The inflation problem is only in the minds of central bankers

Yesterday we looked at the trend towards negative interest-rates and today we can link this into the issue of inflation. So let me open with this morning’s release from Swiss Statistics.

The consumer price index (CPI) remained stable in December 2019 compared with the previous month, remaining at 101.7 points (December 2015 = 100). Inflation was +0.2% compared with the same month of the previous year. The average annual inflation reached +0.4% in 2019.These are the results of the Federal Statistical Office (FSO).

The basic situation is not only that there is little or no inflation but that there has been very little since 2015. Actually if we switch to the Euro area measure called CPI in the UK we see that it picks up even less.

In December 2019, the Swiss Harmonised Index of Consumer Prices (HICP) stood at 101.17 points
(base 2015=100). This corresponds to a rate of change of +0.2% compared with the previous month
and of –0.1% compared with the same month of the previous year.

Negative Interest-Rates

There is a nice bit of timing here in that the situation changed back in 2015 on the 15th to be precise and I am sure many of you still recall it.

The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%.

If we look at this in inflation terms then the implied mantra suggested by Ben Bernanke yesterday would be that Switzerland would have seen some whereas it has not. In fact the (nearly) 5 years since then have been remarkable for their lack of inflation.

There is a secondary issue here related to the exchange rate which is that the negative interest-rate was supposed to weaken it. That is a main route as to how it is supposed to raise inflation but we find that we are nearly back where we began. What I mean by that is the exchange-rate referred to above is 1.084 compared to the Euro. So the Swiss tried to import inflation but have not succeeded and awkwardly for fans of negative interest-rates part of the issue is that the ECB ( European Central Bank) joined the party reminding me of a point I made just under 2 years ago on the 9th of January 2018.

For all the fire and fury ( sorry) there remains a simple underlying point which is that if one currency declines falls or devalues then others have to rise. That is especially awkward for central banks as they attempt to explain how trying to manipulate a zero-sum game brings overall benefits.

The Low Inflation Issue

Let me now switch to another Swiss based organisation the Bank for International Settlements  or BIS. This is often known as the central bankers central bank and I think we learn a lot from just the first sentence.

Inflation in advanced economies (AEs) continues to be subdued, remaining below central banks’ target
in spite of aggressive and persistent monetary policy accommodation over a prolonged period.

As we find so often this begs more than a few questions. For a start why is nobody wondering why all this effort is not wprking as intended? The related issue is then why they are persisting with something that is not working? The Eagles had a view on this.

They stab it with their steely knives
But they just can’t kill the beast

We then get quite a swerve.

To escape the low inflation trap, we argue that, as suggested by Jean-Claude Trichet, governments
and social partners put in place “consensus packages” that include a fiscal policy that supports demand
and a series of ad hoc nominal wage increases over several years.

Actually there are two large swerves here. The first is the switch away from the monetary policies which have been applied on an ever larger scale each time with the promise that this time they will work. Next is a pretty breathtaking switch to advocacy of fiscal policy by the very same Jean-Claude Trichet who was involved in the application of exactly the reverse in places like Greece during his tenure at the ECB.

Their plan is to simply add to the control freakery.

As political economy conditions evolve, this role should be progressively substituted by rebalancing the macro
policy mix with a more expansionary fiscal policy. More importantly, social partners and governments
control an extremely powerful lever, ie the setting of wages at least in the public sector and potentially
in the private sector, to re-anchor inflation expectations near 2%.

The theory was that technocratic central bankers would aim for inflation targets set by elected politicians. Now they want to tell the politicians what to so all just to hit an inflation target that was chosen merely because it seemed right at the time. Next they want wages to rise at this arbitrary rate too! The ordinary worker will get a wage rise of 2% in this environment so that prices can rise by 2% as well. It is the economics equivalent of the Orwellian statements of the novel 1984

Indeed they even think that they can tell employers what to do.

Finally, in a full employment context,
employers have an incentive to implement wage increases to keep their best performing employees
and, given that nominal labour costs of all employers would increase in parallel, they would able to raise
prices in line with the increase of their wage bills with limited risk of losing clients

Ah “full employment” the concept which is in practical terms meaningless as we discussed only yesterday.

Also as someone who studied the “social contracts” or what revealingly were called “wage and price spirals” in the UK the BIS presents in its paper a rose tinted version of the past. Some might say misleading. In the meantime as the economy has changed I would say that they would be even less likely to work.

Putting this another way the Euro area inflation numbers from earlier showed something the ordinary person will dislike but central bankers will cheer.

Looking at the main components of euro area inflation, food, alcohol & tobacco is expected to have the highest
annual rate in December (2.0%, compared with 1.9% in November),

I would send the central bankers out to explain to food shoppers how this is in fact the nirvana of “price stability” as for new readers that is what they call inflation of 2% per annum. We would likely get another ” I cannot eat an I-Pad” moment.

Comment

Let me now bring in some issues which change things substantially and let me open with something that has got FT Alphaville spinning itself into quicksand.

As far as most people are concerned, there is more than enough inflation. Cœuré noted in his speech that most households think the average rate in the eurozone between 2004 and last year has been 9 per cent (in fact it was 1.6 per cent). That’s partly down to higher housing costs (which are not wholly included in central banks’ measurement of inflation).

That last sentence is really rather desperate as it nods to the official FT view of inflation which is in quite a mess on the issue of housing inflation. Actually the things which tend to go up ( house prices) are excluded from the Euro area measure of inflation. There was a plan to include them but that turned out to be an attempt simply to waste time ( about 3 years as it happened). Why? Well they would rather tell you that this is a wealth effect.

