Both money supply growth and house prices look weak in Australia

The morning brought us news from what has been called a land down under. It has also been described as the South China Territories due to the symbiotic relationship between its commodity resources and its largest customer. So let us go straight to the Reserve Bank of Australia or RBA.

At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.

At a time of low and negative interest-rates that feels high for what is considered a first world country but in fact the RBA is at a record low. The only difference between it and the general pattern was that due to the commodity price boom that followed the initial impact of the credit crunch it raised interest-rates to 4.75%, but then rejoined the trend. That brought us to August 2016 since when it has indulged in what Sir Humphrey Appleby would call masterly inaction.

Mortgage Rates

However central bankers are not always masters of all they survey as there are market factors at play. Here is Your Mortage Dot Com of Australia from yesterday.

The race to raise interest rates is on as two more major lenders announced interest rate hikes of up to 40 basis points across mortgage products.

According to an Australian Financial Review report, Suncorp and Adelaide Bank have raised variable rates of investor and owner-occupied mortgage products to compensate for increasing capital costs.

Adelaide Bank is hiking rates for eight of its products covering principal and interest and interest-only owner-occupied and investor loans.

Starting 07 September, the rate for principal and interest mortgage products will increase by 12 basis points. On the other hand, interest-only mortgage products will bear 35-40 basis points higher interest rates.

 

This follows Westpac who announced this last week.

The bank announced that its variable standard home-loan rate for owner occupiers will increase 14 basis points to 5.38% after “a sustained increase in wholesale funding costs.”

A rate of 5.38% may make Aussie borrowers feel a bit cheated by the phrase zero interest-rate policy or ZIRP. However a fair bit of that is the familiar tendency for standard variable rate mortgages to be expensive or if you prefer a rip-off to catch those unable to remortgage. Your Mortgage suggests that the best mortgage rates are in fact 3.6% to 3.7%.

Returning to the mortgage rate increases I note that they are driven by bank funding costs.

This means the gap between the cash rate and the BBSW (bank bill swap rate) is likely to remain elevated.

That raises a wry smile as when this happened in my home country the Bank of England responded with the Funding for Lending Scheme to bring them down. So should this situation persist we will see if the RBA is a diligent student. Also I note that one of the banks is raising mortgage rates by more for those with interest-only mortgages.

Interest Only Mortgages

Back in February Michele Bullock of the RBA told us this.

Furthermore, the increasing popularity of interest-only loans over recent years meant that by early 2017, 40 per cent of the debt did not require principal repayments . A particularly large share of property investors has chosen interest-only loans because of the tax incentives, although some owner-occupiers have also not been paying down principal.

So Australia ignored the view that non-repayment mortgages were to be consigned to the past and in fact headed in the other direction until recently. Should this lead to trouble then there will be clear economic impacts as we note this.

As investors purchase more new dwellings than owner-occupiers, they might also exacerbate the housing construction cycle, making it prone to periods of oversupply and having a knock on effect to developers.

In central banking terms that “oversupply” of course is code for house price falls which is like kryptonite to them. Indeed the quote below is classic central banker speak.

 For example, since it is not their home, investors might be more inclined to sell investment properties in an environment of falling house prices in order to minimise capital losses. This might exacerbate the fall in prices, impacting the housing wealth of all home owners.

What does the RBA think about the housing market?

Let us break down the references in this morning’s statement.

Conditions in the Sydney and Melbourne housing markets have continued to ease and nationwide measures of rent inflation remain low. Housing credit growth has declined to an annual rate of 5½ per cent. This is largely due to reduced demand by investors as the dynamics of the housing market have changed. Lending standards are also tighter than they were a few years ago, partly reflecting APRA’s earlier supervisory measures to help contain the build-up of risk in household balance sheets. There is competition for borrowers of high credit quality.

Sadly we only have official data for the first quarter of the year but it makes me wonder why Sydney and Melbourne were picked out.

The capital city residential property price indexes fell in Sydney (-1.2%), Melbourne (-0.6%), Perth (-0.9%), Brisbane (-0.6%) and Darwin (-1.1%) and rose in Hobart (+4.3%), Adelaide (+0.5%) and Canberra (+0.9%).

You could pick out Sydney on its own as it saw an annual fall, albeit one of only 0.5%. Perhaps the wealth effects are already on the RBA’s mind.

