Yesterday was a day of equity market surges and this has continued this morning. The US Dow Jones equity index closed 148 points higher at 12,040, which is a new post-credit crunch high and of course a close above 12,000. The UK FTSE 100 also nearly made a triple-digit gain as it rose some 95 points to 5957 and at the time of typing this it has risen another 52 points this morning. Most equity markets followed this trend but the Shanghai Composite equity index remains something of a laggard as it is still down slightly from its opening level in 2011.
What caused this turn-around?
Partly it was improved news from Egypt where the million person march passed peacefully and President Mubarak promised not to stand at the next election. However there is room for more trouble there,sadly, so there had to be more to it. One possible source was the Global Purchasing Managers Index for manufacturers which on a scale where a number above 50 indicates expansion rose from December’s 55.6 to 57.2 for January. Also in the United States the Institute of Supply Management’s survey reported this.
The manufacturing sector grew at a faster rate in January as the PMI registered 60.8 percent, which is its highest level since May 2004 when the index registered 61.4 percent………..ISM’s New Orders Index registered 67.8 percent in January………..ISM’s Employment Index registered 61.7 percent in January.
Whilst I have caveats about relying on survey results these results were strong and there were others around the world. However they came with a kicker.
The ISM Prices Index registered 81.5 percent in January, 9 percentage points higher than the 72.5 percent reported in December and the highest reading since July 2008.
Just to add to the inflationary dangers which are plainly present around the world at this time the CRB spot index rose to a recent high of 556.51 yesterday with foodstuffs and metals in the van of the rise. Brent crude remains above US $100 per barrel too.
The UK Economy: how are we doing?
The recent UK official economic output or GDP figures for the fourth quarter of 2010 have led many to worry about the UK economy and a report showing a fall of 0.5% is worrying. However at the time I pointed out that only twelve days earlier the National Institute of Economic and Social Research(NIESR) had suggested this.
Our monthly estimates of GDP suggest that output grew by 0.5 per cent in the three months ending in December after 0.6 per cent in the three months ending in November.
Accordingly I reported at the time that a good dose of caution was required with the official UK estimate. But that we needed more information to see exactly what had happened and we did get some more yesterday.
The Performance of UK Manufacturing Improves
There was a purchasing managers report for the UK manufacturing sector released yesterday and it reported this.
The Markit/CIPS survey for the purchasing managers’ index rose to 62 in January from 58.7 in December, the highest reading since the survey was created in 1992. Levels of new orders rose at the fastest rate in the survey’s history.
On a scale where a number above 50 indicates expansion these are hopeful numbers and I note that the revised number for December (which of course was in the fourth quarter of 2010) was also solid. So the UK manufacturing sector which represents approximately 13% of our economic output appears to be doing well and this will influence other sectors of our economy which depend on it. the employment sub-category improved too from 57.8 to 58.8.
Again good figures on manufacturing output came with an inflationary kicker. If we look at input prices ( the cost of goods that manufacturers need to assemble their products) then they registered their highest reading on record. Markit also reported that average purchase prices had risen at the steepest pace in the survey’s history, with more than three-fifths of companies reporting an increase.
UK Construction Improves too
This morning has seen the purchasing managers report for UK construction for January and it too reports an improvement.
January data signalled a solid expansion of activity in the UK construction sector, with the seasonally adjusted Markit/CIPS Construction Purchasing Managers’ Index™ (PMI™) posting 53.7, up from 49.1 in December .
And this too came with an inflationary kicker.
Input costs faced by construction companies in the UK rose at the fastest rate since May 2010, driven up by higher raw material prices.
So construction output has begun the year more optimistically than many expected and it represents just under ten per cent of our economic output.
These survey results indicate that UK manufacturing has started 2011 very well and construction has started better than many thought. Whilst this is for January rather than the fourth quarter of last year it does make me think that as time goes by the NIESR may have been more accurate than official statistics for the fourth quarter of 2010. So we had a slowdown rather than a collapse it would appear. With it we have a growing inflation problem which once again challenges the Bank of England’s view that inflationary pressures are “one-off” and “temporary”.
