Why is the Bank of England preparing for a 0% interest-rate?

Sometimes events have their own motion as after enjoying watching England in the cricket yesterday which is far from something I can always I had time to note it was Mansion House speech time. My mind turned back to 2014 when Bank of England Governor Mark Carney promised an interest-rate rise.

There’s already great speculation about the exact timing of the first-rate hike and this decision is becoming
more balanced.
It could happen sooner than markets currently expect.

Of course four years later we are still waiting for the unreliable boyfriend to match his words with deeds. Indeed last night he was sailing in completely the opposite direction as shown by this.

The additional capital means the MPC could, if necessary, re-launch the TFS in future on the Bank’s balance sheet, cementing 0% as the lower bound.

We have learnt in the credit crunch era to watch such things closely as preparations for an easing on monetary policy have so regularly turned into action as opposed to tightening for which in the UK we have yet to see an outright one. All we have is a reversal of the last error ridden cut to a 0.25% Bank Rate as I note that the extra £60 billion of QE, Corporate Bond QE and Term Funding Scheme are still in existence.

There was another mention of a 0% interest-rate later in the piece.

Although the principles guiding the MPC’s choice of threshold still hold, with the lower bound on Bank Rate
now permanently close to 0%,

In the words of Talking Heads “is it?”

The Lower Bound

This has been an area which if we keep our language neutral has been problematic for Governor Carney to say the least! For example last night’s speech mentioned an area I have flagged for some time.

relative to the effective lower bound on Bank
Rate of 0.5% at that time

When the statement was originally made there were obvious issues when we had countries that had negative interest-rates well below the “lower bound”. As an example the Swiss National Bank announced this yesterday morning.

Interest on sight deposits at
the SNB remains at −0.75% and the target range for the three-month Libor is unchanged at
between −1.25% and −0.25%

As they are already equipped for a -1.25% interest-rate and have a -0.75% one it is hard not to smile at the “lower bound” of Mark Carney. The truth in my opinion is that it means something quite different and as ever the main player is the “precious” or the banks.

In August 2016, the MPC launched the Term Funding Scheme (TFS) in order to reinforce the pass-through
of the cut in Bank Rate to 0.25% to the borrowing rates faced by households and companies.

As you can see it is badged as a benefit to you and me which of course is a perfect way to slip cheap liquidity to the banks. After all competing for savings from us must be a frightful bore for them and it is much easier to get wholesale amounts and rates from the Bank of England.

Bank of England balance sheet

There are changes here as well.

With the Chancellor’s announcement tonight of a ground-breaking new financial arrangement and capital
injection for the Bank of England, we now have a balance sheet fit for purpose and the future.

What arrangement? There will be a capital injection of £1.2 billion this year raising it to £3.5 billion. That can go as high as £5.5 billion should the Bank of England make profits bur after that it has to be returned to HM Treasury.

The gearing for liquidity operations is quite something to behold.

The additional capital will significantly increase the amount of liquidity the Bank can provide through
collateralised, market-wide facilities without needing an indemnity from HM Treasury to more than half a
trillion pounds. This lending capacity would expand to over three quarters of a trillion pounds when, as
designed, additional capital above the target level is accrued through retained earnings.

On the first number the gearing would be of the order of 140 times.Care is needed with that though as the Bank of England does insist on collateral in return for the liquidity. Mind you that is not perfect as a guardian as those who recall the episode where the Special Liquidity Scheme was ended early due to “phantom securities”. If you do not know about that the phrase itself is rather eloquent as an explanation.

Reducing the National Debt

Yesterday was  good day for data on the UK public finances but that may be dwarfed by what was announced in the speech.

Today’s announcement increases the amount of risk the Bank can carry on its balance sheet. As a result,
the Bank plans to bring the £127 billion of lending extended through the TFS onto our balance sheet by the
end of 2018/19 the financial year.

That had me immediately wondering if the Office for National Statistics will now drop the requirement for this to be added to the UK National Debt. this would bring us into line with rules elsewhere as for example if you will forgive the alphabetti spaghetti the TLTROs and LTROs of the European Central Bank are not added to the respective national debts. Such a change would reduce our national debt from 85.4% of GDP to below 80%. I am sure I am not the only person thinking that would be plenty to help finance the suggested boost to the NHS should you choose.