The total value of residential dwellings in Australia was $6,913,636.6m at the end of the March quarter 2018, falling $22,498.3m over the quarter. ( usual disclaimer about using marginal prices for a total value)

As to housing credit growth if 5 1/2% is low then there has plainly been a bit of a party. One way of measuring this was looked at by Business Insider back in January.

The ABS and RBA now estimate total Household Debt to Disposable Income at 199.7%, up 3% on previous estimates,

The confirmation that there has been something of a party in mortgage lending, with all the familiar consequences, comes from the section explaining the punch bowl has been taken away! Lastly telling us there is competition for higher credit quality mortgages tells us that there is not anymore for lower quality credit.

Comment

If we look for unofficial data, yesterday brought us some house price news from Business Insider.

Australian home prices fell for an eleventh consecutive month in August, led by declines in a majority of capital cities.

According to CoreLogic’s Hedonic Home Value Index, Australia’s median home price fell 0.3%, adding to a 0.6% drop recorded previously in July.

That took the decline over the past three months to 1.1%, leaving the decline over the past year at 2%.

That is not actually a lot especially if we factor in the price rises which shows how sensitive this subject is especially to central bankers. If we look at the median values we perhaps see why the RBA singled out Sydney ( $855,000) and Melbourne ($703,000) or maybe they were influenced by dinner parties with their contacts.

This trend towards weaker premium housing market conditions is largely attributable to larger falls across Sydney and Melbourne’s most expensive quarter of properties where values are down 8.1% and 5.2% over the past twelve months.

Another issue to throw into the equation is the money supply because for four years broad money growth averaged over 6% and was fairly regularly over 7%. That ended last December when it fell to 4.6% and for the last two months it has been 1.9%. So there has been a clear credit crunch down under which of course is related to the housing market changes. This is further reinforced by the narrower measure M1 which has stagnated so far in 2018.

Much more of that and the RBA could either cut interest-rates further or introduce some credit easing of the Funding for Lending Scheme style. Would that mean one more rally for the housing market against the consensus? Well it did in the UK as we move into watch this space territory.

Also this slow down in broad money growth we have been observing is getting ever more wide-spread,

 

 

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An economic tsunami is hitting Venezuela

Last night a 7.3 magnitude earthquake hit the nation of Venezuela that must feel like it has the four horsemen of the apocalypse on its case right now. Fortunately there does not seem to have been major damage but we cannot say that about the economic earthquake that has been hitting it in recent times. As ever I will do my best to avoid politics in what has become a politically charged area and merely point out that it is another case of a country being held up as an economic model and then seeing trouble hit just like we have seen with Turkey. However the problems here are on a much larger scale.

If we go back to the 7th of November 2013 then Mark Weisbot told us this in the Guardian.

Will those who cried wolf for so long finally see their dreams come true? Not likely.

But how can a government with more than $90bn in oil revenue end up with a balance-of-payments crisis? Well, the answer is: it can’t, and won’t. In 2012 Venezuela had $93.6bn in oil revenues, and total imports in the economy were $59.3bn……… This government is not going to run out of dollars.

Hyperinflation is also a very remote possibility.

And then perhaps the denouement.

Of course Venezuela is facing serious economic problems. But they are not the kind suffered by Greece or Spain, trapped in an arrangement in which macroeconomic policy is determined by people who have objectives that conflict with the country’s economic recovery.

With one bound it could be free.

Venezuela has sufficient reserves and foreign exchange earnings to do whatever it wants, including driving down the black market value of the dollar and eliminating most shortages.

Sadly for Venezuela that analysis has turned out to be a combination of wishful thinking and castles in the sky. Let us start with what should be the jewel in the crown which is oil production as I recall back in the day London Mayor Ken Livingstone planning a big oil deal with Venezuela. From the BBC in February 2007.

Ken Livingstone has signed an oil deal with Venezuela – providing cheap fuel for London’s buses and giving cut price travel for those on benefits.

Now we see very different times as Venezuela seems unable to get the oil out of the ground and to markets as oilprice.com reported on Monday.

Venezuela’s oil production continues to decline. In July, output fell to just 1.278 million barrels per day (mb/d), down 500,000 bpd from the fourth quarter of last year and down nearly 1 mb/d from two years ago. A growing number of analysts see output dipping below the 1-million-barrel-per-day mark by the end of 2018.

This is a big deal for an economy that was summarised like this by Forbes last November.

