apart ( INXS )

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

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Can Portugal trade its way out of its lost decade?

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

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

Bloomberg explains the particular significance of this move.

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

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

Portugal’s economy

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Debt

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

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

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

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

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

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

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

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

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

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

The banks

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

It remains reliant on ECB funding.

Indeed the prognosis remains rather grim.

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

Internal Devaluation

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

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

Comment

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

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

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

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

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

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

 

 

 

Can the “unreliable boyfriend” settle down in November?

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

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

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

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

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

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

The economy is doing better than expected

The initial explanation trips over its own feet.

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

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

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

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

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

Problems with this view

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

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

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

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

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

They have also looked into the detail and concluded this.

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

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

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

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

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

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

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

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

Comment

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

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

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

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

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

After all he told us this only in April.

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

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

Also it is hard to forget these previous episodes.

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

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

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

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

This is what it sounds like
When doves cry

What are the prospects for the UK house prices and rents?

One of the features of economics and economics life is that no matter how unlikely something is if it suits vested interests it will keep being reinvented. On that topic let us see what the Royal Institute of Chartered Surveyors or RICS has reported this morning.

Nationally, 61% felt landlords would exit the market over the coming year, while only 12% felt there would be a greater number of entrants. Moreover, for the next three years, 52% felt there would be a net reduction in landlords, with only 17% suggesting a rise.

Those of us who feel that the UK economy has been tilted too much towards the buy to let sector will be pleased at that but not the RICS which gives a warning.

Given the likely resulting supply and demand mismatch in this area, respondents predict that over the next five years rental growth will outpace that of house prices, averaging 3%, per annum (against 2% for house price inflation).

As to the deja vu element well let me take you back to November 4th last year.

Rents in Britain will rise steeply during the next five years as a government campaign against buy-to-let investing constrains supply, estate agencies have forecast.

Okay how much?

London tenants face a 25 per cent increase to their rents during the next five years, said Savills, the listed estate agency group. Renters elsewhere in the country will not fare much better, it said, with a predicted 19 per cent rise.

Whilst we are looking back to then there was also this.

JLL, another estate agency group, predicted a 17.6 per cent increase across the UK by 2021, with London rents rising 19.9 per cent, far outstripping predicted rates of inflation.

What has happened since last November?

If we look back I was very dubious about this and pointed out a clear problem.

If you look at the pattern of rental growth it follows the improvement in the UK economy with a lag ( of over a year which is another reason why it is a bad inflation measure) which means that it looks to be driven by improving incomes and probably real incomes rather than the underlying economy. Thus if you expect real income growth to fade (pretty much nailed on with likely inflation) or fall which seems likely then you have a lot of explaining to do if you think rents will rise.

In essence there is a strong correlation between income growth and real income growth and rental growth in my opinion. We now know that so far this has worked because back in November I pointed out that the official measure of rental inflation was running at 2.3% and yesterday we were updated on it.

Private rental prices paid by tenants in Great Britain rose by 1.6% in the 12 months to August 2017; this is down from 1.8% in July 2017.

Shall we check in on London?

The growth rate for London (1.2%) in the 12 months to August 2017 is 0.4 percentage points below that of Great Britain.

So we see that my methodology has worked much better than those in the industry as the phrase “vested interest” comes to mind. If you are struggle to predict capital profits ( house price rises) for your customers then promising some increased income (rents) works nicely especially at a time of such low interest-rates and yields elsewhere. The problem with this was highlighted by Supertramp some years ago.

Dreamer, you know you are a dreamer

If you look at the chart then it looks like the only way is down which looks awkward for the vested interests squad. Care is needed as it is a diverse market with rents in Wales rising albeit from a low-level and a variety of levels as shown below.

the largest annual rental price increases were in the East Midlands (2.8%),…….The lowest annual rental price increases were in the North East (0.4%),

But until we see a rise in real incomes then there seems to be little or no case for a recovery overall. At this point the UK establishment will be getting out the champagne as they will feel they put rents into the “most comprehensive” inflation measure CPIH at exactly the right time.