House prices, as measured by the House Price Index, rose by 4.2% in both the euro area and the EU in the
second quarter of 2019 compared with the same quarter of the previous year.

Looking at the situation we see that a sort of Holy Grail has developed – the 2% per annum inflation target – with little or no backing. After all its use was then followed by the credit crunch which non central bankers will consider to be a rather devastating critique. One road out of this is to raise the inflation target even higher to 3%, 4% or more, or so we are told.

There are two main issues with this of which the first is that if you cannot hit the 2% target then 3% or 4% seems pointless. But to my mind the bigger one is that in an era of lower numbers why be King Canute when instead one can learn and adapt. I would either lower the inflation target and/or put house prices in it so that they better reflect the ordinary experience. The reason they do not go down this road is explained by a four letter word, debt. Or as the Eagles put it.

Mirrors on the ceiling
The pink champagne on ice
And she said: “We are all just prisoners here
Of our own device”

The Chinese way of economic stimulus has started already in 2020

Firstly welcome to the new year and for some the new decade ( as you could argue it starts in 2021). The break has in some ways felt long and in other ways short but we have begun a new year with something familiar. After the 733 interest-rate cuts of the credit crunch era the People’s Bank of China ( PBOC ) has started 2020 with this.

In order to support the development of the real economy and reduce the actual cost of social financing, the People’s Bank of China decided to reduce the deposit reserve ratio of financial institutions by 0.5 percentage points on January 6, 2020 (excluding finance companies, financial leasing companies, and auto finance companies).

This is a different type of monetary easing as it operates on the quantity of money ( broad money) rather than the price or interest-rate of it. By increasing the supply ( with lower reserves banks can lend more) there may be cheaper loans but that is implicit rather than explicit. As to the size of the impact Reuters has crunched the numbers.

China’s central bank said on Wednesday it was cutting the amount of cash that all banks must hold as reserves, releasing around 800 billion yuan ($114.91 billion) in funds to shore up the slowing economy.

Care is needed here as we see some copy and pasting of the official release. This is because that is the maximum not the definite impact and also because the timing is uncertain. No doubt some lending will happen now but we do not know when the Chinese banks will use up the full amount. That is one of the reason’s we in the West stopped using this as a policy option ( the UK switched in the 1970s) as it is unreliable in its timing or more specifically more unreliable than interest-rate changes, or so we thought.

Speaking of timing there is of course this.

Freeing up more liquidity now would also reduce the risks of a credit crunch ahead of the long Lunar New Year holidays later this month, when demand for cash surges. Record debt defaults and problems at some smaller banks have already added to strains on China’s financial system.

The PBOC said it expects total liquidity in the banking system to remain stable ahead of the Lunar New Year. ( Reuters).

Although for context this is the latest in what has become a long-running campaign.

The PBOC has now cut RRR eight times since early 2018 to free up more funds for banks to lend as economic growth slows to the weakest pace in nearly 30 years.

You could argue the number of RRR cuts argues against its usefulness as a policy but these days interest-rate changes have faced the same issue.

The translation of the official view is below.

The People’s Bank of China will continue to implement a prudent monetary policy, remain flexible and appropriate, not flood flooding, take into account internal and external balance, maintain reasonable and adequate liquidity, and increase the scale of currency credit and social financing in line with economic development and stimulate the vitality of market players. High-quality development and supply-side structural reforms create a suitable monetary and financial environment.

I would draw your attention to “flood flooding” but let’s face it that makes a similar amount of sense to what other central banks say and write!

I note that it is supposed to help smaller companies but central banks have plugged that line for some time now. The Bank of Japan gave it a go and in my country the Bank of England introduced the Funding for Lending Scheme to increase bank lending to smaller and medium-sized businesses in 2012. The reality was that mortgage lending and consumer credit picked up instead.

Of the latest funds released, small and medium banks would receive roughly 120 billion yuan, the central bank said, stressing that it should be used to fund small, local businesses.

The banks

Having said that this was different to policy in the West there is something which is awfully familiar.

The PBOC said lower reserve requirements will reduce banks’ annual funding costs by 15 billion yuan, which could reduce pressure on their profit margins from recent interest rate reforms. Last week, it said existing floating-rate loans will be switched to the new benchmark rate starting from Jan. 1 as part of a broader effort to lower financing costs. ( Reuters ).

I guess central banks are Simon and Garfunkel fans.

And I’m one step ahead of the shoe shine
Two steps away from the county line
Just trying to keep my customers satisfied,
Satisfied.

The Chinese Economy

There is something of an economic conundrum though if we note the latest economic news.

BEIJING, Dec. 31 (Xinhua) — The purchasing managers’ index (PMI) for China’s manufacturing sector stood at 50.2 in December, unchanged from November, the National Bureau of Statistics (NBS) said Tuesday.

A reading above 50 indicates expansion, while a reading below reflects contraction.

This marks the second straight month of expansion, partly buoyed by booming supply and demand as well as increasing export orders, said NBS senior statistician Zhao Qinghe.

“booming supply and demand”. Really? Well there is growth but hardly a boom/

On a month-on-month basis, the sub-index for production gained 0.6 points to 53.2 in December,

Even it is not backed up by demand.

while that for new orders fell slightly to 51.2, still in the expansion zone.

The wider economy is recorded as doing relatively well.

Tuesday’s data also showed China’s composite PMI slid slightly to 53.4, but was 0.3 points higher than this year’s average, indicating steady expansion in the production of China’s companies.

