UK Austerity and the next Governor of the Bank of England

Today brings into focus an area that has brought good news for the UK over the past couple of years. This has been the improvement in the public finances which rather curiously lagged the period where the economy recorded its fastest economic growth by around 2 years. Also some of the detail along the way has hinted at a better economic situation than that suggested by economic growth measured by Gross Domestic Product or GDP data. This swings both ways in my view as what were called the bond vigilantes will be happier with the state of play. But also those on the other side of the coin who would like more government spending and/or lower taxes would have fiscal room to do so.

Austerity

This has been a matter of debate for some time and let me start by saying there are several ways of looking at this. The harshest would be to actually cut government spending which we have not seen in the UK. Let me add more detail by pointing out that some areas clearly have but overall the story has nor been that as other areas spent more. The more realistic version seems to be restricting government spending in real terms which we have seen some of overall. If we look at it in terms of years then we have recorded on here two main phases firstly from around 2010 when the brakes were applied and from 2012/13 when the pressure on the spending brakes was loosened.

Also there was some tightening on the other side of the fiscal ledger of which the standout was the rise in Value Added Tax or VAT. There was a relatively brief cut from 17.5% to 15% but then a rise to 20% where in spite of the claims of a return to normal it is still at the supposedly emergency rate.

Having established some perspective let us look at this from the IPPR which compared us to these countries “This comprises Austria, Belgium, Denmark, Finland, France, Germany, Italy, Netherlands, Spain and Sweden.”.

We find that on average these countries spend 48.9 per cent of GDP on public spending, compared to just 40.8 per cent in the UK. Furthermore, whilst the UK’s spending has fallen by 7 percentage points – from around 47 per cent of GDP to 40 per cent of GDP – since the onset of austerity, the comparable fall across these countries is just 3 percentage points. Moreover, if the UK were to match their current levels of spending tomorrow it would be worth £2,500 per person per year, of which £1,800 would go towards social spending; meaning health, education and social security.

Okay if we break this down we see that the picture is more complex. Let me show you this by looking at the Euro area in total for 2018 for which we got figures yesterday. There the fiscal deficit was a mere 0.5% of GDP with spending at 46.8% and revenue at 46.3%. Furthermore many of the countries in the IPPR list ran fiscal surpluses in 2018

Germany (+1.7%), the Netherlands (+1.5%), Sweden (both +0.9%), Denmark (+0.5%). Austria (+0.1%).

So on that measure they are more fiscally austere than the UK which ran a deficit. As you can see things are more complex than they argue which is hinted at by the way they use tax revenue as a benchmark rather than total revenues which changes the numbers quite a bit. We have numbers for different periods but my 46.3% for the Euro area is rather different to the 41.1% for their sample and looks a swinging rather than a straight ball to me.

Of course spending is not a free good either. Could we match the spending tomorrow? Yes we could if we wished and for a while with bond yields where they are it would at first be no big deal, but even the IPPR realises it would have to come with this.

But in the UK, as IPPR has previously recommended, significant additional revenue could be raised through increasing the rate of corporation tax in line with the European average, reforming income tax but in a way that protects those on low and middle incomes, and changes to the way in which we tax wealth.

As to Corporation Tax I am dubious as one thing we have learned in the credit crunch era is the way multinationals pretty much choose where they pay tax or if you want the issue in one word, Ireland.

Moving on we see this and again the catch is that in the credit crunch era such Ivory Tower calculations are fine up in the clouds but down here at ground level they have often crumbled.

They find that the cumulative effect of austerity has been to shrink the economy by £100bn today compared to what it would have been without the cuts: that is worth around £3,600 per family in 2019/20 alone.

Today’s Data

The overall picture presented continues to be a strong one.

In the latest full financial year (April 2018 to March 2019), central government received £739.4 billion in income, including £558.6 billion in taxes. This was 5% more than in the previous financial year.

This again hints that the economy has been stronger than the GDP data suggests and follows the labour market theme of rising employment and higher real wages.

On the other side of the ledger the throwing around of the word austerity makes me uncomfortable when we are increasing spending in real terms.

Over the same period, central government spent £741.5 billion, an increase of around 3%.

Well unless you use the RPI as your inflation measure but even then it is roughly flat.

The combination meant this.

Borrowing in the latest full financial year (April 2018 to March 2019) was £24.7 billion, £17.2 billion less than in the previous financial year; the lowest financial year borrowing for 17 years.

Or if you prefer our credit crunch era journey can be put like this.

In the latest full financial year (April 2018 to March 2019), the £24.7 billion (or 1.2% of gross domestic product (GDP)) borrowed by the public sector was less than one-fifth (16.1%) of the amount seen in the FYE March 2010, when borrowing was £153.1 billion (or 9.9% of GDP).

As a single month March was not one for austerity as it looks like departments made sure that they spent their annual budgets so if some potholes were filled in around your locale that is why.

 while total central government expenditure increased by 5.7% (or £3.5 billion) to £65.7 billion.

The explanation is rather bare but if we look at the ledger we see spending on goods and services was up by £1.9 billion. So maybe there was some Brexit stockpiling too.

Comment

The last decade has seen a lot of debate over the concept of austerity involving quite a lot of goalpost moving, so much so that it is fortunate designers give them wheels these days. Whereas we do know what real austerity has been as @fwred made clear yesterday,

Today’s craziest chart goes to Greece, with a primary surplus of 4.4% of GDP in 2018, beating an already insane target of 3.5%. Jaw-dropping for those of us old enough to remember the whole story.

Or as The Nutty Boys put it.

