Greece GDP growth is accompanied by weakening trade and falling investment

Let us take the opportunity to be able to look at some better news from Greece which came from its statistics office yesterday.

The available seasonally adjusted data indicate that in the 3
rd quarter of 2018 the Gross Domestic Product (GDP) in volume terms increased by 1.0% in comparison with the 2
nd quarter of 2018, while in comparison with the 3 rd quarter of 2017, it increased by 2.2%.

So Greece has achieved the economic growth level promised for 2012 in the original “shock and awe” plan of the spring of 2010. Or to be more specific regained it as the 1.3% growth of the second quarter of 2017 saw the annual growth rate rise to 2.5% at the opening of this year before falling to 1.7%. So far in 2018 Greece has bucked the Euro trend but in a good way as quarterly economic growth has gone 0.5%,0.4% and now 1%.

If we continue with the upbeat view there was this on Monday from the Markit PMI business survey of the manufacturing sector.

Greek manufacturing firms signalled renewed growth
momentum in November, with the PMI rising to a six month high. The solid overall improvement in operating
conditions was driven by stronger expansions in output and
new orders. That said, foreign demand was not as robust,
with new export order growth easing to a 14-month low.
Manufacturers increased their staffing numbers further
in November, buoyed by stronger production growth and
domestic client demand.

So starting from a basic level there is growth and it is better than the average for the Euro area with a reading of 54 compared to 51.8. Also there is hopeful news for an especially troubled area.

In line with stronger client demand, manufacturing firms
expanded their workforce numbers at the fastest pace for
three months. Moreover, the rate of job creation was one of
the quickest since data collection began in 1999

Concerns

If we move to the detail of the national accounts we see that even this level of growth comes with concerns.

Exports of goods and services increased by 2.8% in comparison with the 2nd quarter of 2018. Exports of goods increased by 1.0% while exports of services increased by 3.8%.

This looks good at this point for what was called the “internal devaluation” method where the Greek economy would become more price competitive via lower real wages. But it got swamped by this.

Imports of goods and services increased by 7.5% in comparison with the 2nd quarter of 2018. Imports of goods increased by 8.3% while imports of services increased by 2.2%.

If we look deeper we see that the picture over the past year is the same. We start with a story of increasing export growth looking good but it then gets swamped by import growth.

Exports of goods and services increased by 7.6% in comparison with the 3rd quarter of 2017. Exports of goods increased by 7.9%, and exports of services increased by 8.0%…… Imports of goods and services increased by 15.0% in comparison with the 3 rd quarter of 2017. Imports of goods increased by 15.0%, and imports of services increased by 16.0%.

This is problematic on two counts and the first one is the simple fact that a fair bit of the Greek problem was a trade issue and now I fear that for all the rhetoric the same problem is back. Perhaps that is why we are hearing calls for reform again. Are those the same reforms we have been told have been happening. Also I note a lot of places saying Greek economic growth has been driven by exports which is misleading. This is because it is the trade figures which go in and they are a drag on GDP due to higher import growth. We can say that Greece has been both a good Euro area and world member as trade growth has been strong over the past year but it has weakened itself in so doing.

Investment

An economy that is turning around and striding forwards should have investment growth yet we see this.

Gross fixed capital formation (GFCF) decreased by 14.5% in comparison with the 2nd quarter of 2018.

Ouch! Time for the annual comparison.

Gross fixed capital formation (GFCF) decreased by 23.2% in comparison with the 3rd quarter of 2017.

Whilst those numbers are recessionary as a stand-alone they would be signals of a potential depression but for the fact Greece is still stuck in the middle of the current one. For comparison Bank of England Governor Mark Carney asserted that UK investment is 16% lower than it would have otherwise have been after the EU Leave vote so Greece is much worse than even that.

There are issues here around the level of public investment and the squeeze applied to it to hit the fiscal surplus targets. If this from National Bank of Greece in September is to turn out to be correct then it had better get a move on.

A back-loading of the public investment programme, along with positive confidence effects, should provide an additional boost to GDP growth in the H2:2018,

What did grow then?

Rather oddly the other sectoral breakdown we are provided with shows another fall.

Total final consumption expenditure decreased by 0.2% in comparison with the 2nd quarter of 2018.

But the gang banger in all of this is the inventories category which grew by 1321 million Euros or if you prefer accounts for 2.4% quarterly GDP growth on its own. This is not exactly auspicious looking forwards as you can imagine unless there is about to be a surge in demand. The only caveat is that we do not get a chain-linked seasonally adjusted number.

Comment

As you can see there is plenty of food for thought in the latest GDP numbers for Greece.On the surface they look good but the detail is weaker and in some cases looks simply dreadful. That is before we get to the impact of the wider Euro area slow down. The problem with all of this is that of we look back rather than the 2.1% economic growth promised for 2012 Greece saw economic growth plunge into minus territory peaking twice at an annual rate of 10.2%. Or the previous GDP peak of 60.4 billlion Euros of the spring of 2009 has been replaced by 48 billion in the autumn of 2018.

Meanwhile after the claimed triumphs and reform and of course extra cash the banks look woeful. So of course out comes the magic wand. From the Bank of Greece.