QE

There was a change here and this reflects the 0.5% change in the “lower bound”

Although the principles guiding the MPC’s choice of threshold still hold, with the lower bound on Bank Rate
now permanently close to 0%, the MPC views that the level from which Bank Rate can be cut materially is
now around 1.5%.
Reflecting this, the MPC now intends not to reduce the stock of purchased assets until Bank Rate reaches
around 1.5%.

Let me offer you two thoughts on this. Firstly as the Bank of England has yet to raise interest-rates from the emergency 0.5% level then discussing 1.5% or 2% is a moot point. Secondly this is a way of locking in losses as you will be driving the price of the Gilts owned lower by raising Bank Rate. Even holding the Gilts to maturity has issues because you get 100 back and in the days of the panic driven Sledgehammer QE buying where market participants saw free money coming and moved prices away the Bank of England paid way over 100.

Comment

It is hard not to have a wry smile at Governor Carney planning for a 0% Bank Rate as one of his colleagues joins those voting for a rise to 0.75%. Of course Governor Carney wants a rise to 0.75% eventually, say after his term has ended for example. The irony was that the person who has put so much effort into trying to be the next Governor voted for a rise. As to how Andy Haldane’s campaign has gone let me offer you this from Duncan Weldon.

Next month: 6 votes to hold 2 votes to hike And one vote for something involving a dog and a frisbee.

There was a time when people used to disagree with my views about Andy Haldane whereas now the silence is deafening in two respects. One is that I do not get challenged on social media about it anymore and the other is that if you look for the chorus line of support that used to exist it appears to have disappeared and in some cases been redacted.

Moving to more positive news there has been rather a good piece written by the England footballer Raheem Sterling and whilst no doubt there has been some ghostwriting the final message is very welcome I think.

England is still a place where a naughty boy who comes from nothing can live his dream.

 

 

 

 

 

 

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The UK Public Finances are improving fast

A feature of the credit crunch era is the way that the same or similar stories get recycled and this is what I was thinking of when the proposed NHS ( National Health Service) spending boost was announced by Theresa May at the weekend.

There has been a change of Chancellor as George Osborne was removed and replaced with Phillip Hammond and it looks as though the new government will be fiscally looser.

That was from October 3rd 2016 and you may recall it was in tune with the mood music as even the IMF which had helped impose so much austerity on Greece had come out in favour of fiscal stimuli. However like with so much about the current government it never really happened on any scale. In fact if we look at the numbers I quoted then we see that the UK has continued to reduce its deficit and as ever confound the forecasts of the Office of Budget Responsibility or OBR.

In the financial year ending March 2016 (April 2015 to March 2016), the public sector borrowed £76.5 billion. This was £18.9 billion lower than in the previous financial year and less than half of that in the financial year ending March 2010 (both in terms of £ billion and percentage of GDP).

That was the picture then and it has been replaced by a deficit more like £40 billion in the fiscal year just completed. So whilst there has been an ongoing stimulus as we have had a persistent deficit the annual amount has been reduced partly due to growth in the economy which has made the national debt situation look more contained and to some extent better.

Public sector net debt (excluding public sector banks) was £1,777.3 billion at the end of April 2018, equivalent to 85.1% of gross domestic product (GDP), an increase of £56.8 billion (or 0.3 percentage points as a ratio of gross domestic product (GDP)) on April 2017.

As you can see it is rising in amount but the growth in the economy means that relatively it has changed much less.

Today’s data

This morning has brought borrowing figures which are very good.

Public sector net borrowing (excluding public sector banks) decreased by £2.0 billion to £5.0 billion in May 2018, compared with May 2017; this is the lowest May net borrowing since 2005.

Of course monthly data can be erratic but the fiscal year so far seems set fair as well.

Public sector net borrowing (excluding public sector banks) in the current financial year-to-date (April 2018 to May 2018) was £11.8 billion; that is, £4.1 billion less than in the same period in 2017; this is the lowest year-to-date (April to May) net borrowing since 2007.