Madness, madness, they call it madness
Madness, madness, they call it madness
I’m about to explain
A-That someone is losing their brain
Hey, madness, madness, I call it gladness, yee-ha-ha-ha

We have seen nothing like that but now face choices ahead as do we copy the Germand and go for a surplus? Or do we now pick out areas where we can spend more? With borrowing so cheap with our ten-year Gilt yield at 1.2% it is not expensive. As ever some care is needed as we have spent in some areas as I note in the IPPR paper than at 7.4% of GDP we spend the same on health as the countries they compare us too which completes something I recall Tony Blair aiming at back in the day.

Meanwhile this has hit the news. I have floated two candidates in Andrew Sentance and Ann Pettifor, but who would you suggest?

Although if Yes Prime Minister has its usual accuracy the choice has already been made and this is just for show

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Are we on the road to a US $100 oil price?

As Easter ends – and one which was simply glorious in London – those of us reacquainting ourselves with financial markets will see one particular change. That is the price of crude oil as the Financial Times explains.

Crude rose to a five-month high on Tuesday, as Washington’s decision to end sanctions waivers on Iranian oil imports buoyed oil markets for a second day.  Brent, the international oil benchmark, rose 0.8 per cent to $74.64 in early European trading, adding to gains on Monday to reach its highest level since early November. West Texas Intermediate, the US marker, increased 0.9 per cent to $66.13.

If we look for some more detail on the likely causes we see this.

The moves came after the Trump administration announced the end of waivers from US sanctions granted to India, China, Japan, South Korea and Turkey. Oil prices jumped despite the White House insisting that it had worked with Saudi Arabia and the United Arab Emirates to ensure sufficient supply to offset the loss of Iranian exports. Goldman Sachs said the timing of the sanctions tightening was “much more sudden” than expected, but it played down the longer-term impact on the market.

 

So we see that President Trump has been involved and that seems to be something of a volte face from the time when the Donald told us this on the 25th of February.

Oil prices getting too high. OPEC, please relax and take it easy. World cannot take a price hike – fragile! ( @realDonaldTrunp)

After that tweet the oil price was around ten dollars lower than now. If we look back to November 7th last year then the Donald was playing a very different tune to now.

“I gave some countries a break on the oil,” Trump said during a lengthy, wide-ranging press conference the day after Republicans lost control of the House of Representatives in the midterm elections. “I did it a little bit because they really asked for some help, but I really did it because I don’t want to drive oil prices up to $100 a barrel or $150 a barrel, because I’m driving them down.”

“If you look at oil prices they’ve come down very substantially over the last couple of months,” Trump said. “That’s because of me. Because you have a monopoly called OPEC, and I don’t like that monopoly.” ( CNBC)

If we stay with this issue we see that he has seemingly switched quite quickly from exerting a downwards influence on the oil price to an upwards one. As he is bothered about the US economy right now sooner or later it will occur to him that higher oil prices help some of it but hinder more.

Shale Oil

Back on February 19th Reuters summarised the parts of the US economy which benefit from a higher oil price.

U.S. oil output from seven major shale formations is expected to rise 84,000 barrels per day (bpd) in March to a record of about 8.4 million bpd, the U.S. Energy Information Administration said in a monthly report on Tuesday……..A shale revolution has helped boost the United States to the position of world’s biggest crude oil producer, ahead of Saudi Arabia and Russia. Overall crude production has climbed to a weekly record of 11.9 million bpd.

Thus the US is a major producer and the old era has moved on to some extent as the old era producers as I suppose shown by the Dallas TV series in the past has been reduced in importance by the shale oil wildcatters. They operate differently as I have pointed out before that they are financed with cheap money provided by the QE era and have something of a cash flow model and can operate with a base around US $50. So right now they will be doing rather well.

Also it is not only oil these days.

Meanwhile, U.S. natural gas output was projected to increase to a record 77.9 billion cubic feet per day (bcfd) in March. That would be up more than 0.8 bcfd over the February forecast and mark the 14th consecutive monthly increase.

Gas production was about 65.5 bcfd in March last year.

Reinforcing my view that this area has a different business model to the ordinary was this from Reuters earlier this month.

Spot prices at the Waha hub fell to minus $3.38 per million British thermal units for Wednesday from minus 2 cents for Tuesday, according to data from the Intercontinental Exchange (ICE). That easily beat the prior all-time next-day low of minus $1.99 for March 29.

Prices have been negative in the real-time or next-day market since March 22, meaning drillers have had to pay those with pipeline capacity to take the gas.

So we have negative gas prices to go with negative interest-rates, bond yields and profits for companies listing on the stock exchange as we mull what will go negative next?

Economic Impact on Texas

Back in 2015 Dr Ray Perlman looked at the impact of a lower oil price ( below US $50) would have on Texas.

To put the situation in perspective, based on the current situation, I am projecting that oil prices will likely lead to a loss of 150,000-175,000 Texas jobs next year when all factors and multiplier effects are considered.  Overall job growth in the state would be diminished, but not eliminated.  Texas gained over 400,000 jobs last year, and I am estimating that the rate of growth will slow to something in the 200,000-225,000 per year range.

Moving wider a higher oil price benefits US GDP directly via next exports and economic output or GDP and the reverse from a lower one. We do get something if a J-Curve style effect as the adverse impact on consumers via real wages and business budgets will come in with a lag.

The World

The situation here is covered to some extent by this from the Financial Times.

In currency markets, the Norwegian krone and Canadian dollar both rose against the US dollar as currencies of oil-exporting countries gained.