Stock Market

According to Yuan Talks it as ever liked the idea although it is only one day.

#Shanghai Composite index extends gains to 1.5% to approach 3100 mark. #Shenzhen Component Index and #Chinext index are surging near 2%.

Still President Trump would be a fan.

Yuan or Renminbi

Here we see that we have been on a bit of a road to nowhere over the past year. After weakening in late summer towards 7.2 versus the US Dollar the Yuan at 6.96 is up 1.2% on a year ago. So there have been a lot of column inches on the subject but in fact very little of them have been sustained.

Comment

It would appear that the PBOC does not have much faith in the reports of a pick up in the Chinese economy as it has already stepped up its easing programme. There are other issues in play such as the trade war and these next two so let us start with US Dollar demand.

China’s big bang opening of its $45 trillion financial industry begins in earnest next year — a step-by-step affair that’s unfolding just as economic strains threaten the promised windfall luring in global firms.

Starting with its insurance and futures markets, the Communist Party ruled nation will enact the most sweeping changes in decades to allow the likes of Goldman Sachs Group Inc., JPMorgan Chase & Co. and BlackRock Inc. to expand their footprint in China and compete for a slice of its growing wealth. ( Insurancejournal.com )

Will it need a dollar,dollar? We will have to see. Also this issue continues to build.

WARSAW (Reuters) – Bird flu has been detected in turkeys in eastern Poland, authorities said on Wednesday, and local media reported that the outbreak could require up to 40,000 birds to be slaughtered.

China has a big issue with this sort of thing and like in banking and economics the real danger was always possible contagion. So far it has had limited effect on UK pork prices for example as the annual rate of inflation is 0.7% but it is I think a case of watch this space.

Meanwhile according to Yuan Talks the credit may not flow everywhere.

Regulators in the city of Beijing warned financial institutions about risks in the lending to property developers with “extremely high leverage”, indicating the authority is not relaxing financing rules for the cash-starved sector as many anticipated.

Looking at it in terms of money supply growth an annual rate of 8.2% for broad money ( M2) may seem fast in the west but it has not changed much recently in spite of the easing and is slow for China.

 

 

Meet the new boss same as the old boss as the CFA Franc becomes the Eco

As Christmas approaches things usually quieten down but if turn out eyes to Africa and in particular West Africa there have been some currency developments over the weekend. So without further ado let me hand you over to Reuters.

West Africa’s monetary union has agreed with France to rename its CFA franc the Eco and cut some of the financial links with Paris that have underpinned the region’s common currency since its creation soon World War Two.

So we have both an economic/financial element and a colonial one. We have looked at the CFA Franc briefly before but now courtesy of LSE Blogs let us have a refresher.

Firstly, a fixed rate of exchange with the euro (and previously the French franc) set at 1 euro = 655.957 CFA francs. Secondly, a French guarantee of the unlimited convertibility of CFA francs into euros. Thirdly, a centralisation of foreign exchange reserves. Since 2005, the two central banks – the Central Bank of West African States (BCEAO) and the Bank of Central African States (BEAC) – have been required to deposit 50 per cent of their foreign exchange reserves in a special French Treasury ‘operating account’. Immediately following independence, this figure stood at 100 per cent (and from 1973 to 2005, at 65 per cent)……The final pillar of the CFA franc, is the principle of free capital transfer within the franc zone.

As you can see via their relationship with France the countries here became implicit members of the Euro, and follow the broad sweep of its monetary policy. If we return to Reuters the scope of the issue and ch-ch-changes is explained.

The CFA is used in 14 African countries with a combined population of about 150 million and $235 billion of gross domestic product.

However, the changes will only affect the West African form of the currency used by Benin, Burkina Faso, Guinea Bissau, Ivory Coast, Mali, Niger, Senegal and Togo – all former French colonies except Guinea Bissau.

The Central Bank of West African States or BCEAO

If we look at monetary policy here we do see one advantage of this.

The minimum interest rate for bidding on open market transactions (calls for bidding) and the interest rate applicable on the marginal lending window (repo rate), whose levels are currently set by the Monetary Policy Committee at respectively 2.50% and 4.50%, are the principal leading interest rates of the BCEAO.

That is considerably lower than what is common in that part of Africa as Ghana is at 16% and Nigeria 13,5% so there is a gain here.

The Economy

According to Friday’s meeting of the council of ministers for the BCEAO things are in fact going really rather well.

The Council of Ministers has analyzed the recent economic and monetary situation in the Union. To this end, he noted the increased dynamism of economic activity in the third quarter of 2019 as well as the favorable economic outlook in the WAEMU countries. Indeed, growth in real gross domestic product (GDP) came out at 6.6% year-on-year, after 6.4% the previous quarter, under the effect of renewed dynamism in the tertiary and secondary sectors. Economic growth in the Union would be, in real terms, at 6.6% in 2019 as in 2020.

After a year of reporting slowing economic growth that is a cheerful and refreshing report. Indeed whilst more than a few would be screaming DEFLATION looking at the numbers below I welcome them.

The Council also noted the decline in the general level of consumer prices, with an inflation rate, year-on-year, of -1.0% in the third quarter of 2019, after -0.7% in the previous quarter, in combination with falling food prices, favored by abundant cereal production.

Firstly in spite of the fast rate if economic growth these are countries with plenty of poor people who will not only welcome lower food prices they may be a matter of life and death. Also low and indeed negative inflation can be combined with a good economic run and not need the economics establishment to rev up REM on their turntables.

