UK Retail Sales suggest inflation of 3.1% as the Bank of England remains vigilant

Today the focus switches back to the UK at the end of what has been a long hot week if not the long hot summer that The Style Council sang about. The official release brought some good news.

Retail sales volumes increased by 0.5% between May and June 2021, and were up 9.5% when compared with their pre-coronavirus (COVID-19) pandemic February 2020 levels.

I am not sure that such an erratic series can be described as a type of old reliable but it has been the area that has demonstrated a V-shaped recovery. Remember those who told us the whole economy would do that? Well they are hoping you have forgotten.

The shape got damaged by later lockdowns but whenever they had the chance the UK consumer came out to play. This is an example of some of the savings that were built up being spent.

Breaking it Down

The driver was food sales which swung heavily between May and June.

Food store sales volumes increased by 4.2% in June 2021, following a decline of 5.5% in the previous month, when consumers had switched some food spending to hospitality as some restrictions in that sector were relaxed. Feedback from some retailers suggested that sales were positively boosted in June by the start of the Euro 2020 football championship.

If the area around me was any guide plenty of alcohol was sold too. Outside of that area we saw a different picture.

Non-food stores as a whole saw monthly sales volumes fall by 1.7% in June 2021, following strong growth in previous months.

In fact we seem to have by-passed this year’s summer sales or perhaps they have been postponed if we stay with football analogies.

Household goods stores reported a monthly fall in sales volumes of 10.9% in June 2021, driven by falls in furniture stores and electrical household appliance stores. The Bank of England Agents’ summary of business conditions for Quarter 2 (April to June 2021) notes that transportation delays have resulted in shortages of some items, such as furniture and electrical goods……..Clothing and department stores also reported monthly declines, of 4.7% and 3.6% respectively.

The catch-all category showed very strong growth but as you can see there is a lack of detail.

Other non-food stores (such as chemists, toy stores and sports equipment stores) reported monthly growth of 8.6% driven by strong growth in second-hand goods stores.

Online

With more places open this was inevitable.

Online spending values fell in June 2021 by 4.7% when compared with May 2021, with all sectors except clothing stores reporting monthly falls in their online sales…….This resulted in a decline in the proportion of online retail spending values, which fell to 26.7% from 28.4% in May 2021.

But it remains much higher than before with all that implies for physical stores and the high street.

However, this is higher than the proportion of online retail spending in February 2020 (pre-coronavirus (COVID-19) pandemic) of 19.9%.

Inflation

We do get a reading on this from the numbers because the amount spent in June was up 113.1 on last year but the volume increase was 109.7. This leaves us with an inflation rate of the order of 3.1% which gives us another warning as well as another problem for the official inflation numbers.

Markit PMI

These suggested that UK economic growth continued into July but was affected by what has become called the pingdemic where the NHS app has pinged so many for self-isolation it has left some businesses short of staff.

At 57.7 in July, the headline seasonally adjusted IHS Markit  / CIPS Flash UK Composite Output Index registered above the 50.0 nochange value for the fifth consecutive month…….. However, the latest reading was down from 62.2 in June and the lowest since the easing of lockdown restrictions began during March.

As an absolute measure they have been a poor guide and in manufacturing actually misleading so make of that what you will. One area they should be able to get right is inflation pressures.

Average cost burdens increased at the fastest pace since the survey began in January 1998, fuelled by a steeper rise in the service sector. This was linked to wage inflation, higher transport bills and price hikes by suppliers. Manufacturers also recorded another rapid upturn in purchasing prices, but the rate of inflation eased from June’s all-time high.

 

Bank of England

Yesterday we heard from Deputy Governor Ben Broadbent and there is a link to the above as well as my description of him as the absent-minded professor.

So with numbers like these perhaps it’s not surprising to see inflation going up, here and in other countries. In the UK, annual CPI inflation has risen from ½% to 2½% in the past four months.

Actually it has been a surprise to him as the Bank of England did not predict it.This is what we were told as recently as February.

As temporary effects fade and the impact of spare capacity diminishes over 2021, inflation rises towards the target.

Also after Brexit he told us he follows PMIs which led him in the wrong direction back then and this time he seems to have missed their inflation warning.