What about house prices?

As today is a policy announcement day for the Bank of England let us look at what house prices have done during the term of the present Governor Mark Carney. When he arrived in July 2013 the average house price in the UK was £174,592 whereas as of July this year it was £226,185 according to the Office for National Statistics. This replaced a three-year period of stagnation where prices had first fallen a bit and the recovered. So he has been the house owner and buy to let investors friend.

Some of the policy changes to achieve this preceded him as it was under the tenure of the now Baron King of Lothbury that the Funding for ( Mortgage) Lending Scheme was introduced. But Governor Carney could have changed course as he did in other areas. However he did not and I noted back then a fall in mortgage rates of around 1% quite quickly and the Bank of England later calculated a total impact on mortgage rates of up to 2%.

There are of course differences across the country as I looked at on Tuesday where the surges in London have been accompanied by much weaker recoveries all in other areas of which the extreme case is Northern Ireland  But the overall move has been higher and not matched by the lending to small businesses which the policy effort was badged as being for.

So if we now look ahead we see wage growth but real wage declines. We see that there has been an extraordinary effort to reduce mortgage rates from the Bank of England. There was also the Help To Buy programme of the government. All of these factors point to stagnation looking ahead and if anything the surprise has been that the various indices have not fallen further. Should London continue to be a leading indicator then perhaps more patience is needed.

The London* price gauge remains stuck firmly in negative territory, posting the weakest reading since 2008. Furthermore, the price indicator has turned a little softer in the South East of England,  ( RICS)

Comment

There are unknown factors here as for example we could see another wave of foreign purchases in London. The Bank of England could ease policy again however the power of Bank Rate cuts and indeed QE has weakened considerably in this regard. This is because if you look at countries like Sweden and Switzerland then with individual exceptions the bulk of mortgage rates hit a bottom higher than you might imply from the official negative interest-rates. This is in my opinion because banks remain unwilling to pass negative interest-rates onto the retail depositor as they fear what might happen next. So if the Bank of England wants to do more its action would have to be direct I think.

The other road that the Bank of England has been hinting at via its house journal the Financial Times is Forward Guidance about an interest-rate rise. Perhaps we will see more of this today and this is unlikely to support house prices as it would be the doppelganger of the last four years or so, especially of the “Sledgehammer QE” of August 2016. This means that today’s policy move could yet be putting Jane Austen on the new ten pound note. Perhaps the PR spinning around this will manage to put a smoke screen around the fact that there seems to have been a “woman overboard” problem at the higher echelons of the Bank.

 

 

The diversity of modern employment has left the official data behind

Today has opened with the subject of wages and pay in the news ahead of the official data on the subject. The particular issue is described by the Financial Times below.

 

It was Mr Hammond’s predecessor, George Osborne, who first imposed pay restraint on the public sector back in 2011-12, as part of the then coalition government’s efforts to balance the state’s books after the financial crisis. He initially announced a salary freeze, and later a 1 per cent cap on pay rises.

This slipped out of the news when inflation was low but has returned as it has risen and another factor is that a minority government is much less likely to enforce such a policy than a majority one. The actual changes announced so far are below.

 

The government announced on Tuesday that prison officers will be given a 1.7 per cent pay increase, while the police will receive a one-off 1 per cent bonus on top of their 1 per cent rise. The settlement for the prison service is in line with an independent pay review body’s recommendations. The deal for the police is somewhat less generous than the 2 per cent recommended by another pay review body.

So far the changes seem to be fiddling at the edges but those who have read or watched the Dambusters story will know that a small crack can turn into a flood of water. It seems unlikely that teachers and nurses for example will not get such deals although I also note that the new regime remains below inflation.

As to the debate over wages in the public and private sectors the Institute for Fiscal Studies offered some perspective in May.

 

Public sector pay rose compared to private sector pay during and after the 2008 recession, as private sector earnings fell sharply in real terms. Public pay restraint since 2011 has led to the difference between public and private sector pay returning to its pre-crisis level.