The proposed scheme envisages the transfer
of a significant part of non-performing exposures
(NPEs) along with part of the deferred
tax credits (DTCs), which are booked on bank
balance sheets, to a Special Purpose Vehicle
(SPV). value (net of loan loss provisions). The
amount of the deferred tax asset to be transferred
will match additional loss, so that the
valuations of these loans will approach market
prices. Subsequently, legislation will be
introduced enabling to transform the transferred
deferred tax credit into an irrevocable
claim of the SPV on the Greek State with a
predetermined repayment schedule (according
to the maturity of the transaction).

More socialisation of losses?

 

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The Bank of England and Mark Carney are in denial mode

One of the features of the Brexit debate has been the role of the Bank of England in it. One thing that a supposedly independent central bank should do is avoid being accused of being on one side or the other of political debates. Also it has presented a view which is supposedly supported by the whole institution when with such a split nation that seems incredibly implausible. Thus the alternative view of independence and the reason for having external members, which is to provide different perspectives and emphasis, looks troubled at best.

On this road we see an organisation where all the Deputy-Governors are alumni of Her Majesty’s Treasury, which raises the issue of establishment capture. Also this from the Bank of England website suggests the use of another form of motivation to capture individuals.

Dr Ben Broadbent became Deputy Governor on 1 July 2014. Prior to that, he was an external member of the Monetary Policy Committee from 1 June 2011.

I am far from alone in thinking that this sets up all the wrong motivations and strengthens the power of the Governor via patronage. As to appointment of the absent-minded professor maybe one day he will demonstrate why unless of course we already know.

For the decade prior to his appointment to the MPC, Dr Broadbent was Senior European Economist at Goldman Sachs,

Mervyn King

There is something of an irony in the way that any sort of flicker of Bank of England comes from the former Governor the now Baron King of Lothbury although Bloomberg describe him without his new title.

Mervyn King, a professor at the New York University Stern School of Business,

If we move to his critique here are the details.

It saddens me to see the Bank of England unnecessarily drawn into this project. The Bank’s latest worst-case scenario shows the cost of leaving without a deal exceeding 10 percent of GDP.

Why is this wrong?

Two factors are responsible for the size of this effect: first, the assertion that productivity will fall because of lower trade; second, the assumption that disruption at borders — queues of lorries and interminable customs checks — will continue year after year. Neither is plausible. On this I concur with Paul Krugman. He’s no friend of Brexit and believes that Britain would be better off inside the EU — but on the claim of lower productivity, he describes the Bank’s estimates as “black box numbers” that are “dubious” and “questionable.” And on the claim of semi-permanent dislocation, he just says, “Really?” I agree: The British civil service may not be perfect, but it surely isn’t as bad as that.

The productivity issue is one that has been addressed at the Treasury Select Committee ( TSC) this morning. As I listened I heard Deputy Governor Broadbent tell us that productivity has been falling which is true but when it came to a rationale for further Brexit driven effects we got only waffle. Actually the Chair of the TSC Nicky Morgan was much more impressive by discussing the oil price shock of the 1970s as opposed to Ben Broadbent’s New Zealand based example from the same decade. Later questions on this subject had both the Governor and Ben Broadbent in retreat on the issue of how useful an example New Zealand will be especially as it coincided with a large oil price shock.

There are different arguments as to how long any Brexit effect would last. However one would expect at least some of the issues to decline and go away.

Bank of England evidence

If we move to this morning;s questions posed to the Bank of England there has been a clear attempt by Governor Carney to cover off the fire he is under with two methodologies.

  1. To say the Treasury Select Committee asked for the production of scenarios.
  2. To present it as a technocratic and scientific process where we were told 160 people were involved and 600, measurements were taken. We were guided towards some elasticities where the range was presented between 0.75 and 0.16 and told that 0.25 had been chosen.

He has a point with the first issue because they did do that when it would have been better to have asked the Office for Budget Responsibility. After all as it has been drawn from the same establishment base it would have been likely to have given similar answers if that was the purpose and kept the Bank of England out of it. The second argument is very weak as anyone familiar with the methodology knows that economic models depend more on the assumptions used than anything else. You do not need to know much about them to realise that they are an art form much more than they are a science. Usually of course a bad art form.

Next up was Deputy Governor Jon Cunliffe who has spent a career at HM Treasury as well as this described from the Bank of England website.

Before joining the Bank, Jon was the UK Permanent Representative to the European Union, effective from 9 January 2012.

When quizzed on this he told us this was in the past but a mere ten minutes later he was boasting about his experience. Sadly the inconsistency remained unchallenged as did his assertion that the higher cost of doing financial services business in Frankfurt as opposed to London was not going to be a major factor.

The issue of making this accessible came up with an MP just asking “I am looking for human speak” which added to a previous request for Governor Carney to talk like a human being rather than like an economist. This did not go especially well and to my mind left the interventions of the absent-minded professor as mostly waffle.

Sadly this from the Governor was not challenged though.

We are delivering price stability

Since inflation has been above its 2% per annum target for 18 months that is open to quite a bit of debate! That is before we get to the deeper issue of a 2% inflation target not being the price stability but is spun as. Also if we reflect that reality then one may be troubled by the next bit.

We will deliver financial stability.

Comment

There is a fair bit to consider here and as ever I do my best to avoid the politics and cover what has been said as accurately as I can as there is no official transcript yet. But let me return to an issue I raised last Thursday about the scenario where the Bank of England raises Bank Rate to 5.5% and other interest-rates go even higher.