He deploys the usual central banking response which is to move the goal posts, Usually that involves looking a different measures but that cannot have worked so his staff will have been dispatched to change the time frame.

Over the past year and a half as a whole, so including that initial drop, headline and core CPI
have both risen at an average (annualised) rate of 1½-1¾%, a little weaker than pre-pandemic rates.

Ben has a go at claiming he has been right.

And shifts in spending of this sort, at least until (and unless) they’re met by matching shifts in supply, tend to push up
average prices.

But then no he didn’t

In January, I felt that these mismatches would probably get ironed out over time.

After all this he concludes that one day it will end although he does not know when.

And in many of these markets supply looks to be reasonably
“elastic”, at least over the medium and longer term: it responds positively to higher prices, ensuring a degree
of self-correction.

We are already being warmed up for his conclusion.

Along the way we see confirmed a point that many of you have made.

One important place to look will be wage growth. That’s also the place where any “second-round” effects of
the current inflation, via higher expectations for the future, would both appear and most matter.

I do hope Ben raised the issue below with his former colleague Dr. Martin Weale who botched a review of the average earnings figures and left us as described.

Unfortunately, the headline wage numbers are currently beset by a host of distortionary effects.

Ben misses out the fact that the self-employed are excluded as are those at smaller businesses. Still I suppose having been involved in the botching of the RPI Review I guess he feels he would be throwing stones in a glass house.

What is he going to do about it?

And if this was only a story about global goods
prices – and depending how confident you were in its transitory nature – I think the answer could well be
“nothing”.

Comment

There is much that is familiar about the speech from Ben Broadbent. The first is that he has been wrong again but expects us to take his view on the same subject seriously. Next is the effort to pick out an individual area.

Most of the overshoot relative to target in the latest CPI numbers – more than all of it, on some measures –
reflects unusually strong inflation in goods prices.

At some point that will probably fade but he ignores the fact that other areas may take its place. No doubt when they do we will be told they are unusually strong. Rince and repeat. Next is the shift in timing that I regularly report on. When the pandemic hit the response was immediate but when we have inflation now it switches to.

I’m not convinced that the current inflation in retail goods prices should in and of itself mean
higher inflation 18-24 months ahead, the horizon more relevant for monetary policy.

As a final point as an external and thereby supposedly independent member he should never have been promoted to Deputy-Governor. It sets us all the wrong motivations as those appointed to bring diversity find that being a good boy or girl can be very remunerative. No wonder we get so many unanimous votes.

Will it be austerity again for the UK?

The last few weeks have seen a rise in the level of debate about the UK public finances and we can use this morning’s data release to illustrate that. The relatively simple part is what has happened so far.

Central government tax and National Insurance receipts combined in the financial year ending (FYE) March 2021 (April 2020 to March 2021) were £672.4 billion, a fall of £30.6 billion compared with the same period a year earlier. Government support for individuals and businesses during the pandemic contributed to an increase of £204.3 billion in central government day-to-day (or current) spending to £942.7 billion.

That is about as clear an example of fiscal policy being deployed in the UK that I can think of. Some of it was the automatic stabilisers as spending rose due to unemployment benefits and taxes fell. But the extra spending such as the Furlough Scheme was combined with tax cuts such as VAT and as you cannot leave out the housing market Stamp Duty. All of this brought us to this below.

As a result of these low receipts and high expenditure, provisional estimates indicate that in FYE March 2021, the public sector borrowed £297.7 billion, equivalent to 14.2% of the UK’s gross domestic product (GDP).

So the highest level of relative borrowing since the end of the second world war and the highest level of nominal borrowing ever. Economics text books will be full of this as both an example and a test case. One thing that historians are likely to be confused about is why so much faith was placed by some in a body that was so consistently wrong?

This was £29.7 billion less than the £327.4 billion expected by the Office for Budget Responsibility (OBR) in their Economic and Fiscal outlook – March 2021 on a like-for-like basis.

That beat goes on as they will be giving evidence to the Treasury Select Committee later.

Today we’re taking evidence from the @OBR_UK

on their Fiscal Risks Report. We’ll be looking at their assessment of the risks to public finances from the pandemic, climate change and public debt.

They have been consistently wrong about the pandemic which is hardly inspiring for their abilities in the other two areas. Care is needed because the situation has been to say the least volatile, but the issue is that they keep being systematically wrong.