Venezuela’s oil available for export is at its lowest level since 1989. The lost revenue devastates: Oil sales are 50% of Venezuela’s GDP and 95% of its export revenue.

We can do a rough calculation as according to the Latin America Herald Tribune this is the price of oil there.

According to Venezuelan government figures, the average price in 2018 for Venezuela’s mix of heavy and medium crude for 2018 which Caracas now prices in Chinese Yuan is now $59.41.

So as a rough rule of thumb it has been losing some US $60 million a day so far  in 2018. Also I do not know about you but if your largest customer is US oil refineries then trying to price your oil in Yuan does not seem well thought out! Actually what we might call the potential loss is extraordinary as the Herald Tribune continues.

In 1998, the year prior to Hugo Chavez becoming president, Venezuela was producing 3.5 million bpd and had plans to increase that production go 6 to 8 million bpd by 2008.

There are two main consequences here as we note the impact on Venezuela itself which is highly deflationary and on the rest of us which is inflationary. This is because it is this lack of production which has helped drive oil prices higher as Venezuela is a long way short of its OPEC quota.

Money Money Money

There is plenty of this and in theory much more as Reuters hinted at on Friday.

Jittery Venezuelans on Friday rushed to shops and lined up at gas stations on concerns that a monetary overhaul to lop off five zeros from prices in response to hyperinflation could wreak financial havoc and make basic commerce impossible.

Sadly the website of the Central Bank of Venezuela cannot be reached so Bloomberg takes up the tale.

The official rate for the currency will go from about 285,000 per dollar to 6 million, a shock that officials tried to partly offset by raising the minimum wage 3,500 percent to the equivalent of just $30 a month……..The devaluation comes at the same time the government is redenominating the currency by lopping off five zeros and introducing new bills and a name change. So instead of the new minimum wage being 180 million strong bolivars, it will be 1,800 sovereign bolivars. Banks were closed and busy trying to adopt ATMs and online platforms to the new currency rules.

My financial lexicon for these times would of course have warned about any currency with “strong” in its title and the strong Bolivar has behaved as the novel 1984 would suggest. As to inflation please do not adjust your sets ( or screens).

One likely outcome is that inflation, which already was forecast to reach 1 million percent this year, will get fresh fuel from the measures. Prices are currently rising at an annualized rate of 108,000 percent, according to Bloomberg’s Café con Leche index.

If I was there I would only be able to help by providing an inflation index for prisoners as for quite some time it has been illegal to try to measure inflation. If we step back for a moment the numbers here do evoke images of Weimar Germany and the hyperinflation then.

In Venezuela, the old bolivar bills could be seen muddied and crumpled up on the street, so worthless that not even street beggars picked them up. ( Wall Street Journal).

Or to put it another way pictures of cash in wheelbarrows from back then have been replaced by pictures like this.

In theory the currency has backing but in practice we will have to wait and see.

Comment

What we are seeing here is the breakdown of basic economic concepts. Let us start with the simple concept of how to price things.

Many shopkeepers said they had no idea how much to charge customers ( WSJ)

This has a lot of consequences. Firstly how can they operate and sell anything? Basic concepts such as value of stock break down and the value of the business. So it is no surprise that many shops have shut. The concept of a price has broken down which means so has inflation.

Next there is the issue of what Abba called money,money money. As it too loses much meaning. For example the person quoted below in the Wall Street Journal has not been able to get cash for five months!

When Henrique Rosales got to the automated-teller machine on Tuesday to withdraw Venezuela’s new currency, he found it dispensed a maximum of 10 sovereign bolivars a day, the equivalent of 15 U.S. cents.

“This money is going to disappear out of my hands in no time,” said the 29-year-old waiter, who said he hasn’t seen cash in five months. He hasn’t been able to pay for bus fare and walks several miles a day from his hilltop slum to the seafood eatery where he works.

In such a situation the concept of a money supply breaks down as well as if we are in trouble with the cash or high-powered money element what about the rest? If we look at the UK we see that narrow money is about 3% and the other 97% we can summarise as bank lending. But how can banks in Venezuela lend right now? Do they even have the faintest idea what the bank is worth let alone whether it is wise to lend to the customer?

The truth is that numbers like GDP and the like become pretty much meaningless at a time like this as if we do not even have a price the whole theoretical structure breaks down. What we will see are toe factors at play. There must be an element of barter going on and probably a large one and irony of ironies a lot of transactions must be in US Dollars. Back at the height of the Ukraine crisis I pointed out that we needed a US Dollar money supply as well and let us bring things really up to date as we may well need to measure this too.