It’s the end of the world as we know it
It’s the end of the world as we know it

Although there is a catch if the price falls are for products produced and exported.

Thus, price reductions were recorded for cashew nuts
(-23.5%), palm kernel oil (-17.2%), robusta coffee (-7.1%) and cotton (-4.2%). On the other hand,
increases were noted for petroleum (+ 8.8%), rubber (+ 6.5%) and cocoa
(+ 5.0%).  ( BCEAO 2nd Quarter)

There is however a de facto consequence of implicit Euro area membership.

To this end, they invited the member states to continue efforts aimed at bringing the budget deficit below the Community standard of 3.0% of GDP, in particular by widening the tax base and improving performance. as well as the efficiency of tax administrations.

In case you are wondering about the other component of the Stability and Growth Pact it doesn’t really apply at the moment.

Preliminary data point to an increase in total debt to
52.5 percent of GDP in 2018 from 50.1 percent in 2017. ( IMF)

However bond yields are much higher so there are debt servicing issues.

and in total debt service to 33 percent of
government revenue in 2018 from 26.4 percent in 2017. ( IMF)

 

Also the burden is rising.

It rose by 17½ percentage points of GDP over
the last 5 years to reach 52½ percent
at end-2018. ( IMF )

Trade Is A Problem

The IMF puts it like this.

The external current account deficit is estimated to have increased to 6.8 percent in 2018 from 6.6 percent of GDP in 2017. This increase was underpinned by strong public capital spending but also by worsening terms-of-trade
on the back of higher world oil prices.

This is an issue and points straight at the currency being too high which is a challenge for the CFA Franc because it is a fixed exchange rate.

Ch-Ch-Changes

Back to Reuters.

Under the deal, the Eco will remain pegged to the euro but the African countries in the bloc won’t have to keep 50% of their reserves in the French Treasury and there will no longer be a French representative on the currency union’s board.

Comment

In economic terms this is a case of meet the new boss same as the old boss. The switches above are more symbolic than real economic changes as the broad reality is that the Eco is pegged to the Euro. As we stand that is not going too badly with economic growth having been strong for some time.

Despite adverse terms-of-trade shocks and security concerns in some member-countries, real GDP growth is estimated to have exceeded 6 percent for the 7th consecutive year in 2018, fueled by strong domestic demand. ( IMF)

Inflation is also low,

But whilst it is an establishment fashion to look at the fiscal deficit and of course that is a Euro area obsession and some might argue fetish the real issue for me is elsewhere. It is the trade position where we see that whether you call the currency the CFA Franc or the Eco it is too high and as inflation is low maybe a devaluation is in order. Where have we heard that before concerning the Euro?

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Good to see UK wage growth well above house price growth

Today brings the UK inflation picture into focus and for a while now it has been an improved one as the annual rates of consumer, producer and house price inflation have fallen. Some of this has been due to the fact that the UK Pound £ has been rising since early August which means that our consumer inflation reading should head towards that of the Euro area. As ever currency markets can be volatile as yesterdays drop of around 2 cents versus the US Dollar showed but we are around 12 cents higher than the lows of early August. The latter perspective was rather missing from the media reporting of this as “tanks” ( Reuters) and “tanking” ( Robin Wigglesworth of the FT) but for our purposes today the impact of the currency has and will be to push inflation lower.

The Oil Price

This is not as good for inflation prospects as it has been edging higher. Although it has lost a few cents today the price of a barrel of Brent Crude Oil is at just below US $66 has been rising since it was US $58 in early October. Whilst the US $70+ of the post Aramco attack soon subsided we then saw a gradual climb in the oil price. So it is around US $8 higher than this time last year.

If we look wider then other commodity prices have been rising too. For example the Thomson Reuters core commodity index was 167 in August but is 185 now. Switching to something which is getting a lot of media attention which is the impact of the swine fever epidemic in China ( and now elsewhere ) on pork prices it is not as clear cut as you might think. Yes the Thomson Reuters Lean Hogs index is 10% higher than a year ago but at 1.92 it is well below the year’a high of 2.31 seen in early April

Consumer Inflation

It was a case of steady as she goes this month.

The Consumer Prices Index (CPI) 12-month rate was 1.5% in November 2019, unchanged from October 2019.

This does not mean that there were no changes within it which included some bad news for chocoholics.

Food and non-alcoholic beverages, where prices overall rose by 0.8% between October and November 2019 compared with a smaller rise of 0.1% a year ago, especially for sugar, jam, syrups, chocolate and confectionery (which rose by 1.8% this year, compared with a rise of 0.1% last year). Within this group, boxes and cartons of chocolates, and chocolate covered ice cream bars drove the upward movement; and • Recreation and culture, where prices overall rose between October and November 2019 by more than between the same two months a year ago.

On the other side of the coin there was a downwards push from restaurants and hotels as well as from alcoholic beverages and tobacco due to this.

The 3.4% average price rise from October to November 2018 for tobacco products reflected an increase in duty on such products announced in the Budget last year.

Tucked away in the detail was something which confirms the current pattern I think.

The CPI all goods index annual rate is 0.6%, up from 0.5% last month……..The CPI all services index annual rate is 2.5%, down from 2.6% last month.

The higher Pound £ has helped pull good inflation lower but the “inflation nation” problem remains with services.

The pattern for the Retail Prices Index was slightly worse this month.

The all items RPI annual rate is 2.2%, up from 2.1% last month.

The goods/services inflation dichotomy is not as pronounced but is there too.

Housing Inflation ( Owner- Occupiers)

This is a story of many facets so let me open with some good news.

