How will the current financial market turmoil affect the UK economy?

At the moment all eyes are on China as it faces yet more stock market turmoil. My subject of Friday looked into the chaos theory view of the impact of a butterfly fluttering its wings and this morning they have certainly fluttered with the Shanghai Composite falling some 8.7% to 3211. Markets across the Pacific too fell and the Abenomics policy of Japan will not be pleased to see the Nikkei 225 equity index falling 895 points to 18540 as part of it is based on the wealth effects of higher equity prices. Also of course the Bank of Japan has been buying Japanese shares via ETFs (Exchange Traded Funds). My theme of today is to look at the impact on the UK and to have as a sub-plot the impact of falling equity markets on economies and in this case sharply falling ones. This is of course the reverse of modern central banking theory as it is an antithesis of QE (Quantitative Easing) policies being deployed by many central banks around the world which are relying on higher asset prices.

Up Up and Away

Whilst it is in some ways reassuring to be reminded that in Star Wars terms there is indeed a place which is “far,far,away” maybe the UK CBI (Confederation of British Industry) shouldn’t be living there!

The UK’s leading business group is forecasting 2.6% GDP growth for 2015, up from 2.4% in June, and 2.8% in 2016, up from 2.5%.

An interesting time to release that you might reasonably think and also there is the issue of them feeling they can forecast the UK GDP to an accuracy of 0.1%. If only! But let us examine what underlies their positive view of the UK economy.

The upgrade is due to a combination of factors, including signs of recovering productivity in the first half of this year feeding through to stronger wage growth. Combined with continued low inflation from falling commodity prices, this gives a welcome boost to household spending.

Okay so far so reasonable what else?

Furthermore, business investment is also likely to remain healthy, with our surveys indicating robust plans for capital spending.

At this point Goldilocks porridge is looking “just right” as consumption and investment expand together although to be perfect we would hope for more exports.

net trade looks set to drag on GDP growth in both 2015 and 2016.

The underlying message here should be played with the Outhere Brothers on the CBI tannoy.

I say, boom boom boom now let me hear you say wayoh
(Wayoh)

Or to be more specific.

As a result, we expect decent quarterly GDP growth ahead: we anticipate growth to average 0.7% a quarter until the end of 2016, in line with the expansion seen in Q2 2015.

So we move on from a universe where all is happy and bright and rather than continually promising to raise interest-rates the Bank of England has already done so!

UK Retail Sales

Last week’s data reminded us of this.

Year-on-year estimates of the quantity bought in the retail industry grew for the 28th consecutive month in July 2015, increasing by 4.2% compared with July 2014.

And also the reason why it has happened.

Average store prices (including petrol stations) fell by 3.0% in July 2015 compared with July 2014; the 13th consecutive month of year-on-year price falls. All store types except textile, clothing and footwear stores reported decreases.

So the growth is being driven by lower prices and backs up the CBI argument above. Indeed with the price of a barrel of Brent Crude Oil falling towards US $44 this morning we can expect more of it should it remain at such levels. Regular readers will be aware that I was making this point when the headlines were screaming “deflation” as a bad thing. From January 29th.

However if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly.

UK House Prices

If we think of one UK asset price falling then minds naturally turn to wonder what UK house prices will do next. A troubling view which brings many themes of this blog together has been suggested by the Financial Times today.

Companies that bought properties after the credit crunch that ended in 2009 have cashed in £3.4bn of London property — pocketing £870m in profits — in the past two years, according to analysis by property advisers Cushman & Wakefield.

Also the numbers show an extraordinary volume level.

Total investment volumes in the central London market hit a record £24.6bn last year, Cushman & Wakefield’s figures show — topping previous record deal volumes in 2013.

So we are left wondering if the smart money has now been and gone to some extent and also if the newer investors or ones with short time spans meaning that the situation just got more precarious. That is an issue in itself but is also one which may topple over into a least part of the residential housing market.

Nine Elms, is seeing a wave of “flat-flipping” as investors try to sell unbuilt properties amid fears the capital faces a glut of expensive homes.

Oh dear so much for the property boom just up the road from me! I do hope we still get the Tube link it has been promised for the 20 years I have lived there. I also note a comment which provides some perspective from an FT article from 6 months ago.

“About 54,000 homes are either planned or already under construction in the priciest areas of the capital…”

“Most of these homes will be priced at close to or above £1m. However, just 3,900 homes worth more than £1m were sold in these areas in 2014…”

So if the current turmoil continues it will not be only equity prices which are falling in London. Can a bubble burst safely?

Currency Wars

Much is happening here as we see some currencies devalue and depreciate as others rise. I note that Canadian investors have been buying London commercial property and for them the rise of the UK Pound £ versus the Loonie will be welcome and last week there was the devaluation from Kazakhstan added to today by the UK Pound now buying 109 Roubles.