These are survey results so some caution is required in the use of them. The producers of the report insist they ask factual rather than opinion questions but surveys are less reliable than hard numbers. they do however fit with the NIESR GDP report.
A Market Response: The implication for the UK’s mortgage market
Here we saw falls in UK gilt (government bond) prices and rises in yields as the consequences of improving manufacturing and higher input prices were digested. As I am considering the impact on our mortgage market I shall look at the two most relevant benchmarks the two-year and the five-year. If we look at the two-year the yield rose to 1.4% which compares with 1.18% a week ago and 1.09% a month ago. If we look at the five-year the yield rose to 2.53% which compares with 2.34% a week ago and 2.19% a month ago.
Now feed these moves into what is likely to happen to mortgage rates and I hope that you get my point. There is a plain implication for fixed-mortgage rates but a more indirect one for variable rates too. Mortgage companies will be hedging those too in markets influenced by these interest-rates. As the UK housing market is also looking weak what it does not need is a rise in mortgage rates but that is what it is going to get if market rates remain here for any length of time. I have written several articles about the difference in the UK between official and market interest-rates and here we get yet another divergence as the base rate is unchanged at 0.5%. It is my opinion that this trend is making the base rate less and lees relevant and is another policy error by the Bank of England. It is a reinforcement for my view that base rates should rise as this element of a rise is merely making it relevant rather than irrelevant to many.
Whilst I am on the subject of the increasing irrelevance of the official UK base rate let me also point out this. According to Moneyfacts the average interest-rate charged on a UK credit card has risen to 18.9% which is a thirteen year high. The official base rate is at an all-time low of 0.5%…………..
Divergent interest-rates in the UK mortgage market
There is a further problem at play here if we look at the UK mortgage market. Headline best-buy mortgage rates do not look that high but if we stop and think we can see that many will not qualify. Let me illustrate the point by looking at some “best-buys” from Moneyfacts for variable rates.
If you have a 40% deposit the interest-rate is 2.29%
If you have a 10% deposit the interest-rate is 4.29%
So whilst the headline rate is seems attractive, how many will qualify? If we factor in falling house prices and remember that at times of falling prices surveyors tend to under-value properties then more and more will move to higher interest-rates. International readers may be unaware that newer buyers in the UK rarely had much of a deposit so they are likely to be facing higher interest-rates should they remortgage at any point.
So my point is that a lot of care is needed here when one looks at mortgage rates as I feel that what has to be paid by many is not represented by headline rates and I also feel that there is upward pressure on mortgage rates. I have made my views clear in previous articles about the way that the quantity of mortgages available in 2011 is likely to be affected by moves to withdraw liquidity by the Bank of England. I feel it is mostly doing it because it is worried about the so-called “phantom securities” which it accepted as collateral and that whilst they may be a problem they are not of immediate concern as unfortunately they are on its books.
If we add to this the mortgage and bank lending figures released by the Bank of England yesterday there are further issues in the mortgage market. Mortgage approvals fell to 42,563 in December, a larger drop than expected and remortgages also fell back to 30,595 after a rise in November. Households actually paid back more than the borrowed as net mortgage lending contracted during the month by £298million. So lending is not particularly healthy. And in another sign that our banking system has not recovered the version of M4 lending that the Bank of England follows fell by £3 billion in the fourth quarter of 2010 which gave it an annual growth rate of -0.6%.
It would appear that from the recent survey results the official GDP figures for the fourth quarter of 2010 for the UK underestimated UK growth. Even if you remain a believer in them then both manufacturing and construction have started 2011 well. My personal fear for the reasons I have explained today and in recent days is for the UK housing and mortgage market which is in danger of becoming a dragging anchor on our economy as the year develops. One factor which is not in doubt is that we have inflationary issues in many parts of our economy.
Tomorrow we get new data on the services sector of our economy and until then for it as they say in the film Snatch “All bets are off!”