UK average house prices increased by 0.7% over the year to October 2019 to £233,000; this is the lowest growth since September 2012.

This is good because with UK wages rising at over 3% per annum we are finally seeing house prices become more affordable via wages growth. Also you night think that it would be pulling consumer inflation lower but the answer to that is yes for the RPI ( via the arcane method of using depreciation but it is there) but no and no for the measure the Bank of England targets ( CPI) and the one that our statistical office and regulators describes as shown below.

The Consumer Prices Index including owner occupiers’ housing costs (CPIH).

Those are weasel words because they use the concept of Rental Equivalence to claim that homeowners pay themselves rent when they do not. Even worse they have trouble measuring rents in the first place. Let me illustrate that by starting with the official numbers.

Private rental prices paid by tenants in the UK rose by 1.4% in the 12 months to November 2019, up from 1.3% in October 2019.

Those who believe that rents respond to wage growth and mostly real wages will already be wondering about how as wage growth has improved rental inflation has fallen? Well not everyone things that as this from HomeLet this morning suggests.

Newly agreed rents have continued to fall across most of the UK on a monthly basis despite above-inflation annual rises, HomeLet reveals.

Figures from the tenancy referencing firm show that average rents on new tenancies fell 0.6% on a monthly basis between October and November, with just Wales and the north-east of England registering a 1.1% and 0.4% increase respectively.

Both the north-west and east of England registered the biggest monthly falls at 0.8%.

Rents were, however, up 3.2% annually to £947 per month.

This is at more than double the 1.5% inflation rate for November.

As you can see in spite of a weak November they have annual rental inflation at more than double the official rate. This adds to the Zoopla numbers I noted on October 16th which had rental inflation 0.7% higher than the official reading at the time.

So there is doubt about the official numbers and part of it relates to an issue I have raised again with the Economic Affairs Committee of the House of Lords. This is that the rental index is not really November’s.

“The short answer is that the rental index is lagged and that lag may not be stable.I have asked ONS for the detail on the lag some while ago and they have yet to respond.”

Those are the words of the former Government statistician Arthur Barnett. As you can see we may well be getting the inflation data for 2018 rather than 2019.

The Outlook

We get a guide to this from the producer price data.

The headline rate of output inflation for goods leaving the factory gate was 0.5% on the year to November 2019, down from 0.8% in October 2019……..The growth rate of prices for materials and fuels used in the manufacturing process was negative 2.7% on the year to November 2019, up from negative 5.0% in October 2019.

So the outlook for the new few months is good but not as good as it was as we see that input price inflation is less negative now. We also see the driving force behind goods price inflation being so low via the low level of output price inflation.

Comment

In many respects the UK inflation position is pretty good. The fact that consumer inflation is now lower helps real wage growth to be positive. Also the fall in house price inflation means we have improved affordability. These will both be boosting the economy in what are difficult times. The overall trajectory looks lower too if we add in these elements described by the Bank of England.

CPI inflation remained at 1.7% in September and is expected to decline to around 1¼% by the spring, owing to the temporary effect of falls in regulated energy and water prices.

However as I have described above these are bad times for the Office for National Statistics and the UK Statistics Authority. Not only are they using imaginary numbers for 17% of their headline index ( CPIH) the claims that these are based on some sort of reality ( actual rental inflation) is not only dubious it may well be based on last year data.

The Investing Channel

 

Sweden has a growing unemployment problem

Today is one for some humility and no I am not referring to the UK election. It relates to Sweden and developments there in economic policy and its measurement which have turned out to be extraordinary even for these times. Let me start by taking you back to the 22nd of August when I noted this.

I am less concerned by the contraction than the annual rate. There had been a good first quarter so the best perspective was shown by an annual rate of 1.4%. You see in recent years Sweden has seen annual economic growth peak at 4.5% and at the opening of 2018 it was 3.6%.

We now know that this broad trend continued into the third quarter.

Calendar adjusted and compared with the third quarter of 2018, GDP grew by 1.6 percent.

What was really odd about the situation is that after years of negative interest-rates the Riksbank raised interest-rates at the end of last year to -0.25% and plans this month to get back to 0%. So it has kept interest-rates negative in a boom and waited for a slow down to raise them. But there is more.

The Unemployment Debacle

If we step forwards to October 24th there was another development.

As economic activity has entered a phase of lower growth in
2019, the labour market has also cooled down. Unemployment is deemed to have increased slightly during the year. ( Riksbank)

Actually it looked a bit more than slightly if we switch to Sweden Statistics.

In September 2019, there were 391 000 unemployed persons aged 15─74, not seasonally adjusted, an increase of 62 000 compared with September 2018.

The Riksbank at this point was suggesting it would raise to 0% but gave Forward Guidance which was lower! Make of that what you will.

But in late October Sweden Statistics dropped something of a bombshell.

STOCKHOLM (Reuters) – Recent Swedish jobless figures – which that have shown a sharp rise in unemployment and led to calls for the central bank to postpone planned interest rate hikes – are suspect, the country’s Statistics Office said on Thursday………….The problems also led to the unemployment rate being underestimated at the start of the year and then overestimated in more recent months.

The smoothed unemployment rate was lowered from 7.3% to 6.8% in response to this and changed the narrative, assuming of course that they had got it right this time. The headline rate went from 7.1% to 6%.

This morning we got the latest update and here it is.

In November 2019, there were 378 000 unemployed persons aged 15─74, not seasonally adjusted, which is an increase of 63 000 persons compared with the same period a year ago. The unemployment rate increased by 1.0 percentage points and amounted to 6.8 percent.

