If the Euro area outlook is so good how do you explain Deutsche Bank?

This morning we have the opportunity to take a look at the latest forecasts of the European Central Bank. After a frankly rather turgid opening it tells us this.

The euro area economic expansion remains solid and broad-based across countries and sectors, despite recent weaker than expected data and indicators.

The broad-based part rather echoed the words of its President Mario Draghi in April except the direction of travel was somewhat different.

When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

Actually very quickly today’s ECB version seems not quite so sure as it covers nearly all the possible bases.

 The latest economic indicators and survey results are weaker, but remain consistent with ongoing solid and broad-based economic growth.

Having discussed how much central banks love wealth effects this week several times already it would be remiss of me not to point out these bits.

 Private consumption is supported by ongoing employment gains, which, in turn, partly reflect past labour market reforms, and by growing household wealth. ………Housing investment remains robust.

Moving onto the numbers here are the specific forecasts.

The June 2018 Eurosystem staff macroeconomic projections for the euro area foresee annual real GDP increasing by 2.1% in 2018, 1.9% in 2019 and 1.7% in 2020.

So a bit lower for this year. So  in essence the first quarter of 2018 was the template for the rest of the year. The ECB will have its fingers crossed about this on two counts. The first comes from the reality of this.

the Governing Council will continue to make net purchases under the APP at the current monthly pace of €30 billion until the end of September 2018. The Governing Council anticipates that, after September 2018, subject to incoming data confirming its medium-term inflation outlook, it will reduce the monthly pace of the net asset purchases to €15 billion until the end of December 2018 and then end net purchases.

It will fear criticism of this should the economy slow. My critique is deeper as we mull how much of the recent better economic times for the Euro area has been driven by the extraordinary monetary policy of nearly 2 trillion Euros of government bond purchases and negative interest-rates? The irony is that the more successful the ECB has been the deeper the hole it is in. The situation is even worse if you think that the side-effects of this may reduce longer-term growth prospects for example by continuing to prop up what are zombie banks.

Deutsche Bank

Did I mention zombie banks?

Some of the new fears may have been driven by the mention of £29 trillion of derivatives being dependent on Brexit by Bank of England Governor Carney yesterday. After all the fact your own derivative book has been rumoured to be twice that size will hardly calm worries about this area.

Then there are the issues highlighted by Fitch Ratings a week ago.

Deutsche Bank’s ratings and the Negative Outlook reflect Fitch’s view that the bank faces substantial execution risk in its restructuring, which aims to strengthen its business model, stabilise earnings and further strengthen risk controls.

There have to be questions based around the fact that the domestic market situation as in the German economy has been strong so why is Deutsche Bank suffering? With house prices growing at an annual rate of around 4% you would think if you look at the story for the German and indeed Euro area economy that DB should be blooming. But instead it is struggling yet again.

If we move to its bonds which are used as capital or CoCo’s there has been a clear change this year. The 6% coupon one was yielding 4.4% in early February as opposed to the 9.7% today. Still less that early 2016 but of course then the economic outlook was different.

Inflation

The story here has been changing as highlighted by this earlier from @LiveSquawk .

German Baden-Wuerttemberg June CPI M./M: 0.2% (prev 0.5%) German Baden-Wurttemberg June CPI Y/Y: 2.4% (prev 2.3%)

This is one of the higher numbers but there have been other rises around such as the one in Italy rising to 1.5%. Whilst the detail is for Italy’s own inflation measure it does highlight the main player here.

The acceleration of the growth on annual basis of All items index was mainly due to prices of Non-regulated energy products (from +5.3% to +9.4%).

So the ECB has what it wants with inflation until you look at the detail. That tells us that as we have discussed many times QE has had a surprisingly low impact on inflation over time ( partly because asset prices are omitted) but the oil price is invariably a major player. Right now with the oil price above US $77 for a barrel of Brent Crude and the Euro below 1.16 versus the US Dollar the heat is on in this respect. This hurts the Euro area economy via real wages and also because it is an energy importer. If this has you confused then simply forecast that inflation will be the same.

This assessment is also broadly reflected in the June 2018 Eurosystem staff macroeconomic projections for the euro area, which foresee annual HICP inflation at 1.7% in 2018, 2019 and 2020.

Also German inflation prospects will be helped by this.

You can now cop the adidas Germany jersey for 30 percent off: ( @highsnobiety )

Money Supply

Here there is a little cheer as the ECB went to press with the state of play being this.

The monetary analysis showed broad money growth gradually declining in the context of reduced monthly net asset purchases, with an annual rate of growth of M3 at 3.9% in April 2018, after 3.7% in March and 4.3% in February.

Whereas yesterday at least in nominal terms things were a little better.

Annual growth rate of broad monetary aggregate M3 increased to 4.0% in May 2018 from 3.8%
in April (revised from 3.9%) …… Annual growth rate of narrower aggregate M1, comprising currency in circulation and overnight deposits, increased to 7.5% in May from 7.0% in April

The rub comes when you start to allow for inflation.

Comment

The recent period has been one where the ECB and in particular its President Mario Draghi has been able to portray it/himself as a “master of the universe”. The fall in oil prices lead to lower inflation meaning it had an opportunity to push the monetary pedal to the metal whilst claiming it was simply trying to hit its target. Of course this made it extremely popular with politicians as their borrowing costs fell and the economic outlook changed. Sticking with the politicians theme though the clouds gather. As the appointment of the Spanish politician and former minister Luis de Guindos begs various questions. For a start the claim of “political independence” and I do not mean parties here I mean the political class resuming control of monetary policy. Next is the issue of skills and competence which was highlighted when at the most recent press conference President Draghi pointed out they have not found any specific roles for him yet.