There is a deeper impact in the Middle East as for example there has been a lot of doubt about the finances of Saudi Arabia for example. This led to the recent Aramco bond issue ( US $12 billion) which can be seen as finance for the country although ironically dollars are now flowing into Saudi as fast as it pumps its oil out.

The stereotype these days for the other side of the coin is India and the Economic Times pretty much explained why a week ago.

A late surge in oil prices is expected to increase India’s oil import bill to its five-year high. As per estimates, India could close 2018-19 with crude import bill shooting to $115 billion, a growth of 30 per cent over 2017-18’s $88 billion.

This adds to India’s import bill and reduces GDP although it also adds to inflationary pressure and also perhaps pressure on the Reserve Bank of India which has cut interest-rates twice this year already. The European example is France which according to the EIA imports some 55 million tonnes of oil and net around 43 billion cubic meters of natural gas. It does offset this to some extent by exporting electricity from its heavy investment in nuclear power and that is around 64 Terawatt hours.

The nuclear link is clear for energy importers as I note plans in the news for India to build another 12.

Comment

There are many ways of looking at this so let’s start with central banks. As I have hinted at with India they used to respond to a higher oil price with higher interest-rates to combat inflation but now mostly respond to expected lower aggregate demand and GDP with interest-rate cuts. They rarely get challenged on this U-Turn as we listen to Kylie.

I’m spinning around
Move outta my way
I know you’re feeling me
‘Cause you like it like this
I’m breaking it down
I’m not the same
I know you’re feeling me
‘Cause you like it like this

Next comes the way we have become less oil energy dependent. One way that has happened has been through higher efficiency such as LED light bulbs replacing incandescent ones. Another has been the growth of alternative sources for electricity production as right now in my home country the UK it is solar (10%) wind (15%) biomass (8%) and nukes (18%) helping out. I do not know what the wind will do but solar will of course rise although its problems are highlighted by the fact it falls back to zero at night as we continue to lack any real storage capacity. Also such moves have driven prices higher.

As to what’s next? Well I think that there is some hope on two counts. Firstly President Trump will want the oil price lower for the US economy and the 2020 election. So he may grow tired of pressurising Iran and on the other side of the coin the military/industrial complex may be able to persuade Saudi Arabia to up its output. Also we know what the headlines below usually mean.

Podcast

Good to see UK wages rising much faster than house prices at last

Today feels like spring has sprung and I hope it is doing the same for you, or at least those of you also in the Northern Hemisphere. The economic situation looks that way too at least initially as China has reported annual GDP growth of 6.4% for the first quarter of 2019. However the industrial production data has gone in terms of annual rates 5.8%,5.9%,5.4%,5.7%, 5.3% and now 8.7% in March which is the highest rate for four and a half years. Or as C+C Music Factory put it.

Things that make you go, hmm
Things that make you go, hmm
Things that make you go, hmm, hey
Things that make you go, hmm, hmm, hmm

In the UK we await the latest inflation data and we do so after another in a sequence of better wage growth figures. In its Minutes from the 20th of March the Bank of England looked at prospects like this.

Twelve-month CPI inflation had risen slightly in February to 1.9%, in line with Bank staff’s expectations
immediately prior to the release, and slightly above the February Inflation Report forecast. The near-term path
for CPI inflation was expected to be a touch higher than at the time of the Committee’s previous meeting,
though remaining close to the 2% target over the coming months. This partly reflected a 6% increase in sterling
spot oil prices, and the announcement by Ofgem on 7 February of an increase in the caps for standard variable
and pre-payment tariffs, from April, which had been somewhat larger than expected.

I do like the idea of claiming you got things right just before the release, oh dear! Also it is not their fault but the price cap for domestic energy rather backfired and frankly looks a bit of a mess. It will impact on the figures we will get in a month.

Prospects

Let us open with the oil prices mentioned by the Bank of England as the price of a barrel of Brent Crude Oil has reached US $72 this morning. So a higher oil price has arrived although we need context as it was here this time last year. The rise has been taking place since it nearly touched US $50 pre-Christmas. Putting this into context we see that petrol prices rose by around 2 pence per litre in March and diesel by around 1.5. So this will be compared with this from last year.

When considering the price of petrol between February and March 2019, it may be useful to note that the average price of petrol fell by 1.6 pence per litre between February and March 2018, to stand at 119.2 pence per litre as measured in the CPIH.

Just for context the price now is a penny or so higher but the monthly picture is of past falls now being replaced by a rise. Also just in case you had wondered about the impact here it is.

A 1 pence change on average in the cost of a litre of motor fuel contributes approximately 0.02 percentage points to the 1-month change in the CPIH.

If we now switch to the US Dollar exchange rate ( as the vast majority of commodities are priced in dollars) we see several different patterns. Recently not much has changed as I think traders just yawn at Brexit news although we have seen a rise since it dipped below US $1.25 in the middle of December. Although if we look back we are around 9% lower than a year ago because if I recall correctly that was the period when Bank of England Governor Mark Carney was busy U-Turning and talking down the pound.

So in summary we can expect some upwards nudges on producer prices which will in subsequent months feed onto the consumer price data. Added to that is if we look East a potential impact from what has been happening in China to pig farming.

Chinese pork prices are expected to jump more than 70 percent from the previous year in the second half of 2019, an agriculture ministry official said on Wednesday………China, which accounts for about half of global pork output, is struggling to contain an outbreak of deadly African swine fever, which has spread rapidly through the country’s hog herd.