BOE informing the masses. Carney tells that its controversial projection of Bank Rate going up to 5.5% on disorderly Brexit is mechanistic – a calculation from “a sum of squared deviations of inflation from target and output from potential.” Capiche? ( @DavidRobinson2k )

Nobody seems to have told the “squared deviations” that we are dealing with people who have consistently ignored deviations in inflation above target. Apparently though this is a complete success.

Carney adds that there was “a simpler, less-successful time”, when the Bank only focused on inflation…and we know how that turned out [it led to the financial crisis!].

That’s why we now have a financial policy committee to guard the economy, and that’s why the banks are ready for Brexit, the governor explains: ( The Guardian )

 

 

France does not like being told higher inflation is good for it

This weekend has seen a further escalation in the Gilet Jaune or yellow jacket protest in France. This has so unsettled Bloomberg that it is running a piece suggesting it could happen in the UK perhaps as a way of mollifying the bankers it has suggested should go to Paris. However, let us dodge the politics as far as we can as there is a much simpler economic focus and it is inflation. From the Financial Times.

Mr Macron introduced the increases in fuel taxes last year, as part of a package intended to attract investment and revitalise economic growth. They were also intended to support his ambition of setting France on course to ban sales of petrol and diesel cars by 2040. The tax is rising more sharply for diesel fuel, to bring it into line with the tax on petrol, as Mr Macron’s government argues that the advantage it has enjoyed is unjustified. Since the Volkswagen emissions scandal, it has become more widely accepted that diesel vehicles do not have the advantage in environmental impact over petrol engines, although manufacturers are still defending the technology.

Let us analyse what we have been told. How do you revitalise economic growth by raising costs via higher taxes? Perhaps if that was your intention via this move you would reduce taxes on petrol instead of at least reduce petrol taxes by the same amount you raise the diesel ones. As to the point about diesel engines I agree as I am the owner of what I was told was a clean diesel but has turned out to be something polluting both my and other Londoners lungs. Not President Macron’s fault of course as that was way before he came into power and of course he is the French President. But no doubt they encouraged purchases of diesel vehicles ( by the lower tax if nothing else) as we note that when the establishment is wrong it “corrects” matters by making the ordinary person pay. This especially hits people in rural France who rely on diesel based transport.

The details of the extra tax are show by Connexions France from October 2017.

Tax on diesel will rise 2.6 cents per litre every year for the next four years, after MPs voted in favour of the government’s draft budget for 2018.

As this from the BBC shows this is as well as higher taxes on petrol.

the Macron government raised its hydrocarbon tax this year by 7.6 cents per litre on diesel and 3.9 cents on petrol, as part of a campaign for cleaner cars and fuel.

The decision to impose a further increase of 6.5 cents on diesel and 2.9 cents on petrol on 1 January 2019 was seen as the final straw.

If we look at the November CPI data for France we see that it is at 1.9% but is being pulled higher by the energy sector which has annual inflation of 11.9%. In a piece of top trolling Insee tells us this.

After seven months of consecutive rise, energy prices should fall back, in the wake of petroleum product prices.

If we look at this via my inflation theme we see that as well as energy inflation being 11.3% that food inflation is 5%. So whilst central bankers may dismiss that as non-core and wonder what is going on? We can see perhaps why the ordinary person might think otherwise. Especially if they like carrots.

 Vegetable prices rose by 15.2% over one year with prices going up for salads (+15.6%), endives (+19.5%), carrots (+76.7%) and leeks (+54.2%). In contrast, tomato prices went down by 12.3% over one year.  ( Insee October agricultural prices)

Manufacturing

This morning saw the monthly series of Markit purchasing manager’s indices on manufacturing published.

November data pointed to the softest improvement in French manufacturing operating conditions for 26 months. The latest results reflected falling new orders and job shedding…….Manufacturing output was unchanged since October. That said, the latest reading represented stabilisation following a drop in production in the previous month.

It used to be the case that Markit was downbeat on France but these days it is very cheery. If we look at the last two months then production is lower as are jobs and new orders yet we are told this is an improvement! In reality the zone 49-51 represents unchanged and 50.8 is in that, although I do note that the 53.1 of the UK is apparently “lacklustre”. Anyway here is the view of the French situation.

However, any negativity towards unchanged output could be misplaced given it represented stabilisation after October’s decline.

Moving to prices they hinted that the protests might not be about to end any time soon.

On the price front, input costs continued to rise in
November. The rate of inflation was the strongest for nine
months, following two successive accelerations. Panellists
overwhelmingly blamed higher cost burdens on increased
raw material prices.
Survey respondents noted that part of the additional cost
burden was passed onto customers, with charges rising
solidly again in November.

Official data

On Friday we saw that September seems to have seen a slow down in the French economy.

In September 2018, the sales volume in overall trade fell back sharply (−2.1%) after an increase in August (+1.8%)…..In September 2018, the turnover turned down sharply in the manufacturing industry (−2.3%) after a strong increase in August (+2.8%). It also went down in industry as a whole (−1.9% after +2.8% in August)……In September 2018, output in services was stable after a strong increase in August (+2.9%).

As you can see all measures saw weakening in September and eyes will be on the services sector. This is because whilst the national accounts do not present it like this the 1% growth for the sector was what made it a better quarter. So let us also dig into the situation further.

According to business managers surveyed in November 2018, the business climate in services is stable. At 103, it remains above its long-term average (100).

Otherwise, the indicator of October 2018 has been revised downward by two points because of late businesses’ answers that have been taken into account.