Should we continue on anything like such a trajectory this year will see a solid fall in the fiscal deficit.

The NHS Proposal

If we skip the foaming at the mouth over the phrase “Brexit Dividend” it was reported like this by the Financial Times.

The NHS financial settlement — which could be unveiled as soon as next week, ahead of the taxpayer-financed system’s 70th anniversary — is expected to provide increases to the £150bn UK health budget of at least 3 per cent above inflation every year.

As you can see implementing such a policy would be a boost in real terms as at least 3% is circa £5 billion a year. The Institute for Fiscal Studies puts it like this.

Yesterday’s announcement implies that day-to-day spending by NHS England will increase by £16 billion in real terms between now and 2022–23 (with a further £4 billion in 2023–24).

Paying for it

There are three routes. One is simply higher economic growth which in the short-term is problematic as we are in a soft patch which the monetary numbers are signalling will remain through the autumn. Taxes could rise but this government ha shad trouble with that as the debacle over national insurance for the self-employed showed. This leaves borrowing more which in the circumstances seems feasible.

In terms of amount we are borrowing less as discussed above and the cost of our borrowing remains cheap. The UK ten-year Gilt yield is a mere 1.3% and the more relevant for these purposes thirty-year yield is 1.77% . This is of course more expensive than in the late summer of 2016 when Bank of England Governor Mark Carney spent £60 billion on in this respect kamikaze style purchases driving the market to all-time price highs and yield lows including in the madness some negative ones. But it is in terms of the thirty-years I have been following this market certainly low and in fact ultra low.

The Institute of Fiscal Studies is rather dismissive of this route.

But a significant increase in forecast borrowing would mean that the government was not taking its stated commitment to eliminate the deficit by the mid-2020s seriously. The deficit is already forecast to be £21 billion in 2022–23, implying further consolidation measures – in the form of tax rises or spending cuts –would need to be implemented.  The Government could decide to abandon its fiscal objective, as its predecessors have frequently done in the past.

Actually the recent fiscal data suggests that they probably would not have to do that as we see yet another Ivory Tower lost in the clouds of its own rhetoric.

What has today’s data told us?

For all the talk of a fiscal stimulus something of a squeeze has been going on.

In the latest financial year-to-date, central government received £112.9 billion in income, including £82.6 billion in taxes. This was around 3% more than in the same period in 2017.

Over the same period, central government spent £123.6 billion, roughly equal to that spent in the same period in 2017.

In terms of controlling public spending we have come to learn that this is about as good as it gets. We are mostly incapable of reducing it in nominal terms but we do have phases of reducing it in real terms.

Also the receipts data hint at the economy having been stronger than we thought. What I mean by this is that income tax receipts have risen by £2,5 billion to £25,5 billion in the latest couple of months. Indeed even the much maligned retail sector may be getting some support as VAT ( Value Added Tax) receipts rose by £1.1 billion to £23.2 billion. In case this seems like over explaining the rise the numbers are influenced by Bank of England QE from which dividend or coupon payments are taken as receipts and that was a -£0.9 billion influence.

Oh and the spending numbers have been boosted by a fall in debt costs as the rise in ( RPI) inflation washes out of the system.

Comment

There is a lot to consider here so let us start with the UK public finances. Back in October 2016 they were disappointing in the circumstances and now they are good in the circumstances. As some tax receipts represent past activity there may be at least some logic at play as it takes time for the numbers to reflect it. If the data carries on like this then those who use tax receipts as a measure of the economy may feel it is out performing what the GDP data tells us and fits the employment numbers.

The catch is the current slow down and the one we expect from the money supply data which will weaken the above trends. However we find yet another situation where the first rule of OBR Club has hit the cricket ball for six.

 and £5.7 billion less than official (Office for Budget Responsibility) expectations;

So as we stand the UK Public Finances might shrug off a fiscal boost for the NHS although as ever recession would change that. As to how much of a good idea it is remains open to question. On a personal level Frimley Park Hospital gave good care to my father and on less serious matters my mother and I am grateful to Chelsea and Westminster for the work on my knee. Yet there is also an institutional problem.