Cryptocurrency Dash is seeing a surge in new merchant sign-ups and wallet downloads in Venezuela as hyperinflation in the country runs wild………..”We are seeing tens of thousands of wallet downloads from the country each month,” Ryan Taylor, the CEO of the Dash Core Group, told Business Insider. “Earlier this year, Venezuela became our number two market even ahead of China and Russia, which are of course huge into cryptocurrency right now.” ( Business Insider)

At a time like this we perhaps get the clearest guide from other indicators.

Over the past three years about 3,000 Venezuelans have entered Colombia every day and the country has granted temporary residence to more than 800,000.

Peru says that last week alone, 20,000 Venezuelans entered the country. ( BBC)

Meanwhile the Economist Intelligence Unit does give us a clue as to a cause of the hyper inflation.

The government heavily relies on monetisation to fund its deficits,

India is counting the cost of its crude oil dependency

Tucked away in the news stream of the past few days has been a developing situation in India. Whilst the headlines have been made by Turkey there have been currency issues in the largest part of the sub-continent as well. Here is DNA India on the subject.

Indian Rupee on Thursday had hit a fresh record low, the Rupee opened at 70.22 versus the US dollar. In wake of the Turkey crisis, the Indian currency started off the session on a weak note. Earlier on Tuesday, after opening at a marginal high of 69.85 against the US Dollar, the Indian rupee touched an all-time low of 70 per US dollar.

The Indian currency touched an all-time low of 70.08 against the US dollar, while marking depreciation of around 10 per cent in 2018.

The fall came majorly due to a drop in Turkish Lira, which helped the US dollar to gained strength on the back of fears that economic crisis in Turkey could spread to other global economies.

In fact it fell to 70.7 this morning versus the US Dollar which is an all time low. Some of the move may have been exacerbated by the issues facing Turkey but over the past couple of days the Turkish Lira has rallied strongly whereas the Rupee has continued to fall. A factor has been the strength of the US Dollar or what is being called King Dollar. This reminds me that themes and memes can change rather quickly in the currency world if we step back in time to the 25th of January.

“Obviously a weaker dollar is good for us as it relates to trade and opportunities,” Mnuchin told reporters in Davos. The currency’s short term value is “not a concern of ours at all,” he said.

If pressed now I guess the US Treasury Secretary would emphasise this bit.

“Longer term, the strength of the dollar is a reflection of the strength of the U.S. economy and the fact that it is and will continue to be the primary currency in terms of the reserve currency,” he said.

Returning to the Rupee we see that it had started to fall before the turn in the US Dollar as conveniently it began at the turn of the year when it was at 63.3 versus it.

What are the consequences?

The first is simply inflation or as DNA India puts it.

Continuous downfall in Indian Rupee is worrisome for imported goods as the cost of imports will go up.  Currently, India imports around 80 per cent of its crude requirement. The rupee downfall will expand India’s import bill and will eventually be contributing to the inflation.

This will add to the situation below. From The Times of India.

Inflation based on consumer price index (CPI) for the month of July came at 4.17 per cent, government data ..

That was an improvement and as so often in India the swing factor was food prices.

The food inflation came at 1.37 per cent, driven by cooling of pulses, vegetable and sugar rates.

However a boost is on its way and as inflation is above the 4% target things could get especially awkward should food prices swing the other way.

Interest-Rates

One of the economics 101 assumptions is that higher interest-rates boost a currency but as I warned back on the 3rd of May the situation is more complex than that and Argentina reminded us again by raising to 45% earlier this week. As for India we see this.

increase the policy repo rate under the
liquidity adjustment facility (LAF) by 25
basis points to 6.5 per cent. ( Reserve Bank of India August Bulletin)

That was the second rise this year and these have reversed the previous downwards trend. Of course the problem is that the RBI is perhaps only holding station with the US Federal Reserve.

Intervention

India maintains a sizeable foreign currency reserve which was US $406 billion at the last formal update in March. However it will not be that now if this from Reuters on Tuesday is any guide.

Subhash Chandra Garg, secretary at the department of economic affairs…………said the RBI has spent about $23 billion so far to intervene ..

