Firstly let me welcome everyone to 2011 and wish you all a Happy New Year. As I have written before I expect it to be a very busy one on the economic front and one which will be subject to quite a few influences several of which are contradictory. As not everywhere takes as long a break as the UK it is already plain that equity investors were not happy with the pre-Christmas gains of the “Santa Rally” and used the first trading day of 2011 to push equity prices higher. The US Dow Jones equity index closed up some 93 points at 11,670 and if we add the fact that it closed at the end of November 2010 at 11,006 we can see that since then it has rallied by 6% which is slightly more than it had managed in the rest of 2010 put together. Even one of the laggards in terms of equity markets in 2010 the Chinese Shanghai Composite index has rallied some 44 points to 2853 this morning. The net effect of all this is that the UK FTSE 100 has followed the nursery rhyme of the Grand Old Duke of York as after dropping 71 points on New Years Eve today it has rallied by just over 100 points so that it has for now regained 6000.
Purchases of US government bonds by the US Federal Reserve Bank
The Fed was out early in the New Year and purchased some US $7.8 billion of US Treasury Bonds (government debt) in the 7 to 9 year maturity range yesterday. Various people have tried to establish a direct link in terms of correlation between these purchases and equity market rises but the truth is that the situation is more complicated than that. So it comes down to opinion about indirect effects and I can help the feeling that the asset purchases under the so-called QE 2 programme are supporting equity prices but it is also true that this is very difficult to prove!
US Economic News: ISM Report
The Institute for Supply Management reported yesterday and whilst there is always debate over whether a report meets economists expectations what cannot be argued is that a reading of 57 for December 2010 on a scale where a reading above 50 indicates expansion is good news for the US economy and in particular for its manufacturing sector. The new orders index was even better at 60.9. The report goes on to say.
The manufacturing sector continued its growth trend as indicated by this month’s report. We saw significant recovery for much of the U.S. manufacturing sector in 2010. The recovery centered on strength in autos, metals, food, machinery, computers and electronics, while those industries tied primarily to housing continue to struggle. Additionally, manufacturers that export have benefitted from both global demand and the weaker dollar. December’s strong readings in new orders and production, combined with positive comments from the panel, should create momentum as we go into the first quarter of 2011.
So a strong report which the ISM itself suggests is consistent with an economic growth rate of some 5%. I think that one should be careful of such hyperbole and if we break the report down we see that according to the ISM then US manufacturing is doing well but the housing sector is not doing so well. Looked at like this we are back, in my opinion, to the picture of the US economy that we have had since late summer. That is of economic growth but at a level which is not yet sufficient to make much,if any,of a dent in US unemployment levels. The employment level in the ISM report dipped to 55.7 from November’s 57.5 so growth in manufacturing employment is slowing which only adds to the uncertainty for 2011.
One matter did not escape my attention which is that if you read further down the report you get a very long list of commodities prices which have risen but only one (natural gas) which had fallen.
Foreclosuregate: Bank of America
Tucked away in the news was a report that Bank of America had reached an agreement on this subject with the two main state subsidised mortgage companies in the US which glory in the names of Fannie Mae and Freddie Mac. For those unaware of this scandal it has created quite a cloud over the US housing market. The reason for this is that banks and loan servicers used false documents and signatures to justify hundreds of thousands of foreclosures or what we in the UK call repossessions making them in effect illegal. The scale of these actions made it unlikely that these were a coincidence and there was an instance of one person completing thousands and possibly tens of thousands of these, of course there is now some uncertainty over whether this person was also a fiction. So the US foreclosure situation was grim as many states simply stopped allowing them.
As you can imagine fears were high for the US banking sector and accordingly news that Bank of America had settled by paying some US $ 2.8 billion to Freddie Mac and Fannie Mae was perceived as good news in this context.However care is needed as the deal is a cap for exposure with Freddie Mac it is not at its sister agency Fannie Mae and of course there are plenty of private insurers still to settle with. So I suspect that the euphoria may well be somewhat short-lived and the story is not yet finalised.