Now we enter a more difficult phase as for example being a banking regulator made not be fun if DB continues to weaken or the Italians continue to interpret the rules for their own banks. Next comes the issue of the economic situation which is summed up below I think.

ABN Amro now expect the ECB to raise its deposit rate in December 2019 (Prev. September 2019) by 10bps to -0.3% ( @RANSquawk )

So the outlook is so bright they can only raise interest-rates by 0.1% in 18 months or so? Also there is the implied insanity that changing interest-rates by 0.1% achieves anything apart from employment for a few sign writers.

 

Me on Core Finance

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Rising inflation trends are putting a squeeze on central banks

Sometimes events have their own natural flow and after noting yesterday that the winds of change in UK inflation are reversing we have been reminded twice already today that the heat is on. First from a land down under where inflation expectations have done this according to Trading Economics.

Inflation Expectations in Australia increased to 4.20 percent in June from 3.70 percent in May of 2018.

This is significant in several respects. Firstly the message is expect higher inflation and if we look at the Reserve Bank of Australia this is the highest number in the series ( since March 2013). Next  if we stay with the RBA it poses clear questions as inflation at 1.9% is below target ( 2.5%) but f these expectations are any guide then an interest-rate of 1.5% seems well behind the curve.

Indeed the RBA is between a rock and a hard place as we observe this from Reuters.

Australia’s central bank governor said on Wednesday the current slowdown in the housing market isn’t a cause for concern but flagged the need for policy to remain at record lows for the foreseeable future with wage growth and inflation still weak.

Home prices across Australia’s major cities have fallen for successive months since late last year as tighter lending standards at banks cooled demand in Sydney and Melbourne – the two biggest markets.

You know something is bad when we are told it is not a concern!

If we move to much cooler Sweden I note this from its statistics authority.

The inflation rate according to the CPI with a fixed interest rate (CPIF) was 2.1 percent in May 2018, up from 1.9 percent in April 2018. The CPIF increased by 0.3 percent from April to May.

So Mission Accomplished!

The Riksbank’s target is to hold inflation in terms of the CPIF around 2 per cent a year.

Yet we find that having hit it and via higher oil prices the pressure being upwards it is doing this.

The Executive Board has therefore decided to hold the repo rate unchanged at −0.50 per cent and assesses that the rate will begin to be raised towards the end of the year, which is somewhat later than previously forecast.

Care is needed here as you see the Riksbank has been forecasting an interest-rate rise for some years now but like the Unreliable Boyfriend somehow it keeps forgetting to actually do it.

I keep forgettin’ things will never be the same again
I keep forgettin’ how you made that so clear
I keep forgettin’ ( Michael McDonald )

Anyway it is a case of watch this space as even they have real food for thought right now as they face the situation below with negative interest-rates.

Economic activity in Sweden is still strong and inflation has been close to the target for the past year.

US Inflation

The situation here is part of an increasingly familiar trend.

The all items index rose 2.8 percent for the 12 months ending May, continuing its upward trend since the beginning of the year. The index for all items less food and
energy rose 2.2 percent for the 12 months ending May. The food index increased 1.2 percent, and the energy index rose 11.7 percent.

This was repeated at an earlier stage in the inflation cycle as we found out yesterday.

On an unadjusted basis, the final demand index moved up
3.1 percent for the 12 months ended in May, the largest 12-month increase since climbing 3.1 percent in January 2012.

In May, 60 percent of the rise in the index for final demand is attributable to a 1.0-percent advance in prices for final demand goods.

A little care is needed as the US Federal Reserve targets inflation based on PCE or Personal Consumption Expenditures which you may not be surprised to read is usually lower ( circa 0.4%) than CPI. We do not know what it was for May yet but using my rule of thumb it will be on its way from the 2% in April to maybe 2.4%.

What does the Federal Reserve make of this?

Well this best from yesterday evening is clear.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-3/4 to 2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

If we start with that let me give you a different definition of accommodative which is an interest-rate below the expected inflation rate. Of course that is off the scale in Sweden and perhaps Australia. Next we see a reference to “strong labo(u)r market conditions” which only adds to this. Putting it another way “strong” replaced “moderate” as its view on economic activity.

This is how the New York Times viewed matters.

The Federal Reserve raised interest rates on Wednesday and signaled that two additional increases were on the way this year, as officials expressed confidence that the United States economy was strong enough for borrowing costs to rise without choking off economic growth.

Care is needed about borrowing costs as bond yields ignored the move but of course some may pay more. Also we have seen a sort of lost decade in interest-rate terms.

The last time the rate topped 2 percent was in late summer 2008, when the economy was contracting and the Fed was cutting rates toward zero, where they would remain for years after the financial crisis.

Yet there is a clear gap between rhetoric and reality on one area at least as here is the Fed Chair.

The decision you see today is another sign that the U.S. economy is in great shape,” Mr. Powell said after the Fed’s two-day policy meeting. “Most people who want to find jobs are finding them.”

Yet I note this too.

At a comparable time of low unemployment, in 2000, “wages were growing at near 4 percent year over year and the Fed’s preferred measure of inflation was 2.5 percent,” both above today’s levels, Tara Sinclair, a senior fellow at the Indeed Hiring Lab, said in a research note.

So inflation is either there or near but can anyone realistically say that about wages?

Mr. Powell played down concerns about slow wage growth, acknowledging it is “a bit of a puzzle” but suggesting that it would normalize as the economy continued to strengthen.

What is normal now please Mr.Powell?