An expert on hospital mortality data has said scandals such as the deaths at Gosport War Memorial Hospital could be being replicated elsewhere in the NHS.

Prof Sir Brian Jarman told the Today Programme he thinks “it is likely” similar situations are happening in other hospitals.

An inquiry found doctors at the hospital gave patients “dangerous” amounts of powerful painkillers.

More than 450 older patients’ lives were shortened as a result. ( BBC)

 

Can the Bank of England improve productivity?

This morning has brought a reminder of a challenge to the Bank of England,

Labour has said it will set the Bank of England a new 3 per cent target for productivity growth but refused to specify when this should be achieved. John McDonnell, shadow chancellor, will on Wednesday launch Labour’s final report on the UK’s financial system. ( Financial Times)

Reading this raised a wry smile as of course the reforms of Governor Carney reduced productivity by changing the output of the Monetary Policy Committee from 12 meetings a year to 8. But I think we all know they are likely to overlook that one.

Why?

The interim report was published in December and hammered out a familiar beat about UK productivity.

UK productivity has stagnated since the financial crisis of 2007/08. Real output per hour worked rose
just 1.4% between 2007 and 2016 . Within the G7, only Italy performed worse (-1.7%). Excluding the UK, the G7 countries have experienced a 7.5% productivity increase over this period, led by the US, Canada and Japan.

Also there is this.

In addition, the ‘productivity gap’ for the UK – the difference between output per hour in 2016 and
its pre-crisis trend – is minus 15.8%. The productivity gap for the G7 ex-UK countries is minus 8.8%.

I have been consistently dubious about “productivity gap” type analysis for several reasons. Firstly some economic activity and hence productivity before the credit crunch was just an illusion or a type of imagination. Otherwise we would not have had a credit crunch. Also the simple reality is that we have ups and downs not just ups.

Added to that is the problem of international comparisons. Let me illustrate that with some official data from the Office for National Statistics.

The UK’s long-running nominal productivity gap with the other six G7 economies was broadly unchanged in 2016: falling from 16.4% in 2015 to 16.3% in 2016 in output per hour worked terms.

Yet there are clearly problems with this as I note we are doing better than Japan which is a strong exporting nation.

On a current price gross domestic product (GDP) per hour worked basis, UK productivity in 2016 was: above that of Japan by 8.7%, with the gap narrowing from 10.0% in 2015

Also we have apparently done much better than Italy in the credit crunch era by getting worse relative to them!

lower than that of Italy by 10.5%, with the gap widening from 9.6% in 2015

Or if you prefer I think the comparison with France tells us the most if we recall that our economies are much more similar than we often like to admit and yet we are.

lower than that of France by 22.8%, with the gap widening from 22.2% in 2015

Thus we can only conclude that the numbers are not giving us the full picture. For example I think it is the UK’s success with employment that has to some extent worsened recorded productivity.

Also the Financial Times is in error on the data.

Productivity growth has never exceeded 3 per cent a year in Britain.

I think there is a clue in the phrase Industrial Revolution which challenges that! Or more recently there was over 6% in 1940 and 41 or 5% in 1968 in terms of total factor productivity according to FRED the database of the St.Louis Fed.

How would this happen?

A basic problem is identified which I agree with.

UK banks have helped to create a distorted economy. Lending is flowing into unproductive sectors.

This goes further.

As a central bank sitting at the heart of
the UK financial system, the Bank of England needs to be playing an active, leading role, ensuring banks
are helping UK companies to innovate. Flow of funds analysis shows that banks are diverting resources
away from industries vital to the future of this country.

Here I depart a little as I think that the Bank of England should set an environment to help banks change but it is not its role to centrally direct. I do agree with the last sentence as for example I have written many times about how the Funding for Lending Scheme pumped up UK mortgage lending rather than business lending.

One way this occurs is that banks have to put much more capital aside for business lending than they do for mortgage lending or unsecured lending. Also on the demand side for business lending there is a feature which my late father ( who was a small business owner) really,really,really,really ( h/t Carly Rae Jepson)  hated. Here is Dan Davies on Medium pointing out the reality here.