Of course not everyone has suffered as salaries for Members of Parliament have risen from £65,768 in April 2010 when an “independent” body was appointed to £76,011thia April.

House Prices

One of the features of using a national average is that some do better and some do worse. On that vein there is this from the Yorkshire Building Society.

However, homes in 54% of local authority areas – including Edinburgh, Birmingham, Peterborough, Leeds and Harrogate – are more affordable now than they were before the financial crash due to wages increasing at a higher rate than property values over this period.

This leads to this conclusion.

At a national level, since September 2007 affordability has improved by 0.6% in Britain overall, by 18.9% in Scotland, 17.2% in Wales but has worsened by 3.3% in England.

My challenge to their calculations come from the fact that they use earnings which have of course risen as opposed to real earnings which have fallen in the credit crunch era. But it is a reminder that in some places house prices have fallen. For example if the “Burnley Lara” Jimmy Anderson was to buy a place back home with the earnings created by over 500 test wickets he would see an average house price of £77,629 as opposed to £94,174 back in 2007.

Oh and as you click on their site they announce their lowest mortgage rate of all time which is 0.89% variable for two years. I also note that it is only variable down to 0% as perhaps they too fear what the Bank of England might do in the future.

Also this morning’s data release reminds us that official UK earnings data ignores the increasing numbers of self-employed.

self-employed people increased by 88,000 to 4.85 million (15.1% of all people in work)

The UK employment miracle

It is easy to forget that the numbers below would have been seen by economists as some sort of economic miracle pre credit crunch.

For May to July 2017, 75.3% of people aged from 16 to 64 were in work, the highest employment rate since comparable records began in 1971…..For May to July 2017, there were 32.14 million people in work, 181,000 more than for February to April 2017 and 379,000 more than for a year earlier.

Some of this is likely due to changes in the state pension age for women but there is also a rise apart from that.  The overall picture is completed by the unemployment numbers.

The unemployment rate (the proportion of those in work plus those unemployed, that were unemployed) was 4.3%, down from 4.9% for a year earlier and the lowest since 1975…….There were 1.46 million unemployed people (people not in work but seeking and available to work), 75,000 fewer than for February to April 2017 and 175,000 fewer than for a year earlier.

The good news does leave us with several conundrums however. For example if the situation is so good ( employment rising when it is already high) why is economic activity growth weak? Or to put it another way why do we have low and sometimes no productivity growth? Last time around when we had a dichotomy between the quantity labour data and GDP it was the labour market which was the leading indicator but of course we do not know that looking ahead from now.

Average Earnings

These continued recent trends.

Between May to July 2016 and May to July 2017, in nominal terms, both regular pay and total pay increased by 2.1%, the same as the growth rates between April to June 2016 and April to June 2017.

There was a cautionary note in that if we look at the data for July alone there was a fall in bonus payments particularly to the finance sector so there is a possible slow down in pay on the way. However those numbers are erratic as we saw the same in April and then a bounce back.

Moving onto real wages we get something of a confirmation of my critique of the Yorkshire Building Society analysis above.

average total pay (including bonuses) for employees in Great Britain was £487 per week before tax and other deductions from pay, £35 lower than the pre-downturn peak of £522 per week recorded for February 2008 (2015 prices).

If we look at the annual rate of fall it is around 0.4% if you use the official inflation data which has switched to CPIH but around 1% higher if you use the Retail Prices Index.

Comment

This month has brought us a reminder that the credit crunch has affected people in many different ways. There was something of an economic aphorism that recessions were 80/20 in that for 80% not much changed but for 20% it did but these days more are affected. For example there are increasing numbers of self-employed about whose wages we know little. No doubt some are doing well but I fear for others. If we move to house prices some are seeing what are increasingly unaffordable values whilst others have seen price falls.

National statistics have been caused difficulties by this as for example depending on the survey used the base level is 10 employees or 20 depending on the survey. This was less of a problem when the economy moved in a more aggregate fashion but now assuming that is a mistake in my view. It also misses out ever more people.

I know the tweet below is from the United States but it covers a few of my themes including if you look closely an improvement apparently related to a methodology change.