However on the other side of the coin the Euro has strengthened again in a move one might not have expected in the midst of the ECB’s continuing QE program. At nearly 1.15 versus the US Dollar it has pushed us below 1.37.

Comment

Back in July 2012 the Bank of England told us this.

In fact, the Bank’s assessment is that asset purchases have pushed up the price of equities by at least as much as they have pushed up the price of gilts.

Which in its view contributed to this.

it is important to remember that without the Bank’s asset purchases, most people in the United Kingdom would have been worse off. Economic growth would have been lower. Unemployment would have been higher. More companies would have gone out of business.

They estimated that the wealth gain could have been £600 billion or £10,000 each if distributed evenly. Of course the distribution is far from even as the concept of the 0.1% demonstrates. The Bank of England then somewhat contradicted its hype by started the Funding for Lending Scheme to subsidise banks via pumping up house prices as a result of lower mortgage rates.

So we see that the Bank of England was not as convinced of the beneficial wealth effects from a rising equity market as it claimed as otherwise it would not have started FLS. With the FTSE 100 at 6050 some of the beneficial effects have gone and that is before we consider what may have happened to margin traders on the drop. Also there is the fact that falls like this have a different impact to a sustained rise as China is about to find out.

However the real driver for the UK economy in an asset price sense is the housing market and house prices. If we move from what the Bank of England says to what it did (FLS) we know that it agrees. So if the UK economy is to be affected we need not only to look at other economies such as China but also keep a close eye on the property market.

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34 thoughts on “How will the current financial market turmoil affect the UK economy?

  1. Hi Shaun
    The “South sea bubble 1720” is now
    relived once more!
    The unfortunate 99.9% will once more
    bear the losses and “The fools burnt bandaged
    fingers went back once more into the fire” I know
    that logic doesn’t apply to very much at present
    but do you see city property prices reducing in
    the near future?

    As Joe Walsh sang

    It’s hard to leave
    When you can’t find the door

    JRH

    • Hi JRH

      On the property theme does not that song also go?

      I have a mansion forget the price
      ain’t never been there they tell me its nice

      70 s excess for rock stars sounds a bit like the 0.1% today. At least Joe wrote a great song and played some mean guitar.

      As to the near future I would expect more easing into a drop so QE4 in the US and adding to the £375 billion QE in the UK or as I have pointed out often an interest-rate cut. So falls would be resisted for a time but I think they would end up being like King Canute.

  2. Hi Shaun

    In my view the CBI is one of the many Panglossian views of the economy.

    Let’s face it we have one of the highest debt ratios of any of the developed economies (public plus private) and we have one of the largest financial sectors relative to GDP. This spells vulnerability and yet the CBI forecasts that everything is pretty good, if not quite awesome. It seems to me that the only way that these forecasts can be remotely correct is if the growth is based upon debt (I understand the OBR figures are indeed based on debt). However, if the international situation gets darker by the hour how is this view sustainable? I don’t think it would be sustainable even if we had far less leverage in the economy because an economic slowdown would certainly mean less private debt at least and the Plunge Protection Teams (the BOE and Treasury) now have far fewer weapons in their arsenal..

    We’re in a deep hole and more and more people are going to see this and they will not like what they see.

      • hmm, I’d posit that debts of this kind are divorced from the real economy anyways , would it matter to the serfs if the Bankers went bust ?

        Well the Bankers say so , but they would anyway !

        Its not as if they are borrowing from people , its from each other and kinda points to either ponzi or a giant game of chicken …..

        Forbin

        • yes buzz , a crunch

          one like the 1930’s they ‘ve been avoiding with QE

          So as they’ve been “successful” last time

          then this time we will see more , won’t we Shaun ?

          what else is left?

          Raise rates? lower them ? hasn’t worked for Japan….

          song ? footy anthem

          ” ‘ere we go, ‘ere we go, ‘ere we go, ‘ere weeeeee go ooh , ‘ere we go!”

          Forbin

    • I don’t think the CBI are saying it’s sustainable, merely that it will be good for the next 15 months or so, which I would concur with. The current market turmoil is effectively created by China’s woes but investors overlook the CBI UK forecast (which I agree with), the USA which looks good from now until approx November and then who knows and the EZ which is doing well and will continue to do so till year end and slightly into the new year.

      Investors are fixated on China and have decided that a fall is coming from China that will be so immense it will take the world with it. I don’t think so, being quasi capitalist/semi communist regime the authorities have all kinds of weaponry in their arsenal which the imperialist capitalist west doesn’t. They can’t afford to let things get out of hand as the chinese don’t respond well to financial turmoil (think riots and killings).