That is likely to have an impact here as China offers higher prices for alternative sources of supply. So bad news for us in inflation terms but good news for pig farmers.

Today’s Data

I would like to start with something very welcome and indeed something we have been waiting for on here for ages.

Average house prices in the UK increased by 0.6% in the year to February 2019, down from 1.7% in January 2019 . This is the lowest annual rate since September 2012 when it was 0.4%. Over the past two years, there has been a slowdown in UK house price growth, driven mainly by a slowdown in the south and east of England.

This means that if we look at yesterday’s wage growth data then any continuation of this will mean that real wages in housing terms are rising at around 3% per annum. There is a very long way to go but at least we are on our way.

The driving force is this and on behalf of three of my friends in particular let me welcome it.

The lowest annual growth was in London, where prices fell by 3.8% over the year to February 2019, down from a decrease of 2.2% in January 2019. This was followed by the South East where prices fell 1.8% over the year.

As they try to make their way in the Battersea area prices are way out of reach of even what would be regarded as good salaries such that they are looking at a 25% shared appreciation deal as the peak. Hopefully if we get some more falls they will be able to average down by raising  to 50% and so on but that is as Paul Simon would say.

Everybody loves the sound of a train in the distance
Everybody thinks it’s true

One development which raises a wry smile is that house price inflation is now below rental inflation.

Private rental prices paid by tenants in the UK rose by 1.2% in the 12 months to March 2019, up from 1.1% in February 2019……..London private rental prices rose by 0.5% in the 12 months to March 2019, up from 0.2% in February 2019.

What that tells us is not as clear as you might think because the numbers are lagged. Our statisticians keep the exact lag a secret but I believe it to be around nine months. So whilst we would expect rents to be pulled higher by the better nominal and real wage data the official rental series will not be showing that until the end of the year

Comment

The development of real wages in housing terms is very welcome. Of course the Bank of England will be in a tizzy about wealth effects but like so often they are mostly for the few who actually sell or look to add to their mortgage as opposed to the many who might like to buy but are presently priced out. Also existing owners have in general had a long good run. Those who can think back as far as last Thursday might like to mull how house price targeting would be going right now?

Moving to consumer inflation then not a lot happened with the only move of note being RPI inflation nudging down to 2.4%. The effects I described above were in there but an erratic item popped up and the emphasis is mine.

Within this group, the largest downward effect came from games, toys and hobbies, particularly computer games

If a new game or two comes in we will swing the other way.

Looking further up the line I have to confess this was a surprise with the higher oil price in play.

The growth rate of prices for materials and fuels used in the manufacturing process was 3.7% on the year to March 2019, down from 4.0% in February 2019.

So again a swing the other way seems likely to be in play for this month.

Meanwhile,what does the ordinary person think? It is not the best of news for either the Bank of England or our official statisticians.

Question 1: Asked to give the current rate of inflation, respondents gave a median answer of 2.9%, compared to 3.1% in November.

Question 2a: Median expectations of the rate of inflation over the coming year were 3.2%, remaining the same as in November.

Central bankers are warming us up for more inflation again

A feature of the credit crunch era is the repetition of various suggestions from governments and central banks. One example of this has been the issue of Eurobonds which invariably has a lifespan until the nearest German official spots it. Another has been the concept of central banks overshooting their inflation target for a while. It is something that is usually supported by those especially keen on ( even more) interest-rate cuts and monetary easing so let us take a look.

Last Wednesday European Central Bank President Mario Draghi appeared to join the fray and the emphasis is mine.

Well, on your second question I will answer saying exactly the same thing. We don’t tolerate too low inflation; we remain fully committed to using all necessary instruments to return inflation to 2% without undue delay. Likewise, our inflation aim doesn’t imply a ceiling of 2%. Inflation can deviate from our objective in both directions, so long as the path of inflation converges towards our medium-term objective. I believe I must have said something close to this, or something to this extent a few other times in the past few years.

Nice try Mario but not all pf us had our senses completely dulled by what was otherwise a going through the motions press conference. As what he said at the press conference last September was really rather different.

In relation to that: shouldn’t the ECB be aiming for an overshoot on inflation rather than an undershoot given that it’s been below target for so long?

Second point: our objective is an inflation rate which is below, but close to 2% over the medium term; we stay with that, that’s our objective.

As you can see back then he was clearly sign posting an inflation targeting system aiming for inflation below 2%. That was in line with the valedictory speech given by his predecessor Jean-Claude Trichet which gave us a pretty exact definition by the way he was so pleased with it averaging 1.97% per annum in his term. So we have seen a shift which leads to the question, why?

The actual situation

What makes the switch look rather odd is the actual inflation situation in the Euro area. Back to Mario at the ECB press conference on Wednesday.

According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.4% in March 2019, after 1.5% in February, reflecting mainly a decline in food, services and non-energy industrial goods price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline over the coming months.

So we find that inflation is below target and expected to fall further in 2019. This was a subject which was probed by one of the questions.

 It’s quite clear that the sliding of the five-year-to-five-year inflation expectations corresponds to a deterioration of the economic outlook. It’s also quite clear that as the economic outlook, especially the economic activity slows down, also markets expect less pressure in the labour market, but we haven’t seen that yet.

The issue of markets for inflation expectations is often misunderstood as the truth is we know so little about what inflation will be then. But such as it is again  the trend may well be lower so why have we been guided towards higher inflation being permitted.

It might have been a slip of the tongue but Mario Draghi is usually quite careful with his language. This leaves us with another thought, which is that if he is warming us up for an attitude change he is doing soon behalf of his successor as he departs to his retirement villa at the end of October.