Considering this revision, the turning point indicator stands henceforth in the area indicating an unfavourable short-term economic situation.

The Bank of France remains optimistic however.

According to the monthly index of business activity (MIBA),
GDP is expected to increase by 0.4% in the fourth
quarter of 2018 (first estimate).

Comment

We often discuss the similarities between France and the UK but the ECB has this morning given us another insight, as according to its capital key France is virtually unchanged in relative terms over the past five years if we look at GDP and population combined. I will leave readers to decide for themselves if the Euro area average is good or bad as you mull the official view.

 

Switching back to France it has not been a great year economy wise even if the Bank of France is correct about this quarter. But its establishment seems to be up to the games of those elsewhere whilst is to push its policies via punishment ( higher taxes ) rather than encouragement. These days though more have seen through this and hence the current troubles.

Weekly Podcast

The world of negative interest-rates now has negative economic growth too

It was not that long ago that many of us “experts” in the interest-rate market felt that negative interest-rates could not be sustained. Back then the past Swiss example could be considered a tax – which remains a way of considering negative interest-rates – and the flicker in Japan was covered by it being Japan. Yesterday brought some fascinating news from the front line which has been in danger of being ignored in the current news flow.

Sweden’s GDP decreased by 0.2 percent in the third quarter of 2018, seasonally adjusted, compared with the second quarter of 2018. GDP increased by 1.6 percent, working-day adjusted, compared with the third quarter of 2017. ( Sweden Statistics).

Firstly let me reassure you that Sweden has no Brexit style plans. What it does have is negative interest-rates as this from the Riksbank shows.

Consequently, in line with the previous forecast, the Executive Board has decided to hold the repo rate unchanged at -0.50 per cent.

I bet they now regret opening their latest forward guidance report like this.

Since the Monetary Policy Report in September, economic developments have been largely as expected, both in Sweden and abroad.

In fact the Riksbank was expecting this.

The most recently published National Accounts paint a picture of  slightly weaker GDP growth in recent years. Nevertheless, the Riksbank deems that economic activity in Sweden has been and continues to be strong.

In fact it has been so nonplussed that it has already reached for the central banking playbook and wondered what is Swedish for Johnny Foreigner?

Riksbank Floden: Sees Increased Uncertainty In World Economy ( @LiveSquawk )

Those who have followed my analysis that central banks will delay moving out of extraordinary monetary policy and negative interest-rates and thus are in danger of being trapped, will have a wry smile at this.

The forecast for the repo rate is unchanged since
the monetary policy meeting in September and indicates that the repo rate will be raised by 0.25
percentage points either in December or in February. As with the first raise, monetary policy will also
subsequently be adjusted according to the prospects for inflation.

That’s the spirit! You keep interest-rates negative through a strong phase of economic growth then you raise them when you have a quarterly decline. Oh hang on. I am not being clever after the event here because a month or so before the Riksbank report on the 6th of September I pointed out this.

This is also true of Sweden because if we look at the narrow measure or M1 we see that an annual rate of growth of 10.5% in July 2017 was replaced with 6.3% this July. …..A similar but less volatile pattern can be seen from the broad money measure M3. That was growing at an annual rate of 8.3% in July 2015 as opposed to the 5.1% of this July.

Since then M1 has stabilised but M3 has fallen further and was 4.5% in October. In fact if you were looking for an area it might effect then it would be domestic consumption so lets take a look.

Household consumption expenditures decreased by 1.0 percent and government consumption expenditures remained unchanged, seasonally adjusted, compared with the previous quarter ( Sweden Statistics).

Time for page 2 of the central banking play book.

Riksbank’s Floden: Recent Data Since Latest Policy Meeting Have Been Disappointing -But There Were Some Temporary Effects In 3Q GDP Data,

Something else caught my eye and it was this.

 Exports grew by 0.3 percent and imports declined by 0.6 percent.

So foreign demand flattered the numbers in a rebuttal to the central banking play book. But if we look at the overall pattern then economics 101 has yet more to think about.

J curve R.I.P. (?) – In Sweden, 2018 is heading for the worst trade year ever. The Oct deficit was SEK8.4bn. One observation: J curve effect does not work and thus the exchange rate channel (on real economy) is partially broken.   ( Stefan Mullin)

So let’s see you have negative interest-rates to boost domestic demand which is falling and you look to drive the currency lower which does not seem to be helping trade. Oh and you plan to raise interest-rates into a monetary decline. What could go wrong?

As it is the end of the week let us have some humour albeit of the gallows variety from Forex Crunch yesterday.

Analysts at TD Securities suggest that their nowcast models point to a 0.6% q/q gain to Sweden’s GDP (mkt: 0.2% q/q on a wide range of estimates), which if materialised would leave TD (and likely the Riksbank) comfortable with a December rate hike

Switzerland

Let us start with a response from Nikolay Markov of Pictet Asset Management.

GDP growth plunged to its lowest pace since the introduction of negative rates in Q1 2015. There is no reason to panic as this is a temporary drop:

There are few things more likely to cause a panic than being told there is no reason for it. I also note he was not so kind to the Swedes. Let us investigate using Swiss Statistics.

Switzerland’s GDP fell by 0.2% in the 3rd quarter of 2018, after climbing by 0.7% in the previous quarter. The strong, continuous growth phase enjoyed by the Swiss economy for one and a half years was suddenly interrupted.