      Will the world’s economies collapse one day? Definitely, but certainly not in my life time.

      • Actually it was the CBIs view I said was unsustainable. In my view it won’t be good for the next 15 months and I also think the US is much weaker now than statistics would suggest.

        • Yes, the CBI’s view is that it is not making a comment re long term sustainability, merely the next 15 months or so??

          On the next 15 months we clearly disagree and time will tell but there is a small global slowing coming, not a collapse.

          US stats I am looling at say a slow down in growth this October/November s I said earlier but beyond that the US is much more structurally sound than you seem to think.

          I was looking at numbers last week indicating a probable, though not guaranteed at this juncture, Chinese economy pick up next February/March.

          Personally, I feel the structural moves will be a weaker China and commodity prices over coming years, but this does not mean collapse.

          As always there are conflicting reports but I will leave you with this possible ray of short term sunshine in a blog of despair – http://mni-indicators.com/pressroom/files/mni_china_business_press_release_2015-08.pdf

  3. Hi Shaun

    Great article as always.

    There’s a lot of commentary in the press about Qe not being for the people, or we need to do QE for the people. But surely QE underwrote profligate government spending. Without QE, bond yields would have shot up, and the GM would have been forced to live within its means. We would’ve had to face real (ie Greek) austerity. And not faux austerity where government spending has increased every year.

    The can has only been kicked so far down the road, and we rapidly approach it.

    • Hi Anteos and thank you

      We can say that all the monetary easing has contributed to lower borrowing costs for many governments. It is also true that the Bank of England argued that its QE had reduced Gilt yields and hence borrowing costs for government. Back in 2011 when its QE totalled some £200 billion it argued this.

      “Summing over the reactions in gilt yields to each of the QE news events gives an overall average fall of just under 100 basis points.”

      But the picture is more complex than that as today’s currency moves illustrate. We learn that the ECB do just under 10 billion Euros of QE last week (and presumably this…) as we watch it shoot higher rather than fall! Or the Bank of Japan watching the Yen strengthen through 119 as I type this.

    • hmm, seems more like the Bankers are the dog and HMG is the swan …

      Lots of hissing and postering ……
      and the dog got away without harm !

      Forbin

  4. Hi Shaun
    Interesting times indeed . Shares in USA limit down. NZD in on slide. Cable on rise .Nymex below $39. No inflation. Anyone for ” lift-off”

    • Hi Midge

      We end up at the US close with Brent Crude Oil in the mid US$42s for a 6% drop on the day so we are seeing plenty of disinflation from this source and of course downwards pressure on future consumer inflation. Dr Copper was on the case too according to the Wall Street Journal.

      “The London Metal Exchange’s three-month copper contract was down 2% at $4,953 a metric ton at the PM kerb close, having tumbled to its lowest level since 2009 earlier in trading at $4,855 a ton. It fell below the key $5,000 level for the fifth-straight session. Aluminum, meanwhile, closed down 1.7% at $1,521.50 a ton, after hitting a six-year low during trading at $1,506 a ton.”

      I note that Fed member Lockhart downgraded his view of the “lift-off” in his speech tonight moving away from September hints to this year.

  5. Great column, Shaun, as usual.
    On a completely different topic, I thought you might be interested in the attached op-ed from the Toronto Globe and Mail, since it relates to one of your pet peeves, introducing R&D spending into the real GDP estimates as capital expenditures:
    http://www.theglobeandmail.com/report-on-business/rob-commentary/conservative-partys-taste-for-indebted-households-strains-economic-future/article26041950/
    Mr. Sheikh, who isn’t identified as a former Chief Statistician of Canada by the Globe, writes: “Contrary to the popular myth, that recession [2008-9] was a little deeper here than in the United States, as measured by the decline in GDP.” As a WSJ blog shows, this wasn’t any myth:
    http://blogs.wsj.com/canadarealtime/2013/08/01/canada-outperformed-the-u-s-in-the-great-recession-right-maybe-maybe-not/