The US

Minneapolis Fed President Neel Kashkari suggested this in his #AskNeel exercise on Twitter.

Well we officially have a symmetric target and actual inflation has averaged around 1.7%, below our 2% target, for the past several years. So if we were at 2.3% for several years that shouldn’t be concerning.

Also he reminded those observing the debate on Twitter that the US inflation target is symmetric and thus unlike the ECB.

Yes, i think we should really live the symmetric target and not tap the brakes prematurely. This is why I’ve been arguing for more accommodative monetary policy. But we are undertaking a year long review of various approaches so I am keeping an open mind.

As you can see with views like that the Donald is likely to be describing Neel Kashkari as “one of the best people”.  If we move to the detail there are various issues and my initial one is that inflation tends to feed on itself and be self-fulfilling so the idea that we can be just over the target at say 2.3% is far from telling the full picture. Usually iy would then go higher. Also if your wages were not growing or only growing at 1% you would be concerned about even that seemingly low-level of inflation.

If we consider the review the US Fed is undertaken we see from last week’s speech by Vice Chair Clarida a denial that it has any plans to change its 2% per annum target and we know what to do with those! Especially as he later points out this.

In part because of that concern, some economists have advocated “makeup” strategies under which policymakers seek to undo, in part or in whole, past inflation deviations from target. Such strategies include targeting average inflation over a multiyear period and price-level targeting, in which policymakers seek to stabilize the price level around a constant growth path.

As the credit crunch era has seen inflation generally be below target this would be quite a shift as it would allow for quite a catch-up. Which of course is exactly the point!

Comment

Central bankers fear that they are approaching something of a nexus point. They have deployed monetary policy on a scale that would not have been believed before the credit crunch hit us. Yet in spite of the negative interest-rates, QE style bond purchases and in some cases equity and property buys we see that there has been an economic slow down and inflation is generally below target. Also the country that has deployed monetary policy the most in terms of scale Japan has virtually no inflation at all ( 0.2% in February).

At each point in the crisis where central bankers face such issues they have found a way to ease policy again. We have seen various attempts at this and below is an example from Charles Evans the President of the Chicago Fed from back in March 2012.

My preferred inflation threshold is a forecast of 3 percent over the medium term.

We have seen others look for 4% per annum. What we are seeing now is another way of trying to get the same effect but this time looking backwards rather than forwards.

There are plenty of problems with this. Whilst a higher inflation target might make life easier for central bankers the ordinary worker and consumer faces what economists call “sticky” wages. Or in simple terms prices go up but wages may not and if the credit crunch is any guide will not. My country the UK suffered from that in 2010/11 when the Bank of England “looked through” consumer inflation which went above 5% with the consequence of real wages taking a sharp hit from which they have still to recover.

Next comes the issue that in the modern era 2% per annum may be too high as a target anyway. In spite of all the effort it has been mostly undershot and as 2% in itself has no reason for existence why not cut it? Then we might make progress in real wage terms or more realistically reduce the falls. That is before we get to the issue of inflation measures lacking credibility in the real world as things get more expensive but inflation is officially recorded as low.

Meanwhile central bankers sing along to Marvin Gaye.

‘Cause baby there ain’t no mountain high enough

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Are world equity markets front-running expected central bank buying?

Sometimes we get an opportunity to both take some perspective and also to observe what is considered by some to be cutting edge. So let us open with the perspective of the general manager of the Bank for International Settlements.

Growth cannot depend on monetary policy, Agustín Carstens tells CNBC.

I am sure that many of you are thinking that it is a bit late ( like a decade or so) to tell us now.. Interestingly if you watch the video he says in reference to the Euro area that monetary policy “cannot be the only solution for growth”. This reminds me of the statement by ECB President Mario Draghi that it QE was responsible for the better Euro area growth phrase in 2016 to 17. It also brings me to my first official denial of the day.

Some analysts said a tiered rate would make room for the ECB to cut its deposit rate farther — a prospect that one source said was nowhere near being discussed. ( Reuters )

You know what usually happens next….

Asset Markets

This is an area that central banks have increasing moved into with sovereign and corporate bond buying. But in the same Reuters article I spotted something that looked rather familiar.

TLTRO III, a new series of cheap two-year loans aimed at banks, was unveiled in March as a tool to help lenders finance themselves, particularly in countries such as Italy and Portugal. But policymakers now increasingly see it as a stimulus tool for a weakening economy, the sources said.

With the growth outlook fading faster than feared, even hawkish policymakers have given up pricing the loans at the private market rate. Some are even discussing offering the TLTROs at minus 0.4 percent, which is currently the ECB’s deposit rate, the sources said.

That looks rather like the Funding for Lending Scheme which I mentioned yesterday as the way the Bank of England fired up the UK housing market from 2012 onwards. Essentially if you give banks plenty of cheap funding you get a lot of rhetoric about lending to business ( small ones in particular) but the UK experience was that it declined and mortgage lending rose. This was because mortgage rates fell quite quickly by around 1% and according to the Bank of England the total impact rose as high as 2%.

Thus in my opinion the ECB is considering singing along to the “More,more,more” of Andrea True Connection in relation to this.

House prices, as measured by the House Price Index, rose by 4.2% in both the euro area and the EU in the fourth
quarter of 2018 compared with the same quarter of the previous year.

This is one area where the ECB has managed to create some inflation and may even think that the lack of growth in Italy ( -0.6%) is a sign of its economic malaise. Although you do not have to know much history to mull the 6.7% in Spain and 7.2% in Ireland.