The change has seen annual growth dip from 3.5% to 2.4% so different to Sweden although there has been a fall in the growth of domestic consumption. Quite what a central bank with an interest-rate of -0.75% can do about falling domestic consumption is a moot point. A driver of the decline is a familiar one.

Value added in manufacturing dipped slightly (−0.6%);  Total exports of goods (−4.2%) also contracted substantially.

The official view is that is just a blip but it does require watching as I note this area still seems to be troubled as this from earlier shows.

How cold is ‘s auto market? Passenger car sales down 28% in first 3 weeks of Nov. Whole year drop “inevitable”. Car dealers’ inventory climbing and many of them making losses. Authority said bringing back purchase tax cut will not help much. ( @YuanTalks )

Just as a reminder the Swiss National Bank holds some 778.05 billion Swiss Francs of foreign currency investments as a result of its interventions to reduce the exchange-rate of the Swissy.

Comment

These developments add to those at some other members of the negative interest-rates club or what is called NIRP.

German economic growth has stalled. As the Federal Statistical Office (Destatis) already reported in its first release of 14 November 2018, the gross domestic product (GDP) in the third quarter of 2018 was by 0.2% lower – upon price, seasonal and calendar adjustment – than in the second quarter of 2018.

And another part of discovering Japan.

Japan’s economy shrank in the third quarter as natural disasters hit spending and disrupted exports.

The economy contracted by an annualised 1.2% between July and September, preliminary figures showed. ( BBC )

As you can see we go to part three of the play book as the poor old weather takes another pounding. Quite what this has done to IMF News I am not sure as imagine how it would report such numbers for the UK?

has had an extended period of strong economic growth—GDP expected to rise by 1.1% in 2018.

 

Perhaps it has been discombobulated by a period when expansionary monetary policy has not only crunched to a halt but gone into reverse at least for a bit. But imagine you are a central banker right now wondering of this may go on and you will be starting it with interest-rates already negative. Or to use the old City phrase, how are you left?

Oh and hot off this morning’s press there is also this.

In the third quarter of 2018 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) decreased by 0.1 per cent to the previous quarter and increased by 0.7 per cent in comparison with the third quarter of 2017. ( Italy Statistics)

Japan

There as been a development in something predicted by us on here quite some time ago. So without further ado let me hand you over to The Japan Times.

Japan is considering transforming a helicopter destroyer into an aircraft carrier that can accommodate fighter jets, a government source said Tuesday,

 

 

 

 

What is going on at the Bank of England these days?

Yesterday saw the publication of Brexit forecasts from HM Treasury and the Bank of England. The former was always going to be politically driven but the Bank of England is supposed to be independent, although these days we have to ask independent of what? There is little sign of that to be seen. Let us take a look at the Bank of England scenarios.

The estimated paths for GDP, CPI inflation and unemployment in the Economic Partnership scenarios are
shown in Charts A, B and C. The range reflects the sensitivity to the key assumptions about the extent to
which trade barriers rise, and how rapidly uncertainty declines. GDP is between 1¼% and 3¾% lower than
the May 2016 trend by end-2023. Relative to the November 2018 Inflation Report projection, by end-2023 it is 1¾% higher in the Close scenario, and ¾% lower in the Less Close scenario.

After singing its own fingers last time around it is calling these scenarios rather than forecasts but pretty much everyone is ignoring that. The problem with this sort of thing is that you end up doing things the other way around. Frankly the answers are decided and then the assumptions are picked to get you there. We do know some things.

Productivity growth has slowed, sterling has depreciated and the increase in inflation has squeezed real incomes.

However really the most certainty we have is about the middle part of a lower UK Pound £ and even there the Bank of England seems to omit its own part ( Bank Rate cut and Sledgehammer QE ) in the fall. That caused the fall in real incomes as we see how policy affected the results.

If we move wider the Bank of England attracted fire from both sides as for example this is from the former Monetary Policy Committee member Andrew Sentance who is a remain supporter.

The reputation of economic forecasts has taken a bad blow today with both UK government and appearing to use forecasts to support political objectives. Let’s debate – which I strongly oppose – rationally without recourse to bogus forecasts.

Why would he think that?

Well take a look at this.

The estimated paths for GDP, CPI inflation and unemployment in the disruptive and disorderly scenarios
are shown in Charts A, B and C. GDP is between 7¾% and 10½% lower than the May 2016 trend by end 2023.
Relative to the November 2018 Inflation Report projection, GDP is between 4¾% and 7¾% lower by
end-2023. This is accompanied by a rise in unemployment to between 5¾% and 7½%. Inflation in these
scenarios then rises to between 4¼% and 6½%.

It is the latter point about inflation and a claimed implication of it I wish to subject to both analysis and number-crunching.

How would the Bank of England respond to higher inflation?

Here is the claimed response.

Monetary policy responds mechanically to balance deviations of inflation from target and output
relative to potential. Bank Rate rises to 5.5%.

Let us see how monetary policy last responded to an expected deviation of inflation above target to back this up.

This package comprises:  a 25 basis point cut in Bank Rate to 0.25%; a new Term Funding Scheme to reinforce the pass-through of the cut in Bank Rate; the purchase of up to £10 billion of UK corporate bonds; and an expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion.