UK Bond Yields

Not mentioned in today’s release is the impact of the fall in UK bond ( Gilt) yields that has oiled the above. If we return to the failures of the OBR I recall them predicting back in the day that UK bond yields would be 4% and I am being kind. Whereas we saw some shorted-dated ones go negative and even the 50-year fell to below 0.5% for a while. So as the band Middle of the Road put it borrowing has been.

Ooh wee, chirpy chirpy cheep cheep
Chirpy chirpy cheep cheep chirp

If we bring this right up to date we see that the recent bond market rally has reduced the 50 year yield below 1%. Things have been volatile this week die to the equity market gyrations we have seen but at the moment it is 0.87%.

Inflation Problems

This is an issue I have warned about both generically and for the public finances. This month it started to come into play.

Interest payments on central government debt were £8.7 billion in June 2021, the highest monthly payment on record (records began in April 1997).

Fluctuations in debt interest are largely a result of movements in the Retail Prices Index (RPI) to which index-linked gilts are pegged.

The latter sentence needs an at the moment added because we could see days when conventional bond yields rise again, and they come back into play in this respect. However back to the inflation issue.

The interest related to the £470.7 billion index-linked gilts in circulation (at redemption value) increased by £6.0 billion in June 2021 compared to June 2020, mainly as a result of the large increase in the RPI between March and April 2021 impacting on the uplift of the three-month lagged index-linked gilts.

We now know that rises we have seen in the RPI will be having an impact in future months.

Regular readers will recall I have been making the point that the UK should be issuing more conventional bonds for this reason. A few years back there was something of a debate with Jonathan Portes on this point with him arguing that real yields are negative. The problem as I have consistently pointed out is the gap between theory ( real yields) and reality which is what we are paying.

The Austerity Plan

Whilst fiscal policy has been en vogue there is a cadre at HM Treasury who will have been planning all along to take it back in some sense. That has found a form this week at the Institute for Fiscal Studies.

But his room for manoeuvre in the medium term is far more limited. The government’s existing spending plans imply cuts to some departments, and still make no allowance for additional virus-related spending. Sticking to those plans would mean spending up to £17 billion less on public services per year than what was planned prior to the pandemic, despite rising costs and rising demands.

I am not sure that is going to work and confusingly the IFS seems to think that the government can spend more now.

 The current budget deficit – the difference between what the government spends on day-to-day activities and what it raises in revenues – is, under our forecast, improved by £30 billion for 2021−22, relative to the forecast back in March.

Yes that is another OBR fail. But it would be odd to spend now if you think that there is trouble on the horizon. Frankly it all looks rather confused which is par for the course for both the IFS and HM Treasury.

What about the June numbers?

We arrived at the release with hope because the signals for June employment growth has been strong. The catch is that because many of the numbers are estimates such a thing is likely to be caught later by revisions rather than revealed today.

Central government receipts in June 2021 were estimated to have been £62.2 billion, a £9.5 billion (or 18.0%) increase compared with June 2020. Of these receipts, tax revenues increased by £8.1 billion (or 21.7%) to £45.5 billion.

Income Tax was up 14% on last year as is National Insurance being up by 11%.

Central government bodies spent £84.1 billion in June 2021, £2.5 billion (or 3.1%) more than in June 2020.

This is more than explained by the debt interest rise we have already looked at. On the other side of the coin the various Furlough Schemes dropped by about £6 billion. So the net move was mostly this.

Central government departments spent £31.1 billion on goods and services in June 2021, an increase of £1.7 billion (or 5.7%) including £17.7 billion on procurement and £12.8 billion in pay.

Oh and we paid £800 million to the EU as part of the Brexit settlement.

Comment

There is quite a bit going on here as the economic situation has again turned out better than the official expectation via the OBR. But looking further ahead there are clearly challenges. Any sustained burst of inflation will be expensive. Of course they have a plan for that with the RPI being converted into a another version of CPIH but that will not happen until 2030 at best and hopefully never. Any sustained rise in conventional bond yields will be expensive but at present with its £3.45 billion of weekly purchases the Bank of England is in play here. As it happens bond yields generally have fallen too.