Equities

Regular readers will be aware that the Swiss National Bank and the Bank of Japan started buying equities some time ago now. There are differences in that the SNB is doing so to diversify its foreign exchange reserves which became so large they were influencing the bond markets ( mostly European) they were investing in. So it has bought foreign equities of which the most publicly noted it the holding in Apple because if you invest passively then the larger the company the larger the holding. If we note the Apple Watch this must provide food for thought for the Swiss watchmaking industry.

Japan has taken a different route in two respects in that it buys funds ( Exchange Traded Funds or ETFs) rather than individual equities and that it buys Japanese ones. Also it is still regularly buying as it  bought  70.500,000,000 Yen’s worth on Tuesday, Wednesday and Thursday this week. Whereas buying by the SNB in future will be more ad hoc should it feel the need to intervene to weaken the Swiss Franc again.

Now let us move to Federal Reserve policymaker Neel Kashkari

So an official denial! Also you may note that he has left some weasel room as he has not rejected the Japanese route of indirectly buying them. This is common amongst central bankers as they leave themselves an out and if they fear they might need to introduce a policy that will attract criticism they first deny they intend to do it to give the impression they have been somehow forced.

For a lighter touch @QTRResearch translated it into Trumpese so that the man who many think is really running the US Federal Reserve gets the picture.

Kashkari: We’re not buying stocks, who said anything about buying stocks, we’re definitely not buying stocks, we’d never buy stocks.

It was,of course, only last week that ended with the CIO of BlackRock suggesting that the ECB should purchase equities and no doubt he had a list ready! I suppose it would sort of solve this problem.

ECB will ask Deutsche Bank to raise fresh funds for merger: source ( Reuters)

Although of course that would not open just one can of worms but a whole cupboard full of them. But when faced with a problem the ECB regularly finds itself singing along with Donald Fagen.

Let’s pretend that it’s the real thing
And stay together all night long
And when I really get to know you
We’ll open up the doors and climb into the dawn
Confess your passion your secret fear
Prepare to meet the challenge of the new frontier

Comment

Now let us switch to markets as we remind ourselves that they have developed a habit of front-running or anticipating central bank action. Sometimes by thinking ahead but sometimes sadly via private briefings ( I hope the ECB has stopped them). However you spin it @Sunchartist made me think with this.

*Softbank Group Prices Japan’s Biggest Ever Yen Corporate Bond ¥500 Billion 1.64%

Aramco, Softbank, LYFT, Pinterest, Uber

The gravy train.

Or as Hipster on Twitter put it.

So Uber and Lyft will have a combined market cap of ~$150BN with a combined net loss of ~$3BN

Next there is the issue of something that is really rather uncomfortable.

It’s official: This is an all-time record year for corporate stock buybacks.

Announced buybacks for 2018 are now at $1.1 trillion. And companies are using their authorizations. About $800 billion of stock has already been bought back, leaving about $300 billion yet to be purchased. We’ve seen buyback announcements recently from Lowes’s. Pfizer, and Facebook, but in the last few days, as stocks have moved to new lows, companies are picking up the pace of activity. ( CNBC)

This makes me uncomfortable on several counts. It is the job of a board of directors to run a business not to be punters in its shares. This is especially uncomfortable if their bonuses depend on the share price. Frankly I would look to make that illegal. As to them knowing the future how has that worked out for Boeing? To be fair to CNBC they did highlight a problem.

So the critics of corporate buybacks and dividend raises are correct. It is a form of financial engineering that does not do anything to improve business operations or fundamentals………. obsessing over ways to boost stock prices helps the investing class but not the average American.

Perhaps nothing has been done about this because it suits the establishment after all think of the wealth effects. But that brings inequality and the 0.01% back into focus.

 

Could the UK target house price inflation and should we?

Yesterday brought news of a policy initiative from the Labour party on a subject close to my heart and was a subject which occupied much of my afternoon and evening. It also reminded me of the way that social media can have more than a few different but similar strands ongoing at the same time. So if I missed anyone out apologies but I did my best and did better at least that the respondent who seemed to think my name was Tom.

Here from The Guardian is the basis of the proposal.

The Bank of England could be set a target for house price inflation under plans being explored by the Labour party, with tougher powers to restrict mortgage lending to close the gap between property prices and average incomes.

The shadow housing secretary, John Healey, is considering whether, under a Labour government, the Bank should be set an explicit target following a decade of runaway growth in the property market, with the aim of tackling the housing crisis.

The author of the idea is Grace Blakeley and I replied to her that there are various problems with this but let us set out her idea properly from her paper for the think tank the IPPR.

This would be equivalent to the remit the Monetary Policy
Committee has to control consumer price inflation. Under such a target the Bank of England should aim to keep nominal house price inflation at (say) zero per cent for an initial period – perhaps five years – to reset expectations,
and allow affordability to improve.

As I replied to Grace I am a fan of that in spirit but there are issues including one from the next sentence which I have just spotted.

It should then be increased to the same
rate as the consumer price inflation target of 2 per cent per year, meaning zero real-terms house price growth.

Er no that is not zero in real terms because if you are aiming for “affordability to improve” your objective must be for wage growth to exceed house price growth yet it does not apparently merit a mention there. If for example both consumer and house price inflation were on this target at 2% per annum you would be losing ground if wage growth was below that level.

How would this be enacted?

The target should be implemented using
macroprudential tools such as capital requirements, loan-to-value, and debt to-income ratios.