As you can see eyes will have turned to the headline rate having gone from 6% to 6.8% making us wonder if the new methodology has now started to give similar results to the old one. It had been expected to rise but to say 6.3% not 6.8%. We get some more insight from this.

Among persons aged 15–74, smoothed and seasonally adjusted data shows an increase in both the number of unemployed persons and the unemployment rate, compared with nearby months. There were 384 000 unemployed persons in November 2019, which corresponds to an unemployment rate of 6.9 percent.

A much smaller move but again higher and because it is smoothed we also start to think we are back to where we were as this from Danske Bank makes clear.

Ooops! The very unreliable revised new #LFS data showed a significant bounce back up to 7.3 % seasonally adjusted! This is very close to what our model suggested. Ironically, this is just as bad as the old figures suggested. But perhaps these are wrong too? ( Michael Grahn )

So the new supposedly better data is now giving a similar answer to the old. Just for clarity they are taking out the smoothing or averaging effect and looking to give us a spot answer for November unemployment.

The Wider Economy

One way of looking at the work situation is to look at hours worked.

On average, the number of hours worked amounted to 154.3 million per week in November 2019.

But that is lower than under the old system.

On average, the number of hours worked amounted to 156.5 million per week in September 2019…..On average, the number of hours worked amounted to 156.2 million per week in August 2019.

This is really awkward as under the new system Sweden has just under an extra half a million employees but the total number of house worked has fallen. Make of that what you will.

If switch to production we saw a by now familiar beat hammered out earlier this month.

Production in the industry sector decreased by 3.0 percent in October in calendar adjusted figures compared with the same period of the previous year. The industry for machinery and equipment n.e.c. decreased by 6.8 percent in fixed prices and accounted for the largest contribution, -0.2* percentage points, to the development in total private sector production.

Monthly output was up by 0.2% seasonally adjusted but as you can see was well below last year’s. This means Sweden is relying on services for any growth.

Production in the service sector increased by 1.1 percent in October in calendar adjusted figures compared with the same period of the previous year. Trade activities increased by 3.6 percent in fixed prices and contributed the most, 0.5 percentage points, to the development in total private sector production.

So Sweden has maybe some growth which will get a boost from construction.

Production in the construction sector increased by 2.1 percent in October in calendar adjusted figures compared with the same period of the previous year. This sector increased by 2.1 percent in fixed prices, not calendar-adjusted.

If we switch to private-sector surveys then Swedbank tells us this.

The purchasing managers’ index for the private service sector (Services PMI) dropped in November for the third month in a row to 47.9 from 49.4 in October. The
decrease in the index means that service sector activity is continuing to decline in the fourth quarter to levels that have not been seen in six years and that are
contributing to lower hiring needs in service companies,

So maybe the service sector growth has gone as well. The overall measure speaks for itself.

Silf/Swedbank’s PMI Composite index dropped for the third straight month to 47.2 in November from 48.5 in October, reinforcing the view that private sector activity is
slowing in the fourth quarter. Since November of last year the composite index has fallen 7.6 points

Comment

There are two clear issues in this. Of which the first is the insane way in which the Riksbank kept interest-rates negative in a boom and now is raising them in a slowing.

Updated GDP tracker after Nov LFS dropped to a new low since 2012, just 0.26% yoy. ( Michael Grahn of Danske )

Some signals suggest that this may now be a decline or contraction. But whatever the detail the Swedish economy has slowed and will not be helped much by the slower Euro area and UK economies. An interest-rate rise could be at the worst moment and fail the Bananarama critique.

It ain’t what you do it’s the way that you do it
It ain’t what you do it’s the way that you do it
It ain’t what you do it’s the way that you do it
And that’s what gets results

Next is the issue of lies, damned lies and statistics. I am sure Sweden’s statisticians are doing their best but making mistakes like they have about unemployment is a pretty basic fail. It reminds us that these are surveys and not actual counts and adds to the mess Japan made of wages growth. So we know a lot less than we think we do and this poses yet another problem for the central bankers who seem to want to control everything these days.

Let me end with the thought that UK readers should vote and Rest In Peace to Marie Fredriksson of Roxette.

She’s got the look (She’s got the look) She’s got the look (She’s got the look)
What in the world can make a brown-eyed girl turn blue
When everything I’ll ever do I’ll do for you
And I go la la la la la she’s got the look

 

 

 

 

UK GDP growth is as flat as a pancake

Today brings us the last major set of UK economic data before the General Election on Thursday at least for those who vote in person. It is quite a set as we get trade, production, manufacturing and construction data but the headliners will be monthly and quarterly GDP. As the latter seem set to be close to and maybe below zero no doubt politicians will be throwing them around later. Let’s face it they have thrown all sorts of numbers around already in the campaign.

The UK Pound

This has been the economic factor which has changed the most recently although it has not got the attention it deserves in my opinion. At the time of writing the UK Pound £ is above US $1.31, 1.18 to the Euro and nearing 143 Yen. This means that the effective or trade-weighted index calculated by the Bank of England is at 81.1 which is about as good as it has been since the post EU leave vote fall ( there were similar levels in April of last year). This particular rally started on the 9th of August from just below 74 so it has been strong or if you prefer for perspective we opened the year at 76.4.

Thus using the old Bank of England rule of thumb we have seen the equivalent of more than a 1% rise in official interest-rates or Bank Rate in 2019 so far. This has produced two economic developments or at least contributed to them. The first is that inflation prospects look good and I mean by my definition not the Bank of England one. The CPI versions could head below 1% in the months to come and RPI towards 1.5%. The other is that it may have put a small brake on the UK economy and contributed to our weak growth trajectory although many producers are probably used to swings in the UK Pound by now.