Oh and the increases in 2015/16 came mostly as a result of the lower inflation central bankers tell us are bad for us.

 

UK Inflation rises again but more hopefully the UK pound follows it

I was not expecting to publish an article today but my knee operation planned for today was cancelled with an hour’s notice. Let me wish the trauma patients who came into Chelsea and Westminster Hospital overnight well. Returning to the economics there is a link between today’s subject of inflation and that of yesterday because inflation will be over target and of course the Bank of England choose to ease policy into an inflation rise.

The impact of higher prices on the poor

One of the issues faced by the poor is that they pay a different set of prices to the rest of us. The Joseph Rowntree Federation has looked at this and intriguingly opens with something which could have been written by me.

Reducing the cost of essential goods and services is as important as increasing incomes for reducing poverty in the UK.  The less people must spend on meeting their needs, the more cash in their pocket.

The Bank of England will be annoyed on two counts. Firstly it aims for inflation of 2% per annum and secondly the idea that what it calls non core items are important.

The JRF moves onto the problem.

New research by Bristol University has laid bare the scale of the poverty premium for the first time.  They estimate that on average the poverty premium is costing low-income households £490 per year.

We get some more details.

Some premiums seem inconsequential, such as paying an extra £5 per year for a paper copy of an electric bill because you’re not online, or find it easier to keep on top of your budget with a paper copy. Others are eye watering, such as paying £540 over the odds for a doorstep loan because you can’t access mainstream credit or an additional £120 for a payday loan.

There are various factors at play here but we know that those that are poorer tend to pay more for many products. These comes from an inability to shop around both physically and online as well as being unable to use direct debits. Some of these represent a type of exploitation but it is also true that sometimes the problems create higher costs for businesses which need to be passed on.

There have been calls at times for different inflation measures to represent different groups. What we do know is that the establishment’s choice the Consumer Price Index performs badly in this regard. This is because it is weighted and based on total spending where of course the better off are more highly represented and so this means that rather than representing the median person it tends to represent those more like two-thirds of the way up the income scale. The much maligned Retail Price Index excludes the top 4% in terms of income so performs better in this regard although it does exclude some pensioner households.

The UK establishment’s view on measuring inflation

We can see this from simply looking at the progression of UK inflation targets. First the original one.

The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs), is 4.1%, up from 3.9% last month.

As we note an annual inflation measure that has passed 4% we move onto the current measure.

The all items CPI annual rate is 2.9%, up from 2.6% in July.

The clear trend is downwards and let us now look at the UK statistical establishment’s favourite measure.

The all items CPIH annual rate is 2.7%, up from 2.6% in July.

Of course the reality of price rises and inflation does not change but at the current rate the inflation reality of now will perhaps be accompanied by an official inflation measure at 0% in a few decades.

A major factor

Treatment of the housing market and particularly owner-occupied housing costs is at the heart of the matter. If we look at house prices we are told this by the Office for National Statistics.

Average house prices in the UK have increased by 5.1% in the year to July 2017 (unchanged from June 2017). The annual growth rate has slowed since mid-2016 but has remained broadly around 5% during 2017.

Those buying houses in the UK have seen a considerable amount of house price inflation in recent times.

The average UK house price was £226,000 in July 2017. This is £11,000 higher than in July 2016 and £2,000 higher than last month.

This compares to a pre credit crunch peak of just over £190,000 and a nadir of just under £155,000.

We are told by the UK statistics establishment that the best method in their opinion of measuring the impact of inflation on owner-occupiers of property is to use imputed rents which leads to this.

The OOH component annual rate is 1.9%, down from 2.0% last month.  ( OOH is Owner Occupiers Housing Costs).

As you can see there is something familiar at play a much lower number which is driven by the fact that rental inflation is much lower than house price inflation.

Private rental prices paid by tenants in Great Britain rose by 1.6% in the 12 months to August 2017; this is down from 1.8% in July 2017.