Comment

One of my earliest themes was that central banks would struggle when it comes to reducing all the stimulus because they would be terrified if it caused a slow down. A bit like the ECB moved around 2011 then did a U-Turn. What I did not know then was that the scale of their operations would increase dramatically exacerbating the problem. To be fair to the US Federal Reserve it is attempting the move albeit it would be better to take larger earlier steps in my opinion as opposed to this drip-feed of minor ones.

In some ways the US Federal Reserve is the worlds central bank ( via the role of the US Dollar as the reserve currency) and takes the world with it. But there have been changes here as for example the Bank of England used to move in concert with it in terms of trends if not exact amounts. But these days the Unreliable Boyfriend who is Governor of the Bank of England thinks he knows better than that and continues to dangle future rises like a carrot in front of the reality of a 0.5% Bank Rate.

This afternoon will maybe tell us a little more about Euro area monetary policy. Mario Draghi and the ECB have given Forward Guidance about the end of monthly QE via various hints. But that now faces the reality of a Euro area fading of economic growth. So Mario may be yet another central bank Governor who cannot wait for his term of office to end.

 

 

Putting rents which do not exist in a consumer inflation measure is a disgrace

Yesterday the Economic Affairs Committee took a look at the Retail Price Index measure of consumer inflation in the UK. An excellent idea except as I have contacted them to point out.

Accordingly I am making contact for two reasons. Attending the event would give your members exposure to a much wider range of expertise on the subject of the RPI than the limited group you have today. Also it will help you with the subject of balance as the four speakers you will be listening too today are all against the RPI with some being very strongly so. This gives a very unbalanced view of the ongoing debate on the subject.

The event I refer too is this evening at the Royal Statistical Society at which I will be one of those who reply to the National Statistician John Pullinger.

I intend to point out that the RPI does indeed have strengths and it relates to my letter to Bank of England Governor Mark Carney from February.

“. I am not sure what is a step up from known error but I can say that ignoring something as important to the UK as that sector when UK  house prices have risen by over 29% in your term as Governor when the targeted CPI has only risen by more like 7% is exactly that.”

This is because it makes an effort to reflect this.

This is because the RPI does include owner occupied housing and does so using house prices and mortgage interest-rates. If we look at house prices we see that admittedly on a convoluted route via the depreciation section they make up some 8.3% of the index.

This compares for example with the Consumer Price Index which completely ignores the whole subject singing “la,la,la” when it comes up. There has been a newer attempt to reflect this issue which I look at below.

Also it means that the influence is much stronger that on the only other inflation measure we have which includes house prices which is CPI (NA). In it they only have a weighting of 6.8%. So the RPI is already ahead in my view and that is before you allow for the 2.4% weighting of mortgage interest-rates.

As you can see the new effort at least acknowledges the issue but comes up with a lower weighting. This is because they decided that they only wanted to measure the rise in house prices and not the land. This is what they mean by Net Acquisitions or NA.

Now with 8.3% ( 10.7%) and 6,8% in your mind look what happens with the new preferred measure CPIH.

Now let me bring in the alternative about which the National Statistician John Pullinger and the ONS are so keen. This is where rather than using house prices and mortgages of which there are many measures we see regularly in the media and elsewhere, they use fantasy rents which are never actually paid. Even worse there are all sorts of problems measuring actual rents which may mean that this is a fantasy squared if that was possible.

But this fantasy finds itself with a weight of 16.8% or at least it was last time I checked as it is very unstable. Has our owner-occupied housing sector just doubled in size?

As you can see whilst you cannot count the (usually fast rising ) value of land it would appear that you can count the ( usually much slower rising) rent on it. That is the road that leads to where we are today where the officially approved CPIH gives a lower measure than the alternatives. Just think for a moment, if there is a sector in the UK with fast rising inflation over time it has been housing. So when you put it in the measure you can tell people it is there but it gives a lower number. Genius! Well if you do not have a conscience it is.

Yet the ordinary man or woman is not fooled and Bank of England Governor Mark Carney must have scowled when he got the results of his latest inflation survey on Friday.

After all when asked ( by the Bank of England) they come up with at 3.1% a number for inflation that is closer to the RPI then the alternatives.

Just because people think a thing does not make it right but it does mean you need a very strong case to change it . Fantasy rents are not that and even worse they come from a weak base as illustrated below.

The whole situation gets even odder when you note that from 2017 to this year the weighting for actual rents went from 5.6% to 6.9%.

Who knew that over the past year there was a tsunami of new renters? More probably but nothing like a 23% rise. This brings me back to the evidence I gave to the UK Statistics Regulator which was about Imputed Rents which relies on essentially the same set of numbers. I explained the basis for this was unstable due to the large revisions in this area which in my opinion left them singing along to Fleetwood Mac.

I’m over my head (over my head)
Oh, but it sure feels nice

Today’s data

Let me start with the number which was much the closest to what people think inflation is according to the Bank of England.

The all items RPI annual rate is 3.3%, down from 3.4% last month. The all items RPI is 280.7, up from 279.7 in April.

So reasonably close to the 3.1% people think it is as opposed to.

The all items CPI annual rate is 2.4%, unchanged from last month. The all items CPI is 105.8, up from 105.4 in April

When we ask why? We see that a major factor is the one I have been addressing above.

Average house prices in the UK have increased by 3.9% in the year to April 2018 (down from 4.2% in March 2018). This is its lowest annual rate since March 2017 when it was 3.7%.

In spite of the slow down in house price inflation it remains an upward pull on inflation measures. You will not be surprised to see what is slowing it up.

The lowest annual growth was in London, where prices increased by 1.0% over the year.

Now let me switch to what our official statisticians,regulators and the economics editor of the Financial Times keep telling us is an “improvement” in measuring the above.

The OOH component annual rate is 1.1%, down from 1.2% last month.