The first question is whether you could do this? Mostly a new policy regime could as we already have some moves in this direction from the Bank of England as pointed out in the paper.

The FPC recently implemented a
loan-to-income ratio of 4.5 per cent for 15 per cent of new mortgages,

The two catches as that this area is one where the truth can be and sometimes is hidden as those who recall the  “liar loans” era will know. Next is the concept of shadow banking or if I may be permitted a long word the concept of disintermediation where you restrict the banks so people borrow form elsewhere such as offshore or overseas.

These problems would be especially evident if you tried to implement this.

Since house price inflation is different in parts of the country, the FPC’s guidance should be regionally specific.

That recognition is welcome but the scale of the issue troubles me. Let me give you some examples from right now where house prices are rising in much of the Midlands and Yorkshire as well as Northern Ireland whilst falling in and around London. Also as @HenryPryor pointed what the situation in Northern Ireland is very different to elsewhere.

Confirmation from that despite enjoying robust inflation in recent months, house prices in Northern Ireland remain some 41% 𝐥𝐨𝐰𝐞𝐫 than they were just prior to the start of the financial crisis in 2007.

Perhaps you could define Northern Ireland but is even it homogenous? A clear danger is that you end up with a bureaucratic nightmare with loads of different definitions and all sorts of border issues as well as increasing the likelihood of another form of disintermediation.

The relationship between the Bank of England and the government

A clear issue is that whilst the Bank of England can influence house prices it does not control them and the paper sets out areas where it is not in control.

House prices are also determined by other factors, not least the supply of housing, and therefore adoption of the target would need to be accompanied by a much more active housing policy. This might include public housebuilding, changes to planning policy, and curbs on overseas purchases of UK homes (Ryan-Collins et al 2017). The FPC should be able to request that the government do more with housing policy if it judges that it will be unable to meet its target through macroprudential tools alone.

The supply of housing is something we have discussed on here pretty much since I began writing articles and the theme has been that government’s of many hues have serially disappointed. The Ebbsfleet saga has been the headline in this respect. Also I have to say that the idea of the Financial Planning Committee needing to “request” help from government policy is welcome in one way but problematic in another. First it is a confession that macroprudential policies are far from a holy grail in this area. Second I can see many scenarios of which the main one would be an upcoming election when the government would simply pay lip service or worse ignore the “request”. Thus we would likely find ourselves singing along to Taylor Swift.

I knew you were trouble when you walked in
So shame on me now
Flew me to places I’d never been
Now I’m lying on the cold hard ground
Oh, oh, trouble, trouble, trouble
Oh, oh, trouble, trouble, trouble

I do mostly agree with this part though and so does the Bank of England as otherwise it would not have introduced the Funding for Lending Scheme back in the summer of 2012.

It is also worth noting, however, that recent research has shown that the level of mortgage lending is the primary determinant of house prices (Ryan-Collins et
al 2017).

Comment

There is a lot to consider here and let me again say that as regular readers will be aware I think that economic policy does need to take account of asset price booms and busts. The catch is in the latter part though because the very same Bank of England that you would be asking to reduce house price growth has been explicitly ramping it since the summer of 2012 and implicitly before then with the Bank Rate cuts and QE bond purchases that preceded it. So the current poachers would have to turn into gamekeepers. Would they? I have my doubts because as we look around the world central banks seem to fold like deck chairs when asset prices fall.

Next comes the issue of could this be done? To which the answer is definitely maybe as you could start on this road and at first your theories would apply. But if we look back to the past history of macroprudential policies there was a reason why they were abandoned and it is because they themselves lead to a boom and bust cycle and bringing things up to date I have doubts on these lines as well as I tweeted to Grace.

One of the problems of central banks in the modern era is that they have often ended up operating in a pro-cyclical fashion. How can you be sure with their poor Forward Guidance record that they can be counter cyclical?

It is easy to spot cycles in hindsight but looking ahead it is far harder as otherwise the aphorism that central banks have never predicted a recession would not keep doing the rounds.

Can we fix it? Yes we can make a start as I hinted at here.

Whilst I support the spirit of this in terms of including house prices. I would point out that the UK could change things by simply going back to the Retail Prices Index as an inflation target because it includes house prices.

Personally I would update the RPI ( using the RPIX version to exclude mortgage costs) so that it explicitly has house prices rather than reply on them implicitly via depreciation and as a stop-gap we could drop out fashion clothing to trim the formula effect. So in effect we would be reversing the changes made by Gordon Brown in the early part of the 2000s. Then off we go although something else would have to be changed as well as basically a clear out of current Bank of England policy makers.

you have the issue of it these days also supporting the economy as defined by GDP

Me on The Investing Channel

Manufacturing and Production help to drive UK GDP growth

Today brings us up to date with the latest monthly data on the UK economy. the problem with this is as I feared that the numbers are in practice rather erratic.

Monthly gross domestic product (GDP) growth was 0.5% in January 2019, as the economy rebounded from the negative growth seen in December 2018.

Actually December recorded a -0.4% GDP growth rate so if you take the figures literally there was quite a wild swing. More likely is that some industries do not conform to a regular monthly pattern in the way we have seen the UK pharmaceutical industry grow overall but with a boom and bust pattern on a monthly basis.

There are areas where we see two patterns at once in the UK economy. For example Tesco has produced good figures already this morning.

Tesco has reported a 28.8% rise in full-year pre-tax profits to £1.67bn with revenue at the supermarket rising 11.2% to £63.9bn ( Sky News)

On the other hand this week has already seen this.

Ailing department store chain Debenhams has been rescued by its lenders after falling into administration.