So we see that the fall has come in spite of intervention which sits rather oddly with the claim from Subhash Chandra Garg that the currency fall does not matter. Also it is usually rather unwise to indicate a currency level as he did (80) as events have a way of making a fool of you.
Anyway using reserves can help for a while but care is needed as quickly markets switch to calculating how much you have left and how long they will last at the current rate of depletion. At that point intervening can make things worse.
Trade
Looking at India’s  domestic economy a clear factor in the currency debate is its trade position. The latest numbers were as highlighted above by DNA India heavily affected by the oil price.

 

Oil imports during July 2018 were valued at US $ 12.35 Billion (Rs. 84,828.57 crore) which was 57.41 percent higher in Dollar terms and 67.76 percent higher in Rupee terms compared to US $7.84 Billion (Rs. 50,565.29 crore) in July 2017.

Such a development feeds into the existing Indian trade problem.

Cumulative value of exports for the period April-July 2018-19 was US $ 108.24 Billion (Rs 7,29,823.08 crore)……….Cumulative value of imports for the period April-July 2018-19 was US $ 171.20 Billion (Rs. 11,54,881.70 crore).

Whilst a little care is needed as petroleum exports grew by 30% overall Indian export growth is on a tear at 14%. Many would love that, but the rub is that not only are imports much larger but due to India’s oil dependency they are rising at an annual rate of 17%. So as we stand things are getting worse and according to Business Standard there is trouble ahead.

India’s crude oil import bill is likely to jump by about $26 billion in 2018-19 as rupee dropping to a record low has made buying of oil from overseas costlier, government officials said today…….. If the rupee is to stay around 70 per dollar for the rest of the ongoing fiscal, the oil import bill will be $114 billion, he said.

Comment

The other side of the coin about the Indian economy was highlighted by the IMF only last week.

India’s economy is picking up and growth prospects look bright—partly thanks to the implementation of recent policies, such as the nationwide goods and services tax. As one of the world’s fastest-growing economies—accounting for about 15 percent of global growth—India’s economy has helped to lift millions out of poverty.

Although developments since the writing of the report may have more than a few wondering about this bit.

India can benefit from improving its integration with global markets.

Perhaps it is a case of Blood,Sweat and Tears.

What goes up must come down
Spinnin’ wheel got to go ’round

There was of course the domestic issue created by the demonetisation debacle not that long ago but the real achilles heel for India is oil. Something of a perfect storm has hit it where the oil price has risen by 40% over the past year and more recently that has been exacerbated by a stronger US Dollar.

So both the economic and Rupee issues seem as much to do with energy policy as conventional economics. Can India find a way of weaning itself off at least some of its oil dependency?

Me on CoreFinance TV

 

The UK inflation picture is shifting again

After disappointing news on wage growth yesterday for the Bank of England the day ended with some good news for it on this front. From the Financial Times.

The chief executives of the UK’s biggest listed companies received an 11 per cent raise last year pushing their median pay up to £3.93m, according to a report which found that full-time workers received a 2 per cent rise over the same period. The figures for FTSE 100 bosses include base salary, bonuses and other incentives and have been revealed at a time of growing shareholder activism over big payouts. Shareholders at companies including BT, Royal Mail and WPP have rebelled against chief executive pay at stormy annual investor meetings this year.

So some at least are getting above inflation pay rises Actually you can make the number look even larger if you switch to an average rather than the median as this from the original CIPD report shows.

 If we divide this amount equally among all the CEOs covered by our report, they would each receive a mean annual package worth £5.7 million, 23% higher than the 2016 mean figure of £4.6 million.

Why is this so? Well a lot of it is due to a couple of outliers as this from the FT shows.

The highest-paid chief executive in 2017 was Jeff Fairburn at housebuilder Persimmon who received £47.1m, or 22 times his 2016 pay. Ranking second, Simon Peckham of turnround specialist Melrose Industries banked £42.8m, equal to 43 times his 2016 pay, according to the analysis.

The case of Mr.Fairburn at Persimmon is an especially awkward one for the establishment as he has personally benefited on an enormous scale from the house price friendly policies of the Bank of England and the UK government. As so often we face the irony of the government supposedly being on the case of executive pay which it has helped to drive higher.  Indeed I note this seems to be a wider trend as Persimmon is not alone amongst house builders according to the CIPD report.

Berkeley Group Holding plc’s Rob Perrins, whose total pay package rose from £10.9 million in 2016 to £27.9 million.