Which is essentially driven by this.

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

So they take rents ( which they have had all sorts of trouble measuring and maybe underestimating by 1% per annum) and imagine that those who do not pay rent actually do and hey presto!

The all items CPIH annual rate is 2.3%, up from 2.2% in April.

I often criticise the media but in this instance they deserve praise as in general they ignore this woeful effort.

Comment

Today has been a case of me putting forwards my views on the subject of inflation measurement which I hold very strongly. This has been an ongoing issue since 2012 and regular readers will recall my successful battle to save the RPI back then. I take comfort in that because over time I have seen my arguments succeed and more and more join my cause. This is because my arguments have fitted the events. To give a clear example I warned back in 2012 that the measure of rents used was a disaster waiting to happen whereas the official view was that it was fine. Two or three years later it was scrapped and of course we saw that the Imputed Rent numbers had a “discontinuity”. The saddest part of the ongoing shambles is even worse than the same sorry crew being treated as authorities about a subject they are consistently wrong about it is that we could have spent the last 6 years improving the measure as whilst it has strengths it is by no means perfect.

Let me give credit to the Royal Statistical Society as it has allowed alternative views an airing (me) and maybe there is a glimmer from the House of Lords who have speedily replied to me.

Staff to the Committee will be in attendance this evening, and we have emailed the details to the members: the unfortunate short notice and the busy parliamentary schedule currently means it may be unlikely for them to attend. We will report back to them on the event nevertheless.

I hope the event goes well for you.

Returning to today’s we now face the risk that this is a bottom for UK inflation as signalled by the producer price numbers.

The headline rate of inflation for goods leaving the factory gate (output prices) was 2.9% on the year to May 2018, up from 2.5% in April 2018.Prices for materials and fuels (input prices) rose 9.2% on the year to May 2018, up from 5.6% in April 2018.

This has been driven by the rise in the price of oil where Brent Crude Oil is up 56% on a year ago as I type this and the recent decline in the UK Pound £. This will put dark clouds over the Bank of England as the wages numbers were a long way from what it thought and now it may have talked the Pound £ down into an inflation rise. Yet its Chief Economist concentrates on matters like this.

Multiversities ‘hold key to next leap forward’ says ⁦⁩ Chief Economist Andy Haldane ( @jkaonline)

Isn’t that something from one of the Vin Diesel Riddick films?

 

 

 

 

 

Italy faces another bond market crisis

The situation in Italy has returned to what we now consider as a bond market danger zone although this time around the mainstream media seems much less interested in a subject which it was all over only a fortnight ago. Before we get to that as ever we will prioritise the real economy and perhaps in a type of cry for help the Italian statistics office has GDP ( Gross Domestic Product) per capita at the top of its page. This shows that the post Second World War surge was replaced by such a decline since the 28,699 Euros of 2007 that the 26,338 of last year took Italy back to 1999. The lack of any growth this century is at the root cause of the current political maelstrom as it is the opposite of what the founders of the Euro promised.

Retail Sales

These attracted my attention on release yesterday and you will quickly see why.

In April 2018, both the value and volume of retail trade show a fall respectively of -4.6% and -5.4%
comparing to April 2017, following strong growth in March 2018.

Imagine if that had been the UK Twitter would have imploded! As we look further we see that there seems to be an Italian spin on the definition of a recession.

In April 2018, the indices of retail trade saw a monthly recession, with value falling by 0.7% and volume
dropping by 0.9%.

Taking a deeper perspective calms the situation somewhat but leaves us noting a quarterly decline.

Notwithstanding the monthly volatility, looking at the underlying pattern, the 3 months to April picture
reports a slight decline as value decreased by 0.5% and volume contracted by 0.2%.

This is significant as this is supposed to be a better period for the Italian economy which has been reporting economic growth for a couple of years now. It does not have the UK problem of inflation impacting on real wages because inflation is quite subdued.

In May 2018, according to preliminary estimates, the Italian harmonised index of consumer prices (HICP) increased by 0.4% compared with April and by 1.1% with respect to May 2017 (it was +0.6% in the previous month).

Actually the rise in inflation there may further impact on retail sales via real wages. Indeed the general picture here sees retail sales in April at 98.6 compared to 2015 being 100. Seeing as that is supposed to have been a better period for the Italian economy I think it speaks for itself.

The economy overall

This is consistent with the general European theme we have been both observing and expecting. From yesterday’s official monthly report.

The downturn in the leading indicator continues, suggesting a deceleration in economic activity for the coming months.

This would continue the decline as in terms of GDP growth we have seen 0.5% twice then 0.4% twice and then 0.3% twice. Ironically that had shifted Italy up the pecking order after the 0.1% for the UK and the 0,2% for France after its downwards revision. But the detail is not optimistic.

Italian growth has been fostered by change in inventories (+0.7 percentage points) and by domestic consumption expenditures (+0.3 percentage points).

The inventory position seems to be a case of “what goes up must come down” from the aptly named Blood Sweat & Tears and we have already seen that retail sales will not be helping consumption.

The trade position is in general a strong one for Italy but the first quarter showed a weakening which seems to have continued in April.

In April, exports toward non-EU countries recorded a contraction (-0.9% compared to the previous month) less marked than in the previous months (- 3.1% over the last three months February-April). In the same quarter, total
imports excluding energy showed a negative change (-0.7%).

So lower exports are not good and lower imports may be a further sign of weakening domestic demand as well. As ever the monthly data is unreliable but as you can see below Italy’s vert strong trade position with non EU countries has weakened so far this year as we mull the stronger Euro.

The trade balance registered a surplus of 7,141 million euro compared to the surplus of 7,547 million euro in the same period of 2017.