    The official GDP estimates showed a substantially bigger drop in real GDP from peak to trough in the US than in Canada, 4.7% versus 4.2%. This changed when the US Bureau of Economic Analysis revised its GDP estimates in July 2013, and the American drop shrunk to 4.3%, still a bigger drop than Canada suffered, but almost within the bounds of measurement error. A big chunk of this revision was due to the change in the treatment of R&D spending. As the blog shows, this revised picture was treated with considerable skepticism by Doug Porter, the BMO Capital Markets Chief Economist, who didn’t believe it accorded well with the employment and domestic spending data of the two countries.
    In any case, the real GDP decline in the US was still steeper in the US than in Canada according to official estimates, and it remains very slightly so, as I write. The quarterly decline in real GDP from the 2008Q3 peak to the 2009Q2 trough for Canada was -4.19%. (Canada also has monthly GDP estimates, but not the US.) The quarterly real decline in real GDP from the 2007Q4 peak to the 2009Q2 trough for the US was -4.24%. Of course the difference between the two is well within measurement error. Since US real GDP fell in 2008Q1 but rose slightly in 2008Q2, Mr. Sheikh must be treating the 2008Q1 drop as a one-quarter contraction, rather than part of the Great Recession, which would bring the decline in real GDP from peak to trough for the US to -4.06%, slightly less than the estimate for Canada. This is contrary to the NBER Business Cycle Dating Committee’s judgement. It ruled that 2007Q4 was the peak quarter. It is also contrary to logic, since real GDP in the US was lower in 2008Q2 than in 2007Q4.
    In any case, the Canadian recession was shorter than the US recession, three quarters versus six quarters, or, if one goes by Mr. Sheikh’s dysfunctional dating, four quarters. In Canada, the Great Recession wasn’t so great, just another recession. I sent a letter to the Globe about this. So far it has neither been acknowledged nor published. Je garde espoir.

    • Hi Andrew

      Thanks for the link which poses a question about re-writing history as well as the issue of the treatment of R&D in national accounts. Whilst I am a fan of using new knowledge I regard the R&D changes as much more dubious as readers here will know! I understand that Canada began its switch to what is called ESA 10 standard in 2012 so was R&D affected a lot less in Canada than in the US? It all becomes a bit of a tangled web.

      I wish I had a £ for each example of cherry picking from the data I see…

      • You are very well briefed Shaun. I couldn’t find data for the same year, but the 2012 revision to Canadian GDP estimates saw a 1.2% increase in GDP due to R&D versus 2.6% in the US. Conceptually, both StatCan and the BEA consider it appropriate to capitalize “entertainment, literary or artistic originals” but due to data problems no capitalization was attempted in the 2012 Canadian revisions. This category was capitalized in the 2013 US GDP revision. According to a NYT article, in 2007 this change would have added 0.5% to US GDP. So only one of these adjustments was actually made to the Canadian GDP estimates as well as the American GDP and the R&D adjustment had a smaller impact on Canadian estimates.

  6. China seems to betting the ranch (its citizens’ pensions anyway) on steadying its stock market.
    Failure to succeed would, in keeping with my theme today, be a huge swan of the black variety.

  7. Hi Shaun,

    What monetary policy steps would you recommend for the UK in order to help engineer a soft landing / avoid a debt crisis ?

    PS.
    Posted a late comment on “how many cars Germany would sell with a DMark ?” after my holiday.

    • Hi ExpatInBG

      I hope you enjoyed your holiday. As to monetary policy moves then I would like to get Base Rates up to 1.5% to 2% but that chance sailed away back in 2010/11 and I do not know when it will return. Should things get worse and we really do suffer another downwards lurch then it might be time for some helicopter money but in all other circumstances the Bank of England is maxxed-out as who believes more QE would do any good?

  8. “How will the current financial market turmoil affect the UK economy?” – not much at all Shaun but as you say, keep watching the housing market. SELLING PRICES in my area arenow down 5% on last year despite the MSM rising prices hype – do they mean “asking prices” or “selling prices”?

  9. Hi Shaun, the boat is rocking and it needs steadying. QE won’t act fast enough for internet enabled property market, there a few of the localism and inefficient brakes that accompanied the opaque paper property transactions of the 1990’s. No for my mind the Govt will have to drop in those radio messages, like”don’t worry your money is protected to the sum of £85k” by the whatever it is quango. But this time it will say ” dont worry the Govt promises to by your house at 2008 prices” if you can’t find a buyer. This would underpin a falling market whilst finding a new and innovative use for that QE machine which is now a little rusty after the summer we’ve had. Shall we wait and see……. Paul C.

  10. Hi Shaun,
    What better example of our twisted priorities when sections of the MSM are saying this could be welcome news for mortgage holders as the predicted date of a rate rise gets put back yet again. It seems we are scared of normality returning. Our debt addiction deepens. In the meantime savers are punished for even longer. Your prediction of a cut looks more likely by the day.

    • Hi Zummerzetman

      There is also the issue of all those mortgage holders who have taken the advice of Bank of England Governor Carney and remortgaged on the back of his promises to raise interest-rates. Tactically that was a mistake as any more of this will force lower mortgage rates quite quickly but if he ends up cutting Bank Rate he will have pushed them into a strategic error too. What price Forward Guidance then?

  11. By the by it’s ….er…”nice” to see Boy George busily selling off Government holdings in Lloyds banking group on a falling market just to lock in the losses on my tax pounds!!! AS you would say Shaun you really couldn’t make it up!!

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