So yet again we find that the lower number has been selected! A particular issue here is that it is based on something which does not actually exist. Yes rents are paid by those who rent and they should go into the inflation numbers proportionately. But owner occupiers do not actually receive rent except in the calculations for the national accounts and so a statistical and economic concept replaces what is actually paid which is either the house price or the monthly mortgage repayment.

Oh and if London is a leading indicator ( which it often is) there is this to consider.

The growth rate for London (1.2%) in the 12 months to August 2017 is 0.4 percentage points below that of Great Britain.

Inflation Trends

This month saw a rise in UK inflation across the various measures and was driven by this.

Clothing and footwear, with average prices rising by 2.4% between July and August 2017 compared with a smaller rise of 1.0% between the same two months a year ago. Prices of clothing and footwear usually rise between July and August as autumn ranges start to enter the shops following the summer sales season.

So there was less of a summer sale in clothing this year and we have seen the numbers be erratic before as we move into autumn so we need to tread carefully. Also there was this.

Fuel prices rose by 1.6% between July and August 2017. This contrasts with the same period last year, when fuel prices fell by 1.3%.

Producer Prices

These give us an idea of what is coming down the inflation chain and there was a rise here too reversing recent trends.

Factory gate prices (output prices) rose 3.4% on the year to August 2017, up from 3.2% in July 2017, with the change in the rate being driven mainly by petroleum products. Prices for materials and fuels (input prices) rose 7.6% on the year to August 2017, up from 6.2% in July 2017, with the change in the rate being driven mainly by crude oil.

Comment

Today’s reversal on the inflation front follows a month were there was better news. Not only were the annual consumer inflation  numbers higher today but the producer ones were too. Some care is needed however as it was issue with the measurement of clothing prices and inflation back in 2010 which kicked off a lot of the debate around UK inflation methodology. Actually the issues there are still in dispute!

As to the trends there is something which may help out as we go forwards.

As many commodities including crude oil are priced in US Dollars the rise in the UK Pound £ will help us going forwards. Although of course currency movements do not always last and can turn out to be a figment of our Imagination.

Could it be that it’s just an illusion
Putting me back in all this confusion?
Could it be that it’s just an illusion now?
Could it be that it’s just an illusion
Putting me back in all this confusion?
Could it be that it’s just an illusion now?

 

 

The Bank of England gets ready to cry wolf again

This morning has seen a clarion call from the Bank of England using its house journal the Financial Times. Its economics editor Chris Giles has reported this.

The Bank of England will this week step up its warnings that households, businesses and investors are underestimating how soon interest rates will rise.

Okay let us park for the moment the feeling of “deja vu all over again” and look for the explanation.

 

A strong body of opinion in the central bank, including the governor, believes that the economy is more vulnerable to inflation, so even a small improvement in its forecast for growth would require higher borrowing costs to stave off rising prices.

The last set of Monetary Policy Committee Minutes are mentioned and let me give a longer quote from them than used by the Financial Times.

some tightening of monetary policy would be required to achieve a sustainable return of inflation to the target. Specifically, if the economy were to follow a path broadly consistent with the August central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than the path implied by the yield curve underlying the August projections.

This was all really rather mealy-mouthed and was so unconvincing that the 5 year Gilt yield which opened that day at 0.62% ( if we look back at the behaviour of the Pound £ back then some seemed to actually believe the Bank of England might act that day) fell sharply on the day. Other events have intervened ( North Korea) but it is now 0.45% which does not have much scope for Bank Rate rises to say the least.

We are also directed by the Financial Times to this in the August Quarterly Inflation Report.

 

Mark Carney, governor, backed this message up in the inflation report press conference saying that the BoE’s assumption at the time of “more than one interest rate hike over the course of three years . . . would be insufficient” to control inflation. Ben Broadbent, his deputy, added: “The important point is that one should not think that the economy, at the moment, can grow at the sort of rates we used to enjoy, certainly before the crisis before running into inflationary pressure”.

As you can see from the Gilt yield changes I pointed out above these two gentlemen could have saved themselves the embarrassment of everybody yawning and ignoring them.

Why might this be?

One problem is the Bank of England’s poor forecasting record combined with its problems with economics highlighted by this from my update on February 3rd.