An ominous hint of trouble ahead comes if we note the likely impact of a higher oil price on Italy’s energy trade balance deficit of 12.4 billion Euros for the first four months of 2018.

Bond Markets

These are being impacted by two main factors. Via @liukzilla we are able to award today’s prize for stating the obvious to an official at the Bank of Italy.

ROSSI SAYS YIELD SPREAD WIDER DUE TO -EXIT RISK: ANSA || brilliant…

It seems to have been a day where the Bank of Italy is indeed in crisis mode as we have also had a case of never believe anything until it is officially denied.

A GRADUAL RISE IN INTEREST RATES TO PRE-CRISIS LEVELS IS NOT A CAUSE FOR CONCERN FOR ITALY -BANK OF ITALY OFFICIAL ( @DeltaOne )

The other factor is the likelihood that the new Italian government will loosen the fiscal purse strings and spend more. It is already asking the European Union for more funds which of course will come from a budget that will ( May?) lose the net contribution from the UK.

Thus the bond market has been sold off quite substantially again this week. If we look at it in terms of the bond future ( BTP) we see that the 139 and a bit of early May has been replaced by just under 123 as I type this. Whilst there are implications for those holding such instruments such as pension funds the main consequence is that Italy seems to be now facing a future where the ten-year benchmark yields and costs a bit over 3%. This is a slow acting factor especially after a period where the ECB bond purchases under QE have made this cheap for Italy. But there has already been one issue at 3% as the new drumbeat strikes a rhythm.

There has also been considerable action in the two-year maturity. Now this is something that is ordinarily of concern to specialists like me but the sharp movements mean that something is going on and it is not good. It is only a few short week’s ago that this was negative before it then surged over 2% in a dizzying rise before dropping back to sighs of relief from the establishment. But today it is back at 1.68% as I type this. In my opinion something like a big trading position and/or a derivative has blown up here which no doubt will be presented as a surprise at some future date.

Meanwhile here is the Governor of the Bank of Italy describing the scene at the end of last month.

Having widened considerably during the sovereign debt crisis, the spread between the average cost of the debt and GDP growth narrowed to around
1 per cent. It could narrow further over the next few years so long as the economic situation remains positive. If the tensions of the last few days subside, the cost of debt will also fall, if only slightly, when the securities
that were placed at higher rates than newly issued ones come to maturity.

Comment

So to add to the other issues it looks like the Italian economy is now slowing and of course it was not growing very much in the first place. This makes me think of the banks who are of course central to this so let us return to Governor Visco’s speech.

Italian banks strengthened capital in 2017. Common equity increased by €23 billion, of which €4 billion was provided by the Government for the recapitalization of Monte dei Paschi di Siena.

Those who paid up will now be mulling losses yet again as even more good money seems to be turning bad and speaking of bad.

NPLs, net of loan loss provisions, have
diminished by about a third with respect to the end of 2015, to €135 billion. The coverage ratio, i.e. the ratio of the stock of loan loss provisions to gross NPLs, has reached 53 per cent, a much higher level than the average for the
leading European banks.

On and on this particular saga goes which will only really ever be fixed by some economic growth which of course is where we came in. Also whoever has done this has no doubt been suffering from a sleepless night or two recently.

The decrease in the stock of NPLs is partly due to the sharp rise in sales on the secondary market, facilitated by the favourable economic situation
(€35 billion in 2017 against a yearly average of €5 billion in the previous four years). This year sales are expected to reach €65 billion for the banking
system as a whole.

 

 

 

Japan is a land of high employment but still no real wage growth

Some days quite a few of our themes come naturally together and this morning quite a few strands have been pulled together by the news from Nihon the land of the rising sun. Here is NHK News on the subject.

Workers in Japan are continuing to take home bigger paychecks. A government survey says monthly wages rose year-on-year for the 9th-straight month in April.

Preliminary results show that pay for the month averaged about 277,000 yen, or roughly 2,500 dollars. That includes overtime and bonuses.

The number is an increase of 0.8 percent in yen terms from a year earlier. But when adjusted for inflation, the figure came in flat.

Nonetheless, labor ministry officials say that wages are continuing on a trend of moderate gains.

As you can see this is rather familiar where there is some wage growth in Japan but once we allow for inflation that fades away and often disappears. This is a particular disappointment after the better numbers for March which were themselves revised down as Reuters explains below.

That follows a downwardly revised 0.7 percent annual increase in real wages in March, which suggests that the government’s repeated efforts to encourage private-sector wage gains have fallen flat.

Growth in March was the first in four months, which had fueled optimism that a gradual rise in workers’ salaries would stimulate consumer spending in Japan.

Actually Reuters then comes up with what might be one of the understatements of 2018 so far.

The data could be discouraging for the Bank of Japan as it struggles to accelerate inflation to its 2 percent price target.

Let us now step back and take a deeper perspective and review this century. According to Japan Macro Advisers real wages began this century at 114.1 in January 2000 and you already get an idea of this part of the “lost decade” problem by noting that it is based at 100 some fifteen years later in 2015. As of the latest data it is at 100.5 so it has been on a road to nowhere.

Abenomics

One of the features of the Abenomics programme which began in December 2012 was supposed to be a boost to wages. The Bank of Japan has launched ever more QE ( which it calls QQE in the same way that the leaky Windscale nuclear reprocessing plant became the leak-free Sellafield) as shown below. From July 2016.

The Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 80 trillion yen.

This is the main effort although as I have noted in my articles on the Tokyo Whale it has acquired quite an appetite for equities as well.