There is a catch in the above in that bond yields have fallen because of fears that economies will slow due to new Covid problems. Today that has been illustrated by Australia where half the population is now in another lockdown. In the end these issues come down to economic growth. That is why government forecasts invariably settle on 3% per annum growth as that fixes most debt problems quite quickly. Therein lies the rub as it has been quite some time since we managed that.

Bank of England QE is coming under increasing fire as inflation rises

This has been a bad week for central bankers as we have seen inflation soar above their predictions. The 5.4% for US CPI is not what the Federal Reserve explicitly targets but suggests a trend well above its thinking and that is before we get to the issue of the “transitory” or it you prefer “temporary” claims they have made. If you look at the statement to Congress of Chair Powell this week he shifted to expectations on inflation in response to this.

To avoid sustained periods of unusually low or high inflation, the Federal Open MarketCommittee’s (FOMC) monetary policy framework seeks longer-term inflation expectations thatare well anchored at 2 percent, the Committee’s longer-run inflation objective.

After all he can claim pretty much what he wants via them as opposed to workers and consumers paying higher prices who have no such choice. Also we had the UK with the targeted inflation measure going to 2.5% so 0.5% over and RPI at 3.9%. That is really rather awkward in a week where you have bought some £3.45 billion of UK bonds as part of a policy ( QE) to raise inflation.

House of Lords

They have published a report today which questions QE on a strategic level. One issue is how much of it is planned.

Since March 2020, the Bank of England has doubled the size of the quantitative easing programme. Between March and November 2020, the Bank of England announced it would buy £450 billion of Government bonds and £10 billion in non-financial investment-grade corporate bonds. In total, by the end of 2021, the Bank will own £875 billion of Government bonds and £20 billion in corporate bonds. This is equivalent to around 40% of UK GDP.

Those who have followed my “More! More! More!” theme which has been running for a decade will have a wry smile at this.

Therefore, the scale and persistence of the quantitative easing programme are substantially larger than the Bank envisaged in 2009.

It has also become the policy of first resort.

Once considered unconventional, more than a decade after its introduction, quantitative easing is now the Bank of England’s main tool for responding to a range of economic
problems.

Yet have things got better?

These problems are quite different from those of 2009.

The House of Lords does not explicitly say it at this point but let me point out that it has created problems along the way as the Cranberries told us.

In your head, in your head
Zombie, zombie, zombie-ie-ie

Inflation

Their Lordships have spotted the 2021 issue.

Despite a growing economy and expansionary monetary and fiscal policy, central banks in advanced economies appear to see the risks of inflation in terms of a transitory, rather than a more long-lasting, problem.

A fair point as after all whilst the flow may stop ( presently planned to be towards the end of 2021) the stock of £895 billion including corporate bonds will remain on the books. After all, so far, the Bank of England has not redeemed a single penny. So in monetary terms there will remain an extra £895 billion in the money supply although care is needed because what follows from it is not as simple as what was thought. especially by the Bank of England itself.

Quantitative easing’s precise effect on inflation is unclear.

It has been made less clear in my view by the establishment effort to remove ways measuring this by downgrading the RPI which is a pretty transparent effort to move the focus away from the house prices it includes. Can anybody think why?

Since they finalised their thinking the statement below has been reinforced by inflation going over its target as well.

The official inflation rate is already higher than
the Bank of England’s previous forecasts.

These factors add to the challenges here.

The Bank of England forecasts that any rise in inflation will be “transitory”; others disagree.

They then pose a challenge whilst also issuing a critique. After all it should have made its thinking clear.

We call upon the Bank of England to set out in more detail why it believes higher inflation will be a short-term phenomenon, and why continuing with asset purchases is the right course of action.

This leads to the crux of the matter because as I have frequently pointed out monetary policy takes around 18 months to 2 years to have its full impact. That may even have lengthened in the modern era due to the increased numbers of fixed-rate mortgages which is considered a major transmission mechanism. Yet we have central bankers who ignore that and at times claim that they can act during or even after the event which to mt mind requires the ability to time-travel.

The Bank should clarify what it means by “transitory” inflation, share its analyses, and demonstrate that it has a plan to keep inflation in check.

Interest-Rates

Their Lordships seem to have stumbled on my point that we will not see many if any interest-rate increases because of the cost of them.