Because, historically, a very high proportion of business lending in the British market has been mortgage-lending-in-disguise. The business loan is usually secured, and usually additionally secured by a charge over the owner’s house.

He hints at some hope for the future but have I clearly pointed out yet that my father hated this feature with a passion? Changes though will need to be throughout the Bank of England infrastructure as the Bank Underground blog has in my view lost the plot as well.

Combining this with firm accounting data, we estimate that a £1 rise in the value of the homes of a firm’s directors leads the average firm in our sample to invest 3p more and increase their total wage bill by 3p.

Yes house prices raise both investment and wages. You might wonder with house prices soaring in recent years compared to almost any other metric it did not trouble anyone that investment and wages are not following it! But instead taking the numbers above with the ones below mean it is apparently a triumph.

This is because the homes of firm directors are worth £1.5 trillion………..Combined with the microeconometric evidence that firms invest 3p more for every £1 increase in the value of their director’s homes, this implies that nominal business investment would rise by around £4.5 billion (0.03*150); an increase of about 2.8%.  By a similar calculation, a 10% increase in real estate prices would increase the total nominal wages paid by firms by 0.8% due to the homes of firm directors.

Thus the answer to life the universe and everything is not 42 as one might reasonably argue especially on international towel day but it is at least according to all echelons of the Bank of England higher house prices. It is time for some PM Dawn to cool us down.

Reality used to be a friend of mine
Reality used to be a friend of mine
Maybe “Why?” is the question that’s on your mind
But reality used to be a friend of mine

Comment

There is a lot to consider here as there is a fair bit of nuance. You see there are areas which can be improved I think. Firstly there are the barriers to business lending around supply ( risk capital requirements) and demand ( having to pledge your home). Next there are changes caused ironically by the higher house prices the Bank of England is so keen on. From Dan Davies again.

we’ve got a generation of young adults coming through who neither own houses, nor have any realistic aspirations to do so. Residential housing as an asset has been more or less completely financialised, and now needs to be seen as part of the pension savings industry .

So the future for millennials is very different and as banks are unlikely to be accepting avocados on toast or otherwise as security this is on its way.

And if you have a generation of businesspeople who don’t own houses, and who therefore can’t be fit into the historic template of British small business lending, then you’ve got the impetus for a total reinvention of small business finance in the UK.

Thus the Bank of England does need to get in tune with Tracy Chapman.

Don’t you know
They’re talkin’ bout a revolution
It sounds like a whisper.

Can it under its present leadership? I very much doubt it but for all the hot air it produces there is an opportunity under the new Governor next year to really drive things forwards. After all he or she hopefully will not be connected to a policy like QE which via its support of zombie banks in particular has worsened productivity.

Meanwhile on a lighter note Financing Investment also suggests this.

Moving some Bank of England functions to Birmingham.

This would help justify HS2 to some extent. But I also recall this from Yes Prime Minister. Here is the Chief of the Defence Staff on relocation.

You can’t ask senior officers to live permanently in the North!  The wives would stand for it for one thing. Children’s schools. What about Harrods? What about Wimbledon? Ascot? Henley? The Army & Navy club? I mean civilisation generally, it is just not on…….Morale would plummet.

Mind you there was some hope

I suppose other ranks can be, junior officer perhaps

 

London House Prices are falling on one measure and also rising!

This morning has seen Rightmove update us on the UK property market and in response we have learnt where Bloomberg journalists live.

London house prices fell the most since the beginning of the year in June as the capital’s property market continued to lag behind the rest of the country.

The price of property coming to market in London dropped by 0.9 percent, bringing the average price to 631,737 pounds ($838,000), property-website operator Rightmove said in a report Monday. Values fell 1 percent from a year earlier, marking the 10th negative month in a row.

The rest of the country only gets a brief look in.

Nationally, prices grew 0.4 percent on the month and 1.7 percent on an annual basis.

Then it is time to get back to the heart of the matter.

In London, “new-to-the-market sellers recognize that the traditionally busier spring selling season is drawing to a close,” said Rightmove Director Miles Shipside.

Oh and as it is Bloomberg there is a consistent scapegoat for pretty much all seasons.

London’s property market has been hit particularly badly by uncertainty surrounding Britain’s impeding exit from the European Union.