Some good news

The trade figures will be helped by this from UK wind.

GB National Grid: #Wind is currently generating 13.01GW (33.08%) out of a total of 39.34GW

The catch is that of course we are reliant on the wind blowing for a reliable supply. Also that it is expensive especially in its offshore guise, as it it both outright expensive to add to the costs of a back-up.

GDP

As to growth well our official statisticians could not find any.

UK GDP was flat in the three months to October 2019.

If we look at the different sectors we see what has become a familiar pattern.

The services sector was the only positive contributor to gross domestic product (GDP) growth in the three months to October 2019, growing by 0.2%. Output in both the production and construction sectors contracted, by 0.7% and 0.3%, respectively. The weakness seen in construction was predominantly driven by a fall of 2.3% in October.

So services grew and production shrank with construction erratic but also overall lower. If you wish to go to another decimal place you can find a small smidgeon of growth as services pushed GDP up by 0.17%, production cost 0.1% and construction cost 0.02% leaving a net 0.05%. But that is spurious accuracy as that puts the numbers under too much pressure.

Services

There was something of note in the monthly series ( October).

Services also grew by 0.2% in October, with widespread growth in several industries. The most notable of these were real estate activities and professional, scientific and technical activities, which both contributed 0.06 percentage points to gross domestic product (GDP) growth. The latter was driven by strength in both architectural and engineering activities, and research and development.

Two things stand out from this. Firstly the quarterly growth was essentially October  and next that much of it was from real estate and architecture. Is Nine Elms booming again? But more seriously something is perhaps going on here that has not been picked up elsewhere.

Production

Here the news has been pretty gloomy all round although the energy part is good news in terms of better weather and less expense for consumers.

Total production output decreased by 0.7% for the three months to October 2019, compared with the three months to July 2019; this was led by manufacturing output, which fell by 0.7%, followed by falls in mining and quarrying (2.6%) and electricity and gas (1.0%).

This reminds us that these areas have been seeing a depression in the credit crunch era.

Production output in the UK remained 6.2% lower for the three months to October 2019 than the pre-downturn peak for the three months to March 2008……..Manufacturing output in the UK remained 3.5% lower for the three months to October 2019 than the pre-downturn peak for the three months to March 2008.

It was not so long ago that it looked like manufacturing was about to escape this but then the trade war happened.

There was a flicker in October alone but the impact of the swings in the pharmaceutical industry are usually much stronger than that.

The growth of 0.1% in total manufacturing output in October 2019, compared with September 2019, was mainly because of widespread strength, with 8 of the 13 subsectors displaying upward contributions. The largest of these came from the volatile pharmaceutical products subsector, which rose by 2.1%, following two consecutive periods of significant monthly weakness during August and September 2019.

Trade

The issue here is the uncertainty of the data which today has illustrated,

The total UK trade deficit (goods and services) widened £2.3 billion to £7.2 billion in the three months to October 2019, as imports grew faster than exports

That seems clear but then again maybe not.

Excluding unspecified goods (which includes non-monetary gold), the total trade deficit narrowed £4.3 billion to £2.9 billion in the three months to October 2019.

The oversea travel and tourism problems have still not be solved.

For earlier monthly releases of UK Trade
Statistics that have also been affected by this error, the versions on the website should be amended
to make clear to users that the errors led the Authority to suspend the National Statistics
designation on 14 November 2014.

Moving on there is also this.

In current prices, the trade in goods deficit widened £6.8 billion to £35.6 billion, largely driven by rising imports; the trade in services surplus widened £4.4 billion to £28.4 billion, largely driven by rising exports.

So there is hope for the UK services exports which seem to be doing well and I have long suspected have been under recorded. For example smaller businesses are likely to be missed out. The scale of this is simply unknown and as we have issues here this must feed into the wider GDP numbers which are so services driven.

So our trade problem is a case of definitely maybe.

Comment

We perhaps get the best perspective from the annual rate of GDP growth which is now 0.8% using the quarterly methodology. If we take out the spring blip that has been declining since the 2% of August 2018. There are some ying and yangs in the detail because of we start with the positive which is services growth ( 1.3%) it has been pulled higher by the information and communication category which is up by 5.4% and education which is up by 3%. But on the other side of the coin the depression in production and manufacturing has worsened as both have fallen by 1.5%. I have little faith in the construction numbers for reasons explained in the past but growth there has fallen to 0%.

There are lots of permutations for the General Election but yet another interest-rate cut by the Bank of England just got more likely. It meets next week. Also political spending plans are getting harder to afford in terms of economic growth,

 

 

 

Why is the US Repo crisis ongoing?

The US Repo crisis is something that seems to turn up every day, or if you prefer as often as we are told there is a solution to trade war between the US and China. On Friday the New York Federal Reserve or Fed provided another US $72.8 billion of overnight liquidity in return for Treasury Bonds ( US $56.1 billion) and Mortgage-Backed Securities ( US $16.7 billion). So something is still going on in spite of the fact that we have two monthly plus Repos ( 42 days) for US $25 billion each in play and 3 fortnightly ones totalling around US $59 billion. So quite a bit of liquidity continues to be deployed and this is before we get to the Treasury Bill purchases.

In accordance with this directive, the Desk plans to purchase Treasury bills at an initial pace of approximately $60 billion per month, starting with the period from mid-October to mid-November.