Quantitative easing hastens the increase in the cost of Government debt because interest on Government bonds purchased under quantitative easing is paid at Bank Rate, which could be much higher than it is now (0.1%) if the Bank of England had to increase Bank Rate to control inflation. As a result, we are concerned that if inflation continues to rise, the Bank may come under political
pressure not to take the necessary action to maintain price stability.

That is of course assuming they do not follow the path trod by the ECB and simply change the rules of the game.

These included an option to not pay interest on commercial bank reserves.

This bit made me laugh and I hope it is humour.

While the UK can be proud of the economic credibility of the Bank of England, this credibility rests on the strength of the Bank’s reputation for operational independence from political decision-making in the pursuit of price stability.
This reputation is fragile, and it will be difficult to regain if lost.

Like so many central banks they lost it years ago.

Michael Saunders

We can now switch to the tactical rather than the strategic and yesterday one of the policy-makers said this.

In my view, if activity and inflation indicators remain in line with recent trends and downside risks to growth and inflation do not rise significantly (and these conditions are important), then it may become appropriate fairly soon to withdraw some of the current monetary stimulus in order to return inflation to the 2% target on a sustained basis. In this case, options might include curtailing the current asset purchase program – ending it in the next month or two and before the full £150bn has been purchased – and/or further monetary policy action next year.

So there may be several votes for ending the QE programme early. Not enough to win a vote but increasing.

Oh and his confession that they had for their forecasts wrong (most of you are no doubt thinking again) is rather devastating for their “transitory” claims.

Comment

If we switch to the benefits we seem to get ever more of something that has unclear results.

We found that the available evidence shows that quantitative easing has had a limited impact on
growth and aggregate demand over the last decade.

They do not point out the moral hazard of the evidence often coming from those operating the policy. There are also losses and problems.

Furthermore, the policy has also had the effect of inflating asset prices artificially, and this has benefited those who own them disproportionately, exacerbating
wealth inequalities.

I am glad they are making this point as I believe they did note my points about house price rises when I gave evidence to the RPI enquiry. Actually even the Financial Times may be forced into a rethink as it is its economics editor Chris Giles who led the charge to remove house prices from the RPI.

Finally it is hard not to have a wry smile at Lord King of Lothbury criticising a policy he started.

“I wonder if I’ve been changed in the night. Let me think. Was I the same when I got up this morning? I almost think I can remember feeling a little different. But if I’m not the same, the next question is ‘Who in the world am I?’ Ah, that’s the great puzzle!” ( Alice In Wonderland )

Inflation is back on the march

Yesterday brought troubling news on the inflation front as the US CPI measure of inflation rose to 5.4%. Personally I was more bothered by the annual rise of 0.9% due to the problems at the moment with annual comparisons created by the Covid pandemic. That set something of an underlying theme for the UK release this morning so to any logical person it is rather curious to find this being reported by in this instance Ed Conway of Sky News.

UK CPI inflation rises above expectations again. Up to 2.5% in June.

If you had not be following the producer prices data we check each month you did get a clue from the US yesterday. It has different specific circumstances but broad trends for oil.food and other commodities will be in play.

Thus this was not really a surprise at all.

The Consumer Prices Index (CPI) rose by 2.5% in the 12 months to June 2021, up from 2.1% to May; on a monthly basis, CPI rose by 0.5% in June 2021, compared with a rise of 0.1% in June 2020.

We can break it down but the initial one helps a bit but as you can see whilst goods inflation is higher by the standards of this the gap is not large. However goods prices have seen a particular acceleration.

The CPI all goods index annual rate is 2.8%, up from 2.3% last month……The CPI all services index annual rate is 2.1%, up from 1.9% last month.

We can take that further although the official analysis is only for the similar CPIH as they try to force people to use their widely ignored favourite.

There were upward contributions to the change in the CPIH 12-month inflation rate from 9 of the 12 divisions, partially offset by a downward contribution from health.

So the move was fairly broad and we can specify it more.

The largest upward contribution (of 0.08 percentage points) to the change in the CPIH 12-month inflation rate came from transport, where prices rose by 1.3% between May and June 2021, compared with a rise of 0.5% between the same two months of 2020. The effect was principally from second-hand cars and motor fuels.