Actually we get a reminder of what Rightmove really say from property industry eye.

New asking prices have bounced up to another record, averaging £309,439.

This morning Rightmove said asking prices for properties new to the market are 0.4% up on last month, and 1.7% up on June last year.

The Rightmove data is not for the price at which property is sold it is what sellers are asking for the property or trying to get. In terms of a rising price by this measure then it is a northern thing as the stock available has declined.

From the west midlands northwards, stock has fallen away since a year ago, by between 2.2% and 10.4% in Scotland.

Stock has also dwindled in Wales, by 10.3%.

Whereas prices are under pressure from something of a wave of more housing stock coming onto the market in the south.

By contrast, the amount of available stock has shot up almost 25% on a year ago in the east of England; by 20% in the south-east; by 16.4% in London; 8.2% in the south-west; and by 4% in the east midlands.

Land of Confusion

I am using the Genesis lyric because if we move to LSL/Acadata we get told something very different about London house prices.

Despite the lack of movement in prices, there is one big change in the market this month: London and the South East are no longer a brake on the market. Taking into account these two regions, there was a 2.2% annual price growth – taking them out of the equation, the growth rate is lower – at 2.1 %. It reverses the trend of most of last year.

Although we have learnt from past experience to feel something of a chill when we read something like this.

This is partly due to a change in methodology, which better captures sales of new build properties. These tend to cost more than existing homes and have a particularly strong impact on the average price in London.

In fact the major impact from this is on flats in London.

This was particularly pronounced for flats, where new build flats sold at an average premium of almost
a third (32.3%). They also made up a substantial proportion of sales of all flats, accounting for more than a quarter (26.4%), whereas new builds accounted for just 2.4% of sales of detached properties.

Once you have done that you get this.

The revised figures in London, taking into account new build properties, show annual growth of 2.9%, the lowest since March 2012. Prices also fell on a monthly basis, down 0.3%, taking the average house price in the capital to £636,947.

In case you are no aware the issue of how to treat new builds is a difficult one and is one where the official Office for National Statistics series has had trouble too. Obviously a brand new property cannot have a price rise per se but you can calculate an index based on say quantity like size or number of bedrooms. Much more difficult and perhaps impossible is to allow for the quality of the property.

Also treating London as one market gets a bit of a critique from reality below.

A number of London boroughs are recording big falls over the 12 months to April 2018. They include the City of London (down 24.9%, albeit on a small number of sales), Southwark, down 19.1% (largely as a result of high value properties sold the year before); and Wandsworth, down 13.1%. Growth has been more modest, with only Kensington and Chelsea, the most expensive borough, recording double-digit growth, up 10.4% to £2.17 million. The next highest increase over the year was Lambeth, where prices increased 5.8%.

The issue at this level is that you are down to a small number of sales in some cases leading to large swings. For obvious reasons people like to view the data for Kensington and Chelsea but if it is based on only a handful of sales it is to say the least problematic. Although sometimes just one sale can be crystal clear at least for it.

For those wondering if the previous owners had overpaid back in 2013 I did ask.

Number Crunching

Moving on here is some Monday morning humour from the British Chambers of Commerce.

The British Chambers of Commerce (BCC) has today (Monday) slightly downgraded its growth expectations for the UK economy, forecasting GDP growth for 2018 at 1.3% (from 1.4%) which, if realised, will be the weakest calendar year growth since 2009, when the economy was in the throes of the global financial crisis. The BCC has also downgraded its GDP growth forecast for 2019 from 1.5% to 1.4%.

Yes they think they can forecast GDP growth to 0.1%!

Next come courtesy of those suffering from a type of amnesia.

Households could be left up to £1,000 a year worse off because of Brexit trade barriers, a report will suggest.

Global consultancy firm Oliver Wyman will say that under the most negative scenario of high import tariffs and high regulatory barriers the cost to the economy could total £27bn.

The problem here is the authors so with the help of FT Alphaville let me show you how their crystal ball has worked out in the past.

It has long been known that consulting firm Oliver Wyman crowned Anglo Irish the world’s best bank in 2006 — just when Anglo was actually… well, you know the story.