Three years ago, the 166-strong chain was worth £900m, compared with £20m as of this week. ( BBC News)

Sadly the BBC analysis seems to avoid this issue highlighted by the Financial Times.

Debenhams troubles stem partly from a period of private equity ownership at the start of the millennium, when CVC, Merrill Lynch and TPG sold off freehold property, added debts and paid themselves large dividends.

It looks a case of asset-stripping and greed followed by over expansion which was then hit by nimbler retailers and the switch to online sales. Without the asset-stripping it would be still with us. Meanwhile the BBC analysis concentrates on Mike Ashley who put up £150 million and offered an alternative. I am no great fan of his business model with its low wages and pressure on staff but he does at least have one.

Wages

Speaking of wages there are several strands in the news so let us start with the rather aptly named Mr. Conn.

The chief executive of Centrica, the owner of British Gas, received a 44% pay rise for 2018, despite a difficult year in which the company imposed two bill increases, warned on profits and announced thousands of job cuts.

Iain Conn received a total pay package worth £2.4m last year, up from £1.7m in 2017, according to Centrica’s annual report. His 2018 packet was bolstered by two bonuses, each worth £388,000.  ( The Guardian )

Yet on the other side of the ledger we see things like this. From The Guardian.

Waterstones staff told how they have had to back on food in order to afford rent as they travelled across the country to deliver a 9,300-signature petition to the chain’s London headquarters, calling for the introduction of a living wage.

Mind you we seem to be making progress in one area at least.

Golden goodbyes for public sector workers will be capped at £95,000 in a clamp down on excessive exit payments, the government has confirmed. ( City-AM)

Although I note that it is something planned rather than already done, so the modern-day version of Sir Humphrey Appleby will be doing his or her best to thwart this. Here is his description of the 7 point plan to deal with such matters.

This strategy has never failed us yet. Since our colleagues in the Treasury have already persuaded the Chancellor to spin the process out until 2008, we can be sure that, by then, there will be a new chancellor, a new prime minister and, quite possibly, a new government. At that point, the whole squalid business can be swept under the carpet. Until next time.

As for payoffs it is the ones for those at the top who are quite often switching jobs which need to stop as often it is merely a name change of their employer.

Today’s GDP data

This was good in the circumstances.

Monthly GDP growth was 0.2% in February 2019, after contracting by 0.3% in December 2018 and growing by 0.5% in January 2019. January growths for production, manufacturing, and construction have all been upwardly revised due to late survey returns.

As you can see December was revised up as was January although not enough in January to raise it by 0.1%. But it is an erratic series so let us step back for some perspective.

UK gross domestic product (GDP) grew by 0.3% in the three months to February 2019

Whilst we do not yet have the March data regular readers may recall that the first quarter in the UK ( and in the US at times) can be weak so this is better than it may first appear.

As ever services were in the van as we continue to rebalance in exactly the opposite direction to that proclaimed by the former Bank of England Governor Baron King of Lothbury.

The services sector was the largest contributor to rolling three-month growth, expanding by 0.4% in the three months to February 2019. The production sector had a small positive contribution, growing by 0.2%. However, the construction sector contracted by 0.6%, resulting in a small negative contribution to GDP growth.

Inside its structure this has been in the van.

The largest contributor to growth was computer programming, which has performed strongly in recent months.

Production

Thanks to the business live section of the Guardian for reproducing this from my twitter feed.

One possible hint is that production numbers for Italy and France earlier have been strongish, will the UK be the same?

It turned out that this was so.

Production output rose by 0.6% between January 2019 and February 2019; the manufacturing sector provided the largest upward contribution, rising by 0.9%, its second consecutive monthly rise……In February 2019, the monthly increase in manufacturing output was due to rises in 11 of the 13 subsectors and follows a 1.1% rise in January 2019; the largest upward contribution came from basic metals, which rose by 1.6%.

In the detail was something I noted earlier as pharmaceutical production was up by 2.5% in the last 3 months which put it 4.3% higher than a year ago in spite of a 0.1% fall in February.

But whilst this was a welcome development for February the overall picture has not been of cheer in the credit crunch era.

Production and manufacturing output have risen since then but remain 6.1% and 1.9% lower respectively for the three months to February 2019 than the pre-downturn gross domestic product (GDP) peak in Quarter 1 (Jan to Mar) 2008.

Things have been singing along with The Beatles since late 2012.

I have to admit it’s getting better (Better)
It’s getting better

but overall we are left mulling the John Lennon counter at the end of this line.

A little better all the time (It can’t get no worse)

Comment

This morning’s numbers were strong in the circumstances and confirm again my theme that we are growing at around 0.3/4% per quarter. Yet again the prediction in the Sunday Times that there would be no growth turned out to be a reliable reverse indicator. Of course there are fears for March after the Markit PMI business survey so as ever we await more detail.

As to stockpiling this has become an awkward beast because I see it being put as the reason for the growth, although if so why did those claiming this not predict it. Anyway I have done a small online survey of what people have been stockpiling.

Okay inspired by and her stockpiling of Scottish water we have from paracetamol for her dad for scare stories and dog has been burying treats

Meanwhile one area which has been troubled for many years continues to rumble on.

The total trade deficit (goods and services) widened £5.5 billion in the three months to February 2019, as the trade in goods deficit widened £6.5 billion, partially offset by a £0.9 billion widening of the trade in services surplus.

Perhaps there was some stockpiling going on there although as any departure from the European Union seems to be at Northern Rail speed those stockpiling may now be wondering why they did it?