As you can see the mechanical response seems to be missing! Unless of course you count the mechanical response of the mind of Mark Carney as he panicked thinking the UK was going into recession. The other 8 either panicked too or meekly fell in line. The point is further highlighted if we look at the scenario assumed for the exchange-rate of the UK Pound £.

And as the sterling risk premium increases, sterling falls by 25%, in addition to the 9% it has already fallen
since the May 2016 Inflation Report.

Let us examine the reaction function. Let us say that the £ had fallen by 10% when the Bank of England took action then if it ” responds mechanically” we would expect this time around to see a 0.625% reduction in Bank Rate and some £150 billion of extra QE as well as another Term Funding Scheme bank subsidy of over £300 billion.

Instead we are expected to believe that the Bank of England would raise and not cut interest-rates and would do so by 4.75%! There is also an issue with the timing as the forward guidance of the Bank of England has been for Bank Rate rises for over 4 years now and we have had precisely 0.25% in net terms. So at the current rate of progress the interest-rate increases would be complete somewhere around the turn of the century.

Actually there is more because other interest-rates would go even higher it would appear.

Uncertainty about institutional credibility leads to a pronounced increase in risk premia on sterling
assets, including a 100bps increase in the term premium on gilts.

So an extra 1% on Gilt yields although this is only related to a particular piece of theory as we skip what they would be apart from an implication of maybe 6.5%. A particular catch in that is the current ten-year yield is a mere 1.33% and over the past 24 hours it has been falling adding to the previous falls I have been reporting for a while now. Markets do of course move in the wrong direction at times but Gilt investors seem to be placing their bets on the Gilt market and ignoring the Bank of England scenario.

But wait there is more.

Overall, interest rates on loans to households and businesses rise by 250bps more than Bank Rate.

Can this sort of thing happen? Yes as we saw it in the build up to the credit crunch as UK interest-rates disconnected from Bank Rate by around 2%. Also yesterday we were noting such a thing via the fact that Unicredit of Italy has found itself paying 7.83% on a bond which was yielding only 1% as recently as yesterday. But there are two main problems of which the first occurred on Mark Carney’s watch as we note that they way he “responds mechanically” to such developments is to sing along with MARRS.

Pump up the volume
Pump up the volume
Pump up the volume
Get down

Actually such a response by the Bank of England was typical before the advent of Governor Carney. Recall this?

For instance, during the financial crisis the exchange rate
depreciated around 30% initially but settled to be around 25% below its pre-crisis peak in the following
couple of years.

So in a broad sweep in line with the new worst case scenario especially as we recall that inflation went above 5% on both main measures. So Bank Rate went to 5.5%? Er now it was slashed by over 4% to 0.5% and we saw the advent of QE that eventually rose in that phase to £375 billion.

Comment

The first comment was provided by financial markets as we have already noted the Gilt market rally which was accompanied by the UK Pound £ rallying above US $1.28. The UK FTSE 100 did fall but only by 13 points. If there is anything a Bank of England Governor would hate it is being ignored.

Actually the timing was bad too. For some reason the report was delayed from 7:30 am to 4:30 pm but due to yet another problem it was another ten minutes late. This means that very quickly eyes turned to this by Federal Reserve Chair Jerome Powell.

Stocks ripped higher on Wednesday after Federal Reserve Chairman Jerome Powell said interest rates are close to neutral, a change in tone from remarks the central bank chief made nearly two months ago. ( CNBC )

Roughly that seems to take 0.5% off the expected path of US interest-rates and has led to the US ten-year Treasury Note yield falling back to 3%. Also trying to convince people about higher inflation is not so easy when the oil price ( WTI) falls below US $50.

Me on Core Finance TV

 

 

 

 

 

The challenge for the ECB remains Italy and its banks

This week has seen something of an expected shifting of the sands from the European Central Bank ( ECB) about the economic prospects for the Euro area. On Monday its President Mario Draghi told the European Parliament this.

The data that have become available since my last visit in September have been somewhat weaker than expected. Euro area GDP grew by 0.2% in the third quarter. This follows growth of 0.4% in both the first and second quarter of 2018. The loss in growth momentum mainly reflects weaker trade growth, but also some country and sector-specific factors.

What he did not say was that back in 2017 quarterly growth had risen to 0.7% for a time. Back then the situation was a happy one for Mario and his colleagues as their extraordinary monetary policies looked like they were bearing some fruit. However the challenge was always what happens when they begin to close the tap? Let me illustrate things by looking again at his speech.

The unemployment rate declined to 8.1% in September 2018, which is the lowest level observed since late 2008, and employment continued to increase in the third quarter…….. Wages are rising as labour markets continue to improve and labour supply shortages become increasingly binding in some countries.

There is a ying and yang here because whilst we should all welcome the improvement in the unemployment rate, we would expect the falls to slow and maybe stop in line with the reduced economic growth rate. So is around 8% it for the unemployment rate even after negative interest-rates ( still -0.4%) and a balance sheet now over 4.6 trillion Euros? That seems implied to some extent in talk of “labour supply shortages” when the unemployment rate is around double that of the US and UK and treble that of Japan. This returns us to the fear that the long-term unemployment in some of the Euro area is effectively permanent something we looked at during the crisis. In another form another ECB policymaker has suggested that.

I will focus my remarks today on the economies of central, eastern and south-eastern Europe (CESEE), covering both those that are already part of the European Union (EU) and those that are EU candidate countries or potential candidates………..Clearly, for most countries, convergence towards the EU-28 average has practically stalled since the outbreak of the financial crisis in 2008

Care is needed as only some of these countries are in the Euro but of course some of the others should be converging due to the application process. Even Benoit Coeure admits this.