Sadly, the report that bestowed this fateful distinction has (quite unaccountably!) vanished from the Oliver Wyman corporate site.

Or this.

North American Investment Bank – Bear Stearns (SPI 230) is the best-performing company in this year’s most improved sector, investment banking.

Comment

After a barrage of contradictory numbers let us step back and take stock. We see that the background for UK house prices is not what it was. For example the Term Funding Scheme of the Bank of England ended in February and whilst it still represents some £126.6 billion of cheap liquidity for the banks it is now gently declining. Other factors such as a 0.5% Bank Rate and £435 billion of QE have been at play in raising prices but that has worn off now. Perhaps we are still seeing the influence of the Help To Buy scheme in the North but unless prices fall more in London many are still above its cap of £600,000.

A welcome development is that house price growth seems to have fallen back in line with wage growth although of course the official numbers still disagree (3.9%). Even that development has the issue of course that it does not help with prices being much too high in many parts of the country. As to detail all we can honestly say is that house price inflation has fallen and some parts of London especially in the centre are seeing falls.

Moving onto my new measure which refers to a block of around 80 flats near the US Embassy in Nine Elms there was an improvement this week, There were signs of life (open windows etc) in 12 as opposed to 8.

 

 

The Bank of England has a credit card problem

This morning has brought a development in two areas which are of high interest to us. So let us crack on with this from the Financial Times.

The Bank of England has issued a warning about the sort of risky lending practices particularly important to Virgin Money, at a critical time in the bank’s negotiations over a £1.6bn takeover by rival CYBG.

When one reads about risky lending it is hard not to think about the surge in unsecured consumer lending in the UK over the past couple of years or so.

The 12-month growth rate of consumer credit was 8.8% in April, compared to 8.6% in March ( Bank of England)

That rate of growth was described a couple of months ago as “weak” by Sir Dave Ramsden. Apparently such analysis qualifies you to be a Deputy Governor these days and even gets you a Knighthood. Also if 8% is weak I wonder what he thinks of inflation at 2/3%?

However the thought that the Bank of England is worried about the consumer fades somewhat as we note that yet again the “precious” seems to be the priority.

In a letter sent to bank chiefs last week seen by the FT, the Prudential Regulation Authority, BoE’s supervisor of the largest banks and insurers, said “a small number of firms” were vulnerable to sudden losses if customers on zero per cent interest credit card offers then leave earlier or borrow less than expected.

How might losses happen?

Melanie Beaman, PRA director for UK deposit takers, wrote that banks with high reliance on so-called “effective interest rate” accounting should consider holding additional capital to mitigate the risks.

The word effective makes me nervous so what does it mean?

EIR allows lenders that offer products with temporary interest-free periods to book in advance some of the revenues they expect to receive once the introductory period ends.

That sounds rather like Enron doesn’t it? I also recall a computer leasing firm in the UK that went bust after operating a scheme where future revenues were booked as present ones and costs were like that poor battered can. Anyway there is a rather good reply to this on the FT website.

I am expecting to win the lottery. Can l  bank the anticipated income now please?  ( TRIMONTIUM)

There is more.

Optimistic assumptions about factors such as customer retention rates and future borrowing levels allow banks to report higher incomes, but increase the risk of valuation errors that could lead to a reversal and weaken their balance sheets, according to the PRA.

Are these the same balance sheets that they keep telling us are not only “resilient” but increasingly so? We seem to be entering into a phase where updating my financial lexicon for these times will be a busy task again. Perhaps “Optimistic” will go in there too?

Moving on one bank in particular seems to have been singed out.

Almost 20 per cent of Virgin Money’s annual net interest income in 2017 came from the EIR method. Industry executives said any perceived threat to capital levels could strengthen CYBG’s (Clydesdale &Yorkshire) hand in negotiations. Virgin Money declined to comment on the PRA’s letter or the merger discussions. CYBG and the PRA also declined to comment.

This is a little awkward as intervening during a takeover/merger raises the spectre of “dirty tricks” and to coin a phrase it would have been “Fa-fa-fa-fa-fa-fa-fa-fa-fa-far better” if they have been more speedy.