The second-hand car effect was something seen in the US where the unadjusted annual number was 45.2%. A lot of reliance was placed on the seasonal adjustment which reduced it to 10.5% as you can see by the difference in the numbers. The UK situation is not so different with second-hand cars seeing a monthly price rise of 4.4%. In terms of the technicalities they have reduced the weight by 20% which has proved convenient in keeping recorded inflation low but looks a clear mistake in hindsight.

Due to second-hand cars, where prices overall rose this year but fell a year ago. There are reports of prices rising as a result of increasing demand. This follows the end of the latest national lockdown and with some buyers turning to the used car market as a result of delays in the supply of new cars caused by the shortage of semiconductor chips used in their production.

That category was also impacted by rises in fuel prices of the order of 2.4 pence per litre which meant a 2% rise on the month for fuels.

Next come something rather troubling for those relying on seasonal adjustment.

A final, large, upward contribution (of 0.05 percentage points) came from clothing and footwear. Prices, overall, rose by 0.8% between May and June this year, compared with a fall of 0.1% between the same two months a year ago. Normally, prices fall between May and June as the summer sales season begins  but the seasonal patterns have been influenced by the timing of lockdowns since the onset of the coronavirus pandemic.

The US Bureau of Labor Statistics which adjusted US used car prices so heavily may have an itchy collar when reading that.

The ongoing issue of how to treat prices in area’s which see heavy discounting or the same from going in and out of best-seller charts swung the other way this month.

The largest downward contribution of 0.06 percentage points came from games, toys and hobbies, where prices fell this year but rose a year ago, with the main effects coming from computer games and games consoles.

Also the rate of increase of prices for pills,lotions and potions has faded.

A partially offsetting, small downward contribution (of 0.03 percentage points) to the change in the CPIH 12-month inflation rate came from health. Prices of pharmaceutical products, other medical and therapeutic equipment rose by 0.8% between May and June 2021, compared with a larger rise of 3.1% between the same two months a year ago.

Tax Cuts

There have been some indirect tax cuts of which the largest has been the cuts to VAT. If you fully factor them in then the inflation episode is a fair bit larger.

The annual rate for CPI excluding indirect taxes, CPIY, is 4.2%, up from 3.8% last month.

 

 

No perhaps it will not all be passed through but even if you halve the impact you end up at 3.4%

Housing Costs

This has been a contentious issue for some time and the heat is not only on it is getting hotter all the time. Why? Well the official view is this.

The OOH component annual rate is 1.6%, up from 1.5% last month. ( OOH = Owner Occupiers Housing Costs)

I had to look that up because they quote all sorts of numbers to try to hide what is so obviously embarrassing. Even the man from Mars that Blondie sang about is probably aware that house prices are soaring and will be wondering how costs are only rising .

by that little? Especially when only 2 and and half hours later we are told this.

UK average house prices increased by 10.0% over the year to May 2021, up from 9.6% in April 2021.

So prices are up 10% but costs only by 1.6%! So what fell? Well mortgages are doing little so our official statisticians have to explain how their smoothed ( it is up to 16 months out of date) number for rents which do not exist impacts with reality.

After all how can you add soaring housing costs to the CPI at 2.5% and manage to then get 2.4% as CPIH does…..

I have regularly pointed out that this is an area of strength for the Retail Prices index or RPI and the reason why is shown below.

Annual rate +4.3%, up from +3.8% last month

It is picking up the rises that everyone can see much more accurately and let me specify that. It uses house prices via depreciation which is good but even it is handicapped by the smoothing process I described earlier and would change given the chance. If so it would give a higher reading right now and be a better measure.

Comment

I thought you might enjoy my perspective on the official inflation view..

The official inflation story
1. There wont be any
2. It will be transitory
3. It was above expectations
4. It is too late to do anything about it now.

Next there is the house price issue which if we put into the CPI measure at current weights would put it at 4%. Regular readers will have noted Andrew Baldwin commenting on this and so let me refine it. In reality if they let house prices in they will have the weights even though no brick is moved,window opened or door closed. But even if we so that we get to 3.2% and the Governor of the Bank of England is in the zone where he has to write an explanatory letter. That would be awkward as this afternoon the Bank of England will buy another £1.15 billion of UK bonds in an attempt to raise the inflation rate.