Specifically, the MPC now judges that the rate of unemployment the economy can achieve while being consistent with sustainable rates of wage growth to be around 4½%, down from around 5% previously.

Remember when Governor Carney suggested that an unemployment rate of 7% was significant? We can argue now about how much significance but by signalling it one might reasonably expect action especially as it was not long before we were given more forward guidance about the unemployment rate.

an estimate of its medium-term equilibrium rate of 6%–6½%.

Of course it is now 4.4% and the output gap theories of the Bank of England have collapsed like Mordor’s Tower of Doom. Although the Ivory Tower thinkers that proliferate in Threadneedle Street continue to believe it is just around the corner.

Also there seems to be a problem with mathematics at the Bank of England as this from the FT highlights.

 

Bank officials say these views have not changed and the argument for rate rises to tame price rises will have strengthened since the last meeting following sterling’s 2 per cent drop, which will further increase the cost of imports and edge inflation higher in the months ahead.

Okay so a 2% drop is important but apparently this from February 3rd was not.

the 18% fall in sterling since its November 2015 peak,

Of course they actually cut interest-rates and added to QE by £70 billion when the UK Pound £ was very weak. This hyping a 2% move rips over its own feet. There is also the problem that the most important exchange rate for inflation purposes is against the US Dollar as so many commodities are priced in it and it is as I type this where it was before the last meeting.

Forward Guidance

The next problem is that Forward Guidance has been a catalogue of misguidance in this area. There was this from Chief Economist Andy Haldane on the 20th of June this year.

I considered the case for a rate rise at the MPC’s June meeting

This provoked a shock as it would have been a road to Damascus turn around for the architect of the “Sledgehammer” monetary easing of August 2016. Yet he has yet to vote for this and whilst he pointed towards later in the year what has happened to change his mind? Nothing really. The problem with dithering and delay is the lags in monetary policy as raising interest-rates now because you expect higher inflation in November is none to bright.

If we look back there was this from Governor Mark Carney back on the 12th of June 2014 in his Mansion House speech.

There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced.

It could happen sooner than markets currently expect.

We are still waiting Mark! Indeed “sooner than” has gone into my financial lexicon for these times alongside “temporary”. As he thought the economy back then was doing this it would be odd to act now rather than then.

with the economy expanding at an annualised rate of 4% and jobs growing at a record pace.

Oh and tucked away in that Mansion House speech was a critique of the policy easing of August 2016.

The economy is still over-levered. The housing market is showing the potential to overheat.

Quantitative Easing

If you wish to start tightening policy then as I suggested several years ago in City-AM it would be best to stop this.

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

Some £1.125 billion will be reinvested today in some short-dated UK Gilts.

Comment

Mark Carney faces quite a list of problems right now. His policy of Forward Guidance has in fact been misguidance and in spite of the supposed reforms its efforts at economic forecasting remain woeful. It is hard not to have a wry smile at this from the Guardian.

The Bank of England enforced a 1% rise on striking staff yet its fantasy forecasts claim a 3% rise for the UK as a whole is just around the corner. Really? How?

Actually if the hints of a change in the public-sector pay cap are true then we may see a modest rise in wages but that does nothing for the years of over optimism based you guessed it on the “output gap”. The deeper question is dodged that via underemployment and self-employment the situation is weaker than the official figures suggest and imply.

Perhaps we will be told the truth in a decade like these words on the BBC today from former Bank of England Governor Mervyn King.

My advice was very clear – we should not reveal publicly the fact we were going to lend to Northern Rock.

Although an ex-colleague of mine still does not seem keen.

The FSA’s former head, Sir Hector Sants, said it would be “inappropriate” for him to comment.

A Break

I plan to take at least a couple of days off as I will be attending Chelsea & Westminster Hospital tomorrow for some keyhole surgery on my knee. It has been a long story as I first ruptured my ACL well over 20 years ago but earlier this year I had another injury and decided this time that (hopefully) improvements in surgery and technology outweighed the risks of a reconstruction. Fingers crossed.