And if there is no credible prospect of lower-income countries catching up soon, there is a risk that people living in those countries begin questioning the very benefits of membership of the EU or the currency union.

I have a couple of thoughts for you. Firstly Lithuania has done relatively well but the fact I have friends from there highlights how many are in London leading to the thought that how much has that development aided its economy? You may need to probe a little as due to the fact it was part of Russia back in the day some prefer to say they are Russian. Also the data reminds us of how poor that area that was once called Yugoslavia remains. It is hardly going to be helped by the development described below by Balkan Insight.

At the fifth joint meeting of the governments of Albania and Kosovo in Peja, in Kosovo, the Albanian Prime Minister Edi Rama backed the decision of the Kosovo government to raise the tax on imports from Serbia and Bosnia from 10 to 100 per cent.

Banks

Here the ECB is conflicted. Like all central banks its priority is “the precious” otherwise known as the banks. Yet it is part of the operation to apply pressure on Italy and take a look at this development.

As this is very significant let us break it down and yes in the world of negative interest-rates and expanded central bank balance sheets Unicredit has just paid an eye-watering 7.83% on some bonds. Just the 6.83% higher than at the opening of 2018 and imagine if you held similar bonds with it. Ouch! Of that there is an element driven by changes in Italy’s situation but the additional part added by Unicredit seems to be around 3.5%.

If we look back I recall describing Unicredit as a zombie bank on Sky News around 7 years ago. The official view in more recent times is that it has been a success story in the way it has dealt with non performing loans and the like. Although of course success is a relative term with a share price of 11.5 Euros as opposed to the previous peak of more like 370 Euros. Now it is paying nearly 8% for its debt we need not only to question even that heavily depreciated share price and it gives a pretty dreadful implied view for the weaker Italian banks such as Monte Paschi which Johannes mentions. Also those non-performing loans which were packaged up and sold at what we were told “great deals” whereas now they look dreadful, well on the long side anyway.

Perhaps this was what the Bank of Italy meant by this.

The fall in prices for Italian government securities has caused a reduction in capital reserves and
liquidity and an increase in the cost of wholesale funding. The sharp decline in bank share prices has resulted
in a marked increase in the cost of equity. Should the tensions on the sovereign debt market be protracted, the
repercussions for banks could be significant, especially for some small and medium-sized banks.

Comment

We can bring things right up to date with this morning’s money supply data.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, stood at 6.8% in October, unchanged from previous month.

So we are holding station to some extent although in real terms we are slightly lower as inflation has picked up to 2.2%. Thus the near-term outlook remains weak and we can expect a similar fourth quarter to the third. Actually I would not be surprised if it was slightly better but still weak..

Looking around a couple of years ahead the position is slightly better although we do not know yet how much of this well be inflation as opposed to growth.

Annual growth rate of broad monetary aggregate M3 increased to 3.9% in October 2018 from 3.6% in September (revised from 3.5%).

On the other side of the coin credit flows to businesses seem to have tightened.

Annual growth rate of adjusted loans to non-financial corporations decreased to 3.9% in October from 4.3% in September

Personally I think that the latter number is a lagging indicator but the ECB has trumpeted it as more of a leading one so let’s see.

The external factor which is currently in play is the lower oil price which will soon begin to give a boost and will reduce inflation if it remains near US $60 for the Brent Crude benchmark. But none the less the midnight oil will be burning at the ECB as it mulls the possibility that all that balance sheet expansion and negative interest-rates gave economic activity such a welcome but relatively small boost. Also it will be on action stations about the Italian banking sector. For myself I fear what this new squeeze on Italian banks will do to the lending to the wider economy which of course had ground to a halt as it is.

 

Where next for the world of Bitcoin?

The world of Bitcoin and indeed all the other altcoins has seen quite a reversal as 2018 has progressed. The days of “free money” have gone and they have been replaced by this according to MarketWatch.

Bitcoin is breaking all sorts of records at the moment, most of them unwanted, and in a few days it will equal a milestone not matched in four years.

Not since October of 2014 has the price of bitcoin   seen four consecutive monthly declines, and a negative close for the month of November, which now seems a foregone conclusion, would match this feat having fallen every month since August, according to Dow Jones Market Data.

So a clear change although in the fast moving world of Bitcoin it is still over ten times higher than it was back then. If anything the fall seems to be picking up the pace.

After opening November above $6,500, bitcoin is down more than 40%, and since the four-month streak began on Aug. 1, the value of the world’s most famous digital currency has more than halved.

As I type this the Bitcoin price is at US $3763.7 which is down some US $282 or a bit under 7%. I note that just to add to the confusion there is also now a Bitcoin Cash. This was created by a fork out of Bitcoin.

Bitcoin cash was one of the marvels of the bitcoin bubble. It is a fork from bitcoin. A fork of a cryptocurrency takes place when someone, anyone declares that a blockchain is going to be transferred to a new set of rules and network infrastructure. ( Forbes)

It did lead to what was free money for a while.

When the fork came out, bitcoin did not fall and bitcoin cash went through the roof rising from the low hundreds to shoot quickly above $1,000. It was free money for bitcoin holders who could get their hands on their bitcoin cash by navigating the technical issues, which were mighty. ( Forbes)

But the gains were short-lived.