FPC

We do not mention this often but let me note this from a speech from Anil Kashyap, Member of the Financial Policy Committee. Do not be embarrassed if you thought “who?” as so did I.

The statute setting up the FPC also makes the committee responsible for taking steps (here I am
paraphrasing) to reduce the risks associated with unsustainable build-ups of debt for households and
businesses. This means that the FPC is obliged to monitor credit developments and if necessary be
prepared to advocate for policies that may lead some borrowers and lenders to change the terms of a deal
that they were otherwise willing to consummate.

Worthy stuff except of course if we move to the MPC and go back to the summer of 2016. This was Chief Economist Andy Haldane in both June and July as he gave essentially the same speech twice.

Put differently, I would rather run the risk of taking a sledgehammer to crack a nut than taking a miniature
rock hammer to tunnel my way out of prison – like another Andy, the one in the Shawshank Redemption.

Seeing as monetary policy easings in the UK had invariably led to rises in unsecured borrowing you might think the FPC would have been on the case. However Andy was something of a zealot.

In my personal view, this means a material easing of monetary policy is likely to be needed, as one part of a
collective policy response aimed at helping protect the economy and jobs from a downturn. Given the scale
of insurance required, a package of mutually-complementary monetary policy easing measures is likely to be necessary. And this monetary response, if it is to buttress expectations and confidence, needs I think to be
delivered promptly as well as muscularly.

Not only had Andy completely misread the economic situation the credit taps were turned open. He and the Bank of England would prefer us to forget that they planned even more for November 2016 ( Bank Rate to 0.1% for example) which even they ended up dropping like it was a hot potato.

My point though is that the cause of this below was the Bank of England itself. So if the FPC wanted to stop it then it merely needed to walk to the next committee room.

Consumer credit had been growing particularly rapidly. It had reached an annual growth
rate of 10.9% in November 2016 – the fastest rate of expansion since 2005 – before easing back
somewhat in subsequent months. ( FPC Minutes March 2017)

As some like Governor Carney are on both committees they could have warned themselves about their own behaviour. Instead they act like Alan Pardew when he was manager of Newcastle United.

“I actually thought we contained him (Gareth Bale) quite well.”

He only scored twice…..

Credit Card Interest-Rates

Whilst the Bank of England is concerned about 0% credit card rates albeit for the banks not us. There is also the fact that despite all its interest-rate cuts,QE and credit easing the interest-rate charged on them has risen in the credit crunch era.

Effective rates on the stock of interest-charging credit cards decreased 22bps to 18.26% in April 2018.

I remember when I first looked back in the credit crunch day and it was ~17%.

Comment

You may be wondering after reading the sentence above whether policy has in fact been eased? I say yes on two counts. Firstly it seems to be an area where there is as far as we can tell pretty much inexhaustible demand so the quantity easing of the Bank of England has been a big factor eventually driving volumes back up. Next is a twofold factor on interest-rates which as many of you have commented over the years a lot of credit card borrowing is at 0%. It may well be a loss leader to suck borrowers in but it is the state of play. Next we can only assume that credit card interest-rates would be even higher otherwise although of course we do not know that.

What we do know is that unsecured lending of which credit card lending is a major factor has surged in th last couple of years or so. Accordingly it was a mistake to give the Bank of England control over both the accelerator and the brake.

Me on Core Finance TV

 

Rising inflation trends are putting a squeeze on central banks

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

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

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

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

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

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

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

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

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

So Mission Accomplished!

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

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

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

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

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

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

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

US Inflation

The situation here is part of an increasingly familiar trend.

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

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

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

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

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

What does the Federal Reserve make of this?

Well this best from yesterday evening is clear.

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

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

This is how the New York Times viewed matters.

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

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

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

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

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

Yet I note this too.

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

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

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

What is normal now please Mr.Powell?

Comment

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

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

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

 

 

Italy faces another bond market crisis

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

Retail Sales

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

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

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

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

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

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

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

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

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

The economy overall

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

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

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

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

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

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

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

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

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

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

Bond Markets

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

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

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

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

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

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

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

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

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

Comment

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

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

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

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

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

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