The Bank will purchase ETFs so that their amount outstanding will increase at an annual
pace of about 6 trillion yen(almost double the previous pace of about 3.3 trillion yen)

As it likes to buy on dips the recent Italian crisis will have seen it buying again and as of the end of March the Nikkei Asian Review was reporting this.

The central bank’s ETF holdings have reached an estimated 23 trillion yen based on current market value — equivalent to more than 3% of the total market capitalization of the Tokyo Stock Exchange’s first section — raising concerns about pricing distortions.

So not the reduction some were telling us was on the way but my main point today was that all of this “strong monetary easing” was supposed to achieve this and it hasn’t.

The Bank will continue with “QQE with a Negative Interest Rate,” aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner.

The clear implication was that wages would rise faster than that. It is often forgotten that the advocates of QE thought that as prices rose in response to it then wages would rise faster. But that Ivory Tower world did not turn up as the inflation went into asset prices such as bonds,equities and houses meaning that wages were not in the cycle. Or as Bank of Japan Governor Kuroda put it at the end of last month.

Despite these improvements in the real economy, prices and wages have remained sluggish. This phenomenon has recently been labeled the “missing inflation” or “missing wage inflation” puzzle………. It is urgent that we explore the mechanism behind the changes in price and wage dynamics especially in advanced economies.

Most people would think it sensible to do the research before you launch at and in financial markets in such a kamikaze fashion.

The economy

There are different ways of looking at this. Here is the economic output position.

The economy shrank by 0.6 percent on an annualized basis, a much more severe contraction than the median estimate for an annualized 0.2 percent.

Fourth quarter growth was revised to an annualized 0.6 percent, down from the 1.6 percent estimated earlier. ( Reuters)

Imagine if that had been the UK we would have seen social media implode! As we note that over the past 6 months there has been no growth at all. In case you are wondering about the large revision those are a feature of the official GDP statistics in Japan which reverse the stereotype about Japan by being especially unreliable.

If we move to the labour market we get a different view. Here we see an extraordinary low-level of unemployment with the rate being a mere 2.5% and the job situation is summed up by this from Japan Macro Advisers.

In March 2018, New job offers to applicant ratio, a key indicator in Japan to measure the tightness of the labor demand/supply was 2.41 in March, signifying that there are 2.41 new job postings for each new job seeker. The ratio of 2.41 is the highest in the statistical history since it begun in 1963.

So the picture is confused to say the least.

Comment

There is a fair bit to consider here but let us start with the reality that whilst there are occasional flickers of growth so far the overall pattern in Japan is for no real wage growth. Only yesterday we were looking at yet another Bank of England policymaker telling us that wage growth was just around the corner based on a Phillips Curve style analysis. We know that the Bank of England Ivory Tower has an unemployment rate of 4,25% as the natural one so that the 2.5% of Japan would see Silvana Tenreyro confidently predicting a wages surge. Except reality is very different. If we stick to the UK perspective we often see reports we are near the bottom of the real wage pack but some cherry picking of dates when in fact Japan is  worse.

Moving back to Japan there was a paper on the subject of low unemployment in 1988 from Uwe Vollmer which told us this.

Even more important, the division of annual labour income
into basic wages, overtime premiums and bonuses
allows companies to adjust wages flexibly to changes in
macroeconomic supply and demand conditions,
resulting in low rigidities of both nominal and real wages.

On the downside yes on the upside no as we mull the idea that in the lost decade period Japan has priced itself into work? If so the Abenomics policy of a lower exchange-rate may help with that but any consequent rise in inflation will make the Japanese worker and consumer worse off if wages continue their upwards rigidity.

Meanwhile as we note a year where the Yen was 110 or so a year ago and 110 now there is this from an alternative universe.

The Bank of Japan’s next policy move may be to raise its bond-yield target to keep the yen from weakening too much, according to a BOJ adviser and longtime associate of Gov. Haruhiko Kuroda.

Or maybe not.

With its inflation target still far away, the BOJ must continue its current monetary stimulus for now, Kawai said

Also in his land of confusion is a confession that my critique has been correct all along.

While a weak yen helps the BOJ’s efforts to stoke inflation — and has been an unspoken policy objective — too much weakness can hurt businesses that import raw materials, while some consumers would feel the pain of higher prices for imports.

He seems lost somewhere in the Pacific as in terms of the economics the economy has seen a weak patch and you are as far away as ever from your inflation target yet you do less? Still the inflation target will be helped by a higher oil price except as I often point out Japan is a large energy importer so this is a negative even before we get to the fact that it makes workers and consumers poorer.

 

 

 

The Bank of England seems determined to ignore the higher oil price

This morning has brought the policies of the Bank of England into focus as this from the BBC demonstrates.

Petrol prices rose by 6p a litre in May – the biggest monthly increase since the RAC began tracking prices 18 years ago.

Average petrol prices hit 129.4p a litre, while average diesel prices also rose by 6p to 132.3p a litre.

The RAC said a “punitive combination” of higher crude oil prices and a weaker pound was to blame for the increases.

It pointed out that oil prices broke through the $80-a-barrel mark twice in May – a three-and-a-half year high.

As well as the higher global market price of crude, the pound’s current weakness against the US dollar also makes petrol more expensive as oil is traded in dollars.

There is little or nothing that could have been done about the rising price of crude oil but there is something that could have been done about the “pound’s current weakness against the US dollar”. In fact it is worse than that if we look back to April 20th.

The governor of the Bank of England has said that an interest rate rise is “likely” this year, but any increases will be gradual.