As an example Friday saw some US $7.525 billion of these bought. So the sums are getting larger.

How did this start?

The Bank for International Settlements or BIS which is the central bankers central bank puts it like this.

On 17 September, the secured overnight funding rate (SOFR) – the new, repo market-based, US dollar overnight reference rate – more than doubled, and the intraday range jumped to about 700 basis points. Intraday volatility in the federal funds rate was also unusually high. The reasons for this dislocation have been extensively debated; explanations include a due date for US corporate taxes and a large settlement of US Treasury securities. Yet none of these temporary factors can fully explain the exceptional jump in repo rates.

Indeed, as for a start the issue has proved to be anything but temporary.

Where the BIS view gets more interesting is via the role of the banks or rather a small group of them.

US repo markets currently rely heavily on four banks as marginal lenders. As the composition of their liquid assets became more skewed towards US Treasuries, their ability to supply funding at short notice in repo markets was diminished.

As the supply of reserves fell in the QT or Quantitative Tightening era they stepped up to the plate on a grand scale.

As repo rates started to increase above the IOER from mid-2018 owing to the large issuance of Treasuries, a remarkable shift took place: the US banking system as a whole, hitherto a net provider of collateral, became a net provider of funds to repo markets. The four largest US banks specifically turned into key players: their net lending position (reverse repo assets minus repo liabilities) increased quickly, reaching about $300 billion at end-June 2019 . At the same time, the next largest 25 banks reduced their demand for repo funding, turning the net repo position of the banking sector positive (centre panel, dashed line).

So things became more vulnerable as we note this.

At the same time, the four largest banks held only about 25% of reserves (ie funding that they could supply at short notice in repo markets).

Then demand for Repo funding was affected by the US Treasury.

After the debt ceiling was suspended in early August 2019, the US Treasury quickly set out to rebuild its dwindling cash balances, draining more than $120 billion of reserves in the 30 days between 14 August and 17 September alone, and half of this amount in the last week of that period. By comparison, while the Federal Reserve runoff removed about five times this amount, it did so over almost two years

As you can see the drain from QT was added to in spite of the fact that the market had become more vulnerable due to the lack of players. There was a clear lack of joined up thinking at play and perhaps a lack of any thinking at all. A factor here was something the BIS identifies for the banks.

For instance, the internal processes and knowledge that banks need to ensure prompt and smooth market operations may start to decay. This could take the form of staff inexperience and fewer market-makers, slowing internal processes

After a decade the experienced hands had in general moved on.

But it was not enough to collapse the house of cards. There were other nudges as well on the horizon.

Market commentary suggests that, in preceding quarters, leveraged players (eg hedge funds) were increasing their demand for Treasury repos to fund arbitrage trades between cash bonds and derivatives. Since 2017, MMFs have been lending to a broader range of repo counterparties, including hedge funds, potentially obtaining higher returns.

So hedge funds were playing in the market but as it happened were not an issue for a while as the US Money Market Funds (MMF) turned up. But then they didn’t.

 During September, however, quantities dropped and rates rose, suggesting a reluctance, also on the part of MMFs, to lend into these markets. Market intelligence suggests MMFs were concerned by potential large redemptions given strong prior inflows. Counterparty exposure limits may have contributed to the drop in quantities, as these repos now account for almost 20% of the total provided by MMFs.

So there is a hint that maybe a hedge fund or two became such large players that they hit counterparty limits. Also redemptions from MMFs would hardly be a surprise as we note the interest-rate cuts we have seen in 2019.

Why should we care?

There is this.

 Repo markets redistribute liquidity between financial institutions: not only banks (as is the case with the federal funds market), but also insurance companies, asset managers, money market funds and other institutional investors. In so doing, they help other financial markets to function smoothly.

So they oil the wheels of financial markets and when they don’t? Well that is one of the causes of the credit crunch.

The freezing-up of repo markets in late 2008 was one of the most damaging aspects of the Great Financial Crisis (GFC).

In case you did not know what they are.

A repo transaction is a short-term (usually overnight) collateralised loan, in which the borrower (of cash) sells a security (typically government bonds as collateral) to the lender, with a commitment to buy it back later at the same price plus interest.

Also it is one of those things which get little publicity ( mostly ironically because they usually work smoothly) but there is a lot of action.

 Thus, any sustained disruption in this market, with daily turnover in the US market of about $1 trillion, could quickly ripple through the financial system.

Comment

Some of the factors in the Repo crisis were unpredictable. But it is also true that the US Fed was at best rather flat-footed. There had been a long-running discussion over the use of Interest On Excess Reserves or IOER to banks on such a scale which was not resolved. Then there was the way that so few banks (4) were able to become such large players creating an obvious risk. Then the role of the MMFs as by their very nature they flow into and out of markets and are likely to flow out when interest-rates are declining.

The BIS analysis adds to what we know but changes in stocks give us broad trends rather than telling what flowed where or rather did not flow on September 17th or since. As David Bowie put it.

Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
Don’t want to be a richer man
Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
There’s gonna have to be a different man
Time may change me
But I can’t trace time

Number Crunching

The BIS has been looking into some other areas.

An analysis of the #TriennialSurvey finds that global notional for #OTCderivatives rose to $640 trn in 2019, dominated by #InterestRateDerivatives

Average daily turnover of OTC interest rate derivatives more than doubled over 2016-19 to $6.5 trillion, taking OTC markets’ share to almost half total trading

30 years, 53 countries, 1,300 reporting dealers, and $6.6 trillion daily FX trades,

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