Looking ahead we see that whilst the shove is not as large as last month there still is a large one.

The headline rate of output prices showed positive growth of 4.3% on the year to June 2021, down from 4.4% in May 2021.

The headline rate of input prices showed positive growth of 9.1% on the year to June 2021, down from 10.4% in May 2021.

The monthly rise for output prices was 0.4% so the beat goes on. In terms of the input ones there was a 0.1% dip but this was mostly driven by the swings in oil so we need to check again next month.

Meanwhile is some action building in services inflation?

The annual rate of growth for the Services Producer Price Index (SPPI) showed positive growth of 2.0% in Quarter 2 (Apr to Jun) 2021, up from 1.3% in Quarter 1 (Jan to Mar) 2021.

The Bank of England will be vigilant in its efforts to ignore house price rises

This morning has been one where a little known committee has emerged blinking into the spotlights. It is the Financial Policy Committee (FPC) of the Bank of England and just to prove that they are central bankers they got straight to what is the beating heart of their concerns.

he UK banking system has the capacity to continue to provide that support. The FPC continues to judge that the banking sector remains resilient to outcomes for the economy that are much more severe than the Monetary Policy Committee’s central forecast. This judgement is supported by the interim results of the 2021 solvency stress test.

We have learnt to be more than suspicious about the use of the word “resilient” especially after noting how across the Irish Sea what was labelled the best bank in the word suddenly collapsed in the credit crunch.  As so often it was time to throw The Precious a bone.

The FPC supports the Prudential Regulation Committee’s (PRC’s) decision that extraordinary guardrails on shareholder distributions are no longer necessary, consistent with the return to the Prudential Regulation Authority’s (PRA’s) standard approach to capital‐setting and shareholder distributions through 2021

How many civil servants does it take to let the banks pay dividends again? As you can imagine it has gone down well with bank shareholders.

Whilst they are there I guess they felt they also needed to help keep the lending taps open.

To support this, the FPC expects to maintain the UK countercyclical capital buffer rate at 0% until at least December 2021. Due to the usual 12‐month implementation lag, any subsequent increase would therefore not be expected to take effect until the end of 2022 at the earliest.

What about the real economy?

Some businesses have been hit hard.

The increase in indebtedness has not been large in aggregate, but has been more substantial in some sectors and among small and medium‐sized enterprises (SMEs)…..companies with weaker balance sheets, particularly in sectors most affected by restrictions on economic activity and SMEs, may be more vulnerable to increases in financing costs.

But it is not going to worry about them because others have not.

UK businesses’ aggregate interest payments as a proportion of earnings did not increase over 2020, and are around historic lows.

Such statements can hide a lot of woes especially for businesses where earnings have been hit hard.

As to households things are not as bad as when things collapsed last time.

The share of households with high debt‐servicing burdens has increased slightly during the course of the pandemic, but remains significantly below its pre‐global financial crisis level

Pumping up house prices was one of the few things we could do.

House price growth and housing market activity during 2021 H1 were at their highest levels in over a decade, reflecting a mix of temporary policy support and structural factors.

We need to find a way that people can borrow even more.

However, so far, there has only been a small increase in mortgage borrowing relative to income in aggregate, and debt‐servicing ratios remain low.

It has been good to see that low equity mortgages are back but in case that backfires again we had better cover ourselves.

The FPC’s mortgage market measures are in place and aim to limit any rapid build‐up in aggregate indebtedness and in the share of highly indebted households. The FPC is continuing its review of the calibration of its mortgage market measures.

Markets

This is an awkward area for central bankers. After all their main policy lever these days is pumping up asset prices via purchases of government bonds. The Bank of England will do another £1.15 billion of that this afternoon. So we get this sort of buck passing statement.

Risky asset prices have continued to increase, and in some markets asset valuations appear elevated relative to historical norms. This partly reflects the improved economic outlook, but may also reflect a ‘search for yield’ in a low interest rate environment, and higher risk‐taking.

Ah the very yields the central banks have set out to take away! This is also why those who set interest-rates and have previously been so busy cutting them are always in a rush to blame secular trends. It wasn’t their fault you see. Of course if it had worked it would have been their triumph.