This was quite an unreliable boyfriend style reversal on the previous forward guidance towards a Bank Rate rise in May that the Financial Times thought was something of a triumph. But the crucial point here is that the UK Pound £ was US $1.42 the day before Mark Carney spoke as opposed to US $1.33. Some of that is the result of what we call the King Dollar but Governor Carney gave things a shove. After all we used to move with the US Dollar much more than we have partly because our monetary policy was more aligned with its. Or to be precise only cuts in interest-rates seem likely to be aligned with the US under the stewardship of Governor Carney.

Just as a reminder UK inflation remains above target where it has been for a while.

The Consumer Prices Index (CPI) 12-month rate was 2.4% in April 2018, down from 2.5% in March 2018.

The welcome fall in inflation due to the rally in the UK Pound £ has been torpedoed by the unreliable boyfriend and a specific example of this is shown below.

Let us give the BBC some credit for releasing those although the analysis by its economics editor Kamal Ahmed ignores the role of the Bank of England.

Silvana Tenreyro

Silvana in case you are unaware is a member of the Monetary Policy Committee who gave a speech at the University of Surrey yesterday evening. As you can imagine at a time of rising inflation concerns she got straight to what she considers to be important.

Many critics have laid the blame on the tools that economists use – our models.So, in my speech today, I
will attempt to shed some light on how and why economists use models. Specifically, I will focus on how they
are useful to me as a practitioner on the MPC

Things do not start well because in my life whilst there has been a change from paper based maps to the era of Google Maps they have proved both useful and reliable unlike economic models.

An oft-used analogy is to think of models as maps

Perhaps Silvana gets regularly lost. She certainly seems lost at sea here.

Similarly, economic models have improved with greater
computing power, econometric techniques and data availability, but there is still significant uncertainty that
cannot be eliminated.

Let me add to this with an issue we have regularly looked at on here which is the Phillips Curve and associated “output gap” style analysis.

Many commentators have recently argued that the Phillips curve is no longer apparent in the data – the
observed correlation between inflation and slack is much weaker than it has been in the past. If the Phillips
curve truly has flattened or disappeared, then the current strength of the UK labour market may be less likely
to translate into a pick-up in domestic inflationary pressures. Given that the Phillips curve is one of the
building blocks of standard macroeconomic models, including those used by the MPC, a breakdown in the
relationship would also call for a reassessment.

Er no I have been arguing this since about 2010/11 as the evidence began that it was not working in the real world. However Silvana prefers the safe cosy world of her Ivory Tower.

My view is that these fears are largely misplaced. I expect that the narrowing in labour market slack we have
seen over the past year will lead to greater inflationary pressures, as in our standard models.

The fundamental problem is that the Bank of England has told us this for year after year now. One year they may even be right and no doubt there will be an attempt to redact the many years of errors and being wrong but we are now at a stage where the whole theory is flawed even if it now gets a year correct. As we stand with four months in a row of falling total pay in the UK the outlook for the Phillips Curve is yet again poor. Here is how Silvana tells us about this.

Although average weekly earnings (AWE) growth has now been strengthening since the middle of 2017,

Inflation

Fortunately on her way to the apparently important work of explaining to us of how up is the new down regarding economic models Silvana does refer to her views on inflation.

such as energy costs. And indeed, Chart 2 shows that the contribution of the purple bars to inflation
is correlated with the peaks and troughs of oil-price inflation over the past decade or so

It is probably because her mind is on other matters that she has given us a presumably unintentional rather devastating critique of the central bankers obsession with core inflation which of course ignores exactly that ( and food). Mind you it does not take her long to forget this.

Since the effects of oil-price swings are transitory, there is a good case for ‘looking through’ their impact on inflation.

Oh and those who recall my critique of the Bank of England models on the subject of the impact of the post EU leave vote will permit me a smile as I note this.

But in the past few quarters, we have seen some
building evidence that import prices have been rising slightly less than we had expected (only by around half
of the increase in foreign export prices – Chart 3). For me, this may be one reason why CPI inflation has
recently fallen back faster than we had expected.

I have no idea why they thought this and argued against it correctly as even they now admit. This is of course especially awkward in the middle of a speech designed to boost the economic models that have just been wrong yet again!

Comment

If we move to the policy prescription the outlook is not good for someone who has just dismissed the recent rise in the oil price as only likely to have a “transitory” effect. In fact as we move forwards we get the same vacuous waffle.

While I anticipate that a few rate rises will be needed, the timing of those rate rises is an open question

Okay but when?

With falling imported inflation offset by a gradual pick-up in domestic costs, I judge that conditional on the
outlook I have just described, a gradual tightening in monetary policy will be necessary over the next three
years to return inflation to target and keep demand growing broadly in line with supply.

So not anytime soon!

The flexibility is limited, however – waiting a few more
quarters increases the likelihood that inflation overshoots the target. In May, I felt that as in these scenarios, the costs of waiting a short period of time for more information were
small.

So more of the same although let me give Silvana a little credit as she was willing to point out that Forward Guidance is a farce.

Taken literally, the models suggest implausibly large economic effects from promises about interest rates many years in the future. There is ample empirical evidence that these strong assumptions do not hold in real-world data.

Also she does seem willing to accept that the world is a disaggregated place full of different impacts on different individuals.

Another unrealistic assumption in many macroeconomic models is that everyone is the same. Or more
accurately, that everyone can be characterised by a single, representative household or firm.

 

House price rises are nothing to do with us says the Bank of England

Today brings inflation and in particular UK inflation data into focus and I would like to draw your attention to yesterday’s events. That is because the evidence given by Mark Carney and other members of the Bank of England to Parliament covered pretty much everything but that subject! Food for though for those who still believe it targets an inflation rate of 2% per annum as a priority. Indeed the whole process seemed to coin a phrase to be from an Ivory Tower “far,far,away” as we note one of the written questions.