The central bankers revenge

From a central banking point of view the altcoin world is a disaster as they have no power to set interest-rates and no control over the total amount of it. Even worse it bypasses “the previous” and in the bull market days saw very heavy disinflation as the price of goods and services became much cheaper. At the limit it would make them be an anachronism and then irrelevant.

John Lewis of the Bank of England put it like this on the 13th of this month.

Existing private cryptocurrencies do not seriously threaten traditional monies because they are afflicted by multiple internal contradictions. They are hard to scale, are expensive to store, cumbersome to maintain, tricky for holders to liquidate, almost worthless in theory, and boxed in by their anonymity. And if newer cryptocurrencies ever emerge to solve these problems, that’s additional downside news for the value of existing ones.

There are of course issues there but being “almost worthless in theory” is a critique that could be pointed at central bank fiat currencies which also rely on an act of faith to have value. Also the bit about new companies would have applied to the proliferation of railway companies back in the day. Whereas we know that whilst many failed the railways are still with us. Those suffering commuters who use Southern Rail may wish that they didn’t but they do.

Let us look at his paradoxes or as he might have put it seven deadly sins.

The congestion paradox

But cryptocurrency platforms are different. Their costs are largely variable, their capacity is largely fixed. Like the London Underground in rush hour, crypto platforms are vulnerable to congestion: more patrons makes them *less* attractive.

The storage paradox

Each user has to maintain their own copy of the entire transactions history, so an N-fold increase in users and transactions, means an N-squared fold increase in aggregate storage needs.

The mining paradox

Rewarding miners with new units of currency for processing transactions leads to a tension between users and miners.  This crystalises in Bitcoin’s conflict over how many transactions can be processed in a block. Miners want this kept small………But users want the exact opposite: higher capacity, lower transactions costs and more liquidity, and so favour larger block sizes.

The concentration paradox

This starts in intriguing fashion.

 97% of bitcoin is estimated to be held by just 4% of addresses, and inequality rises with each block.

However this critique is also applicable to the central banking enthusiasm for higher house prices and the “wealth effects”

An asset is valued by the market price at which it changes hands. Only a fraction of the stock is actually traded at any point in time. So the price reflects the views of the marginal market participant.

You can’t all sell at once and certainly not at that price. The list below is somewhat breathtaking in the circumstances.

But for cryptos they are much larger because i)Exchanges are illiquid ii) Some players are vast relative to the market iii) There isn’t a natural balance of buyers and sellers iv) opinion is more volatile and polarised.

As central banks have sucked liquidity of out markets with their actions, for example the Japanese government bond market has often been frozen, the opening point is a bit rich. Ditto point ii) if we look at the size of central bank balance sheets and of course there was no natural balance between buyers and sellers when they surged into markets. For example some of the recent turmoil in the Italian government bond market has been caused by the “unnatural” buying of the ECB being reduced. As to the last point, well maybe, but so many things are polarised these days.

The valuation paradox

The puzzle in economic theory is why private cryptocurrencies have any value at all.

Fiat currencies anyone?

The anonymity paradox

The (greater) anonymity which cryptocurrencies offer is generally a weakness not a strength. True, it creates a core transactions demand from money launderers , tax evaders and purveyors of illicit goods> because they make funds and transactors hard to trace.

This is both true and an attempted smear. After all the recent money laundering spree undertaken in the Baltics by customers of Danske Bank seems to have been at 200 billion Euros or so much larger than the altcoin universe in total.

Of course for a central banker it needs central bankers.

 Keep a cryptocurrency far from regulated institutions and you reduce its value, because it drastically restricts the pool of willing transactors and transactions. Bring it closer to the realm of regulated financial institutions and it increases in value.

The innovation paradox

Perhaps the biggest irony of all is that the more optimistic you are about tomorrow’s cryptocurrencies, the more pessimistic you must be about the value of today’s.

Odd though that this sort of logic is not applied to forward guidance.

Expect it to be worthless in the future, and it becomes worthless now.

Comment

There is a lot to consider here and let me start by offering some sympathy for those who did this back in the day. From CNBC.

Bitcoin is in the “mania” phase, with some people even borrowing money to get in on the action, regulator Joseph Borg said. “We’ve seen mortgages being taken out to buy bitcoin. … People do credit cards, equity lines,” he said. Bitcoin has been soaring all year, starting out at $1,000 and rocketing above $19,000 on the Coinbase exchange last week. ( CNBC )

Hard to believe that was the 11th of December last year as it feels like a lifetime ago. Also yes I do feel sorry for them even though it was pretty stupid. A fortnight or so earlier we were looking at some of the issues above.

That statement is true of pretty much every price although of course some have backing via assets or demand. So often we see a marginal price used to calculate a total based on an average price that is not known………This leaves us with the issue of how Bitcoin functions as a store of money which depends on time. Today’s volatility shows that over a 24 hour period it clearly fails and yet if we extend the time period so far at least it has worked rather well as one.

As to the store of value function that still holds as early buyers have still done really rather well but more recent ones have taken a bath and a cold one at that. Looking ahead it does not look as though the market has capitulated enough to find the ground to rally, But in the background there are still flickers of good news.

Ohio appears set to become the first state to accept bitcoin for tax bills, a show of support for a technology that has garnered lots of hype but failed to gain traction as a form of payment. ( WSJ)