European Purchasing Mangers Index
Figures from this area were also quite firm with the index rising to 57.1 in December from the 55.3 reported in November which indicates that Europe’s manufacturing industry ended 2010 growing strongly on a scale again where over 50 indicates expansion. This was not a new figure but was a revision up from the previously reported 56.8. As ever the expansion was driven by export-led growth from Germany which recorded a PMI of 60.7.
Unfortunately the PMI for Greece was again disappointing with the number slipping back from 43.9 in November to 43.1 in December. There had been a slowdown reported in the contraction of the Greek industrial production figures recently so I have read this figures closely to see any evidence of an improvement. Unfortunately we see the following.
Business conditions across the Greek manufacturing sector deteriorated at a faster pace in December, as domestic demand remained lacklustre and new export orders fell markedly (having broadly stabilised in November). Weaker market demand primarily reflected poor financial and economic conditions, as well as bad weather, in Greece and parts of Europe. Although a sharper depletion of backlogs prevented output from falling as steeply as new work, the latest drop in production was nonetheless substantial. Meanwhile, employment continued to fall and input price inflation accelerated further.
So just to rub it in input prices are rising which is likely to be our old friend commodity price rises again, and in a report devoid of any good news to cling to we see that January’s figures are likely to be affected by strikes in Greece.
I notice that Basil reports that the cafes and shops of Greece were, in his personal experience still doing decent business which is something of a counterpoint to these figures. Regular readers will know that I was always troubled by the danger of a spiral downwards for Greece resulting from the austerity regime in a similar way to what happened to Latvia when she was also under an IMF led austerity regime and I still worry that this is the most likely outcome.
The UK Economy
One hopeful sign is that the UK’s own purchasing managers index has come in very strong this morning at 58.3 which according to Markit who produce the figures is a sixteen year high. Part of the improvement came from net exports which is particularly welcome as we have not managed to take much advantage so far from the reduction in our exchange rate which took place in 2007/08.
However it did not escape my attention that the following was also reported.
Cost inflationary pressures continued to build in December, as average input prices rose at the fastest rate in the nineteen-year survey history………..Part of the increase in purchase prices was passed on to clients in the form of higher selling prices in December.
Care is always needed with survey results and this applies to all of the reports I have discussed today. However a picture os a strong UK economy with growing price pressures is consistent with other signals. Personally I see it as good and bad in the same report. I welcome the signs of growth but am also concerned by yet another report of rising inflation in the UK economy. The simple truth is that the Bank of England is starting to look a along way behind the curve on this subject and whilst members give us hyperbole by claiming that their influences are “inflation,inflation,inflation” to quote Spencer Dale they seem to forget that words need to be followed by deeds.
Inflation in the UK: Institutionalised Inflation
One subject that will occupy a lot of space in media coverage today will be the fact that the rate of Value Added Tax ( a sales tax) has risen overnight from 17.5% to 20%. For serious economic commentators care is needed as this will not directly raise inflation as we had an increase of the same amount this time last year. However with an economy which is beginning to show some signs of overheating on this front concerns are rising about possible price rises being slid in and hidden with the VAT rise. We will have to wait and see what happens on this front as the picture is somewhat confused and muddy. To give an example of this I have just listened to a member of the UK retail industry on the radio tell us that prices will not rise although there might be some increases! The current situation is littered with other examples of such verbal incontinence I am afraid.
However 2011 has already seen several examples of what I call institutionalised inflation in the UK. Commuters have been hit by rises in rail fares of approximately 6% which sits oddly with our political leaders supposed commitment to public transport but perhaps they themselves with their still somewhat friendly expenses regime do not notice such changes personally. Also tucked away on New Years Day was an increase in fuel duty of 0.76 pence per litre which now will be edged higher by the increase in VAT. For those unaware of fuel prices in the UK there had already been rises in the period leading up to Christmas and in the garage around the corner from me the price of a litre of diesel is now 130 pence.
There has been a hopeful start to 2011 for the world economy in most places but whilst this is also true for the UK the combination of a possibly overheating economy with signs of institutionalised inflation pose concerning signs. After suggesting (correctly I believe) that interest-rate rises were needed at this time last year I feel now that it would be just as important for a member of our monetary policy committee to battle institutionalised inflation as I expect more of it in 2011. In my view a risky game is being played……