What is your current estimate of the size of the output gap, the potential rate of productivity growth, the natural unemployment rate, and the equilibrium rate of
interest?

It wouldn’t take me long to point out that the evidence is that they are concepts which mislead rather than help. Moving back to the formal reply from Gertjan Vlieghe we did get an implied view.

 so that the economy will move into excess
demand over the forecast period and domestic inflationary pressure are likely to rise even as the fading contribution from past import price rises leads to a fall in headline
inflation this year.

Gertjan followed this up by suggesting this.

I think policy rates are likely to rise, in my central view, by 25bp to 50bp per year over the forecast period.

The problem for him is that he is like tumbleweed in the wind looking at negative interest-rates then swinging round saying they will rise to 2% so far managing to be something of a reverse indicator.

The UK Pound £

This has been in a weaker phase since the Unreliable Boyfriend Mark Carney did his public U-Turn on a May Bank Rate rise. In terms of the most important currency for inflation trends the US Dollar we are now at US $1.335 some ten cents below the previous peak. Thus we are back in a phase where this will add to inflation. Not all of the move is Mark Carney’s fault because there has also been a phase of what we might call “King Dollar” but he did give it a push down the hill. This means he has operated in the opposite direction to his inflation target.

The Oil Price

Whilst the overnight news is that we have seen a dip back in the price of crude oil the trend since late June has been higher and higher. Thus we face US $79 for a barrel of Brent Crude Oil as opposed to more like US $45 when this move began. Or if you prefer it is some 47% higher than a year ago. So we face some energy price inflation.

Today’s data

If we look we see the clearest example of the two factors above below.

Prices for materials and fuels (input prices) rose 5.3% on the year to April 2018, up from 4.4% in March 2018.

As we look into the detail we get more conformation of this.

 This was driven by crude oil prices, which have increased on the year at a rate of 19.9% in April 2018, 6.4 percentage points higher than in March 2018.

As to the second factor I am sorry to have to tell you that our official statisticians are looking in the wrong place.

The sterling effective exchange rate index (ERI) rose to 80.3 in April 2018. This is a 1.4% increase from March 2018 and is the largest monthly growth since September 2017 when it rose 2.1%……..All else equal, a stronger sterling effective exchange rate will lead to cheaper inputs of imported materials and fuels.

Anyway the month on month figures confirm my theme as well.

 On the month, inflation for imported materials and fuels was up 0.5%, after prices were flat in March 2018.

So we are seeing a turn in the inflation chain from lower to higher which has not yet reached the output data but will do so in the months ahead.

The annual rate of inflation for goods leaving the factory gate (output prices) remained at 2.7% in April 2018 . On the month, output inflation was 0.3%, unchanged from March 2018.

Consumer Inflation

There was better news on this front.

The Consumer Prices Index (CPI) 12-month rate was 2.4% in April 2018, down from 2.5% in March 2018.

Where this particularly impacts on the economy is when we compare it with wage growth. This has been given a lot o media attention and we can now say that real wages have finally stopped falling on this indicator although I am more cautious about saying they are now rising unlike the Bank of England.

wage growth improves somewhat
due to reduced labour market slack, ( Vlieghe)

Perhaps they have found this from talking with Billy Bragg or from areas such as Spotify play lists. So let me help out by saying I have been playing Hold Me by Carly Rae Jepsen at the Fleetwood Mac Festival a couple of years or so ago a lot recently. Sadly the recording quality is not top-notch so if the Bank could help out I would appreciate it.

Moving to the factors giving us lower annual inflation we saw this.

The largest downward contribution to the change in the rate came from air fares, which were influenced by the timing of Easter.

Also the price of men’s clothing fell which provides a bit of gender equality as usually news from this area if from women’s clothing. Against that as I am sure many of you are aware the price of diesel and petrol at the pump rose as the factors I discussed earlier begin to impact.

House prices

We have a familiar drum beat and bass line here.

Average house prices in the UK have increased by 4.2% in the year to March 2018 (unchanged from February 2018).

Although we did get another in my series of updates on never believing anything until it is officially denied. From the Guardian.

Gertjan Vlieghe also denies that QE has fuelled Britain’s housing market.

He points out that many countries have used quantitative easing to stimulate their economies since the financial crisis – but Britain is the only one to have seen such as house price boom.

Ireland?Spain?Germany? Well anyway we could of course simply look at the impact of the Funding for Lending Scheme on mortgage rates which the Bank of England estimated at up to 2%.

Comment

The good news is that UK inflation has been moderating in 2018 so far but the not so good news is that the winds of change are now blowing in the opposite direction. We got a hint of this from the much maligned Retail Price Index today as well as a reminder of a blind spot in UK inflation measurement.

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

The blind spot it highlights is illustrated below.

Other housing components excluded from the CPI, which increased the RPI 12-month rate relative to the CPI 12-month rate by 0.11 percentage points between March and April 2018. The effect came mainly from house depreciation and council tax.

House depreciation is an odd way of doing it but t has house prices in it as well as mortgage rates whereas the CPI has neither. When our establishment felt that they could get away with this no longer they chose to ignore this and assume that owner occupiers pay themselves rent when they do not. That is what an Imputed Rent is and the numbers are based on this.

Private rental prices paid by tenants in Great Britain rose by 1.0% in the 12 months to April 2018; down from 1.1% in March 2018.

I hope to have the opportunity to explain this at the Royal Statistical Society next month at their public meeting. You reduce inflation by excluding things which exist and not only can be measured but are paid and replace then with ones you make up, Many have doubts that they can measure existing rental trends and suggest the numbers are too low by around 1% per annum. So let me credit the UK media who in general have roundly ignored the CPIH inflation measure as they have done exactly the right thing.