Inflation

If we step back for a moment and look at the trends we see that they have shifted in favour of higher inflation. A factor in this has been the US Dollar strength we have seen since the spring which was not helped by the unreliable boyfriend behaviour of Bank of England Governor Mark Carney back in April. So now we face as I type this an exchange rate a bit over US $1.27 meaning we will have to pay more for many commodities and oil.

Moving onto the oil price itself care is needed as whilst we have dropped back from the near US $80 for a barrel of Brent Crude seen at the end of May to US $72 we are up around 42% on a year ago. This time around the OPEC manoeuvering has worked for them but of course not us.

There are various ways these feed into our system and perhaps the clearest is the price of fuel at the pump where a 5 pence rise raises inflation by ~0.1%. We are also experiencing another impact as we see domestic energy costs rise as NPower raised on the 17th of June, SSE on the 11th of July, E.ON will raise them tomorrow and EDF Energy will raise them at the end of the month. These are of course not only the result of higher worldwide energy prices but also a form of administered inflation via changes in energy policy for which we foot the bill. People will have different views on types of green energy which are expensive but much fewer will support the expensive white elephant which is the smart meter roll out and further ahead is the Hinkley Point nuclear plant.

Today’s data

There was a small pick-up.

The all items CPI annual rate is 2.5%, up from 2.4% in June

Some of it was from the source described above.

Transport, with passenger transport fares seeing larger price rises between June and July 2018
compared with the same period a year ago. Motor fuels also made an upward contribution,

Another was from the area of computer games where we seem to have found another area that the statisticians are struggling with.

these are heavily dependent on the composition of bestseller charts, often resulting
in large overall price changes from month to month;

Let us hope that this clams down as we have plenty to deal with as it is! As to downwards influences we should say thank you ladies as we mull whether this is being driven by the problems in the bricks and mortar part of the retail sector.

Clothing and footwear, with prices falling by 3.7% between June and July 2018, compared with a smaller fall of 2.9% between the same two months a year ago. The effect came mainly from women’s clothing and footwear.

If we look further down the inflation food chain we see a hint of what seems set to come from the lower Pound £.

Prices for materials and fuels (input prices) rose 10.9% on the year to July 2018, up from 10.3% in June 2018.

In essence it was driven by this.

 The annual rate was driven by crude oil prices, which increased to 51.9% on the year in July 2018, up from 50.2% in June 2018.

However in a quirk of the data this did not feed into output producer price inflation which dipped from 3.3% to 3.1%. Whilst welcome I suspect that this is a quirk and it will be under upwards pressure in the months ahead if we see the Pound £ remain where it is and oil ditto.

House Prices

Here we saw what might be summarised as a continuation of the trend we have seen.

Average house prices in the UK have increased by 3.0% in the year to June 2018 (down from 3.5% in May 2018). This is its lowest annual rate since August 2013 when it was also 3.0%. The annual growth rate has slowed since mid-2016.

However there is a catch because even at this new lower level it is still considerably above what we are officially told is inflation in this area.

Private rental prices paid by tenants in Great Britain rose by 0.9% in the 12 months to July 2018, down from 1.0% in the 12 months to June 2018.

This is what feeds into what is the inflation measure that the Office for National Statistics has been pushing hard for the last 18 months or so. But there also is the nub of its problem. Actually they have problems measuring rents in the first place which affects the process of measuring inflation for those who do rent but then fantasising that someone who owns a property rents it to themselves has led to quite a mess.

Comment

As we look forwards we see the prospect of inflation nudging higher again. However there are two grounds for optimism. One is short-term in that the next two monthly increases for comparison are rises of 0.6 and then 0.3 in the underlying index for CPI .The other is that I do not think that the all the prices which rose back in late 2016 early 2017 went back down again so we may see a lesser impact this time around.

Meanwhile the issue around the RPI has arisen again. Some of it has been driven by Chris Grayling suggesting the use of CPI for rail fares. Ed Conway of Sky News has been joining in the campaign against the RPI this morning on Twitter.

Don’t let anyone tell you RPI is better/different because it includes housing. First, these days CPI does include a housing element.

To the first bit I will and to the second I am waiting for a reply to my point that CPI excludes owner-occupied housing. As it happens RPI moved downwards this month which will be welcomed by rail travellers as it is the number used to set many of the annual increases.

The all items RPI annual rate is 3.2%, down from 3.4% last month.

 

 

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

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?