It gets worse in the next bit. The Bank of England piled into the Corporate Bond market in spite of the fact that previously it had got into a mess in doing so. This is because UK businesses of that size are mostly international and thus often choose to issue in Dollars and Euros to match currency risk. Thus the £ sterling market is smaller than you might think and it ended up being like The London Whale in there. Also it was so desperate to find bonds to buy it bought the ones of Apple. Exactly what support did the richest company in the world need? Yet it tries to point put what is below as if it had nothing to do with it.

The proportion of corporate bonds issued that are high‐yield is currently at its highest level in the past decade, and there is evidence of loosening underwriting standards, especially in leveraged loan markets.

Encouraging that was official Bank of England policy. Below is as close to admitting they have stored up trouble for the future as they will ever get.

This could increase potential losses in a future stress, and highly leveraged firms have also been shown to amplify downturns in the real economy.

Next is even more classic central banker speak which completely ignore their role in creating this.

Asset valuations could correct sharply if, for example, market participants re‐evaluate the prospects for growth or inflation, and therefore interest rates.

Even Bloomberg pointed this out last week. What did central bankers think would happen in response to this?

Central banks in the U.S., Europe and Japan have become ultimate market whales during the pandemic, with combined assets of $24 trillion.

Is there any market-based finance left after all their interference?

Any such correction could be amplified by vulnerabilities in market‐based finance, and risks tightening financial conditions for households and businesses.

Many reviewing this will think The Beatles were rather prescient here about QE.

You never give me your money
You only give me your funny paper

Especially if their situation is like this.

Out of college, money spent
See no future, pay no rent
All the money’s gone, nowhere to go

Comment

There are a couple of contexts here. I have critiqued the FPC as being a waste of space where people you have mostly never heard of are selected because they have the “right” views. The official view was that the FPC would set macroprudential policies which would keep house prices under control. Remember macropru as it became called? Where are all its supporters now as they seem to have disappeared?

“Over the last twelve months, our index has shown the average price of a home sold in England and
Wales has increased by some £32,500, or 10.7%. If we exclude London from this then the figure is a
very considerable 14%. Nevertheless, even including the capital, this is the highest annual rate since
February 2005. It is now fourteen months since any of the areas in our index have recorded a fall in
house prices, and this is while the UK economy has been under the severest pressure it has faced in
living memory.” ( Acadata)

So where are they then?

Still it looks as though one member has been checking his own position.

BOE’S DEP. GOV. SIR CUNLIFFE: PAYING CAREFUL ATTENTION TO THE RELATIONSHIP BETWEEN HOME PRICES AND DEBT. ( @FinancialJuice )

 

UK Trade figures are subject to a lot more doubt than we are usually told

Today is a cleat example of the morning after the night before so let me open by congratulating Italy on their victory in the European Championships football last night. However I wish to look back to Friday lunchtime when the UK released some new details on trade some 5 hours after they were supposed to be released. A good day to bury bad news or has the issue of there being rather different numbers on European trade being produced by the UK and EU come to a head?

What were the numbers for May?

They started well as we note a rise in exports.

Total exports of goods, excluding precious metals, increased by £1.3 billion (4.9%) in May 2021, driven by a £1.0 billion (8.0%) increase in exports to EU countries.

The first part is no great surprise as we are looking at a period where economies picked up and the second part of a rise to the EU is hopeful for the post Brexit era. As it happens the other side of the balance sheet was good for the trade balance too.

Total imports of goods, excluding precious metals, fell by £0.5 billion (1.4%) in May 2021 because of a £0.7 billion (3.4%) fall in imports from non-EU countries, which offset a slight increase of £0.1 billion (0.8%) to EU countries.

So we imported less in spite of the economy growing by 0.8% in May and it was a non-EU issue. Indeed by our admittedly poor standards we seem to be in a better run for the trade data.

In the three months to May 2021, the total trade deficit, excluding precious metals, narrowed by £2.2 billion to £3.5 billion.

If we now switch to the Brexit issue we see that there has been a change.

Monthly goods imports from non-EU countries, excluding precious metals, continues to be higher than the EU for the fifth consecutive month, but the gap is narrowing.

But that was it and as someone who has formally asked for more detail on services trade it is hard not to have a wry smile. Because we have ended up with it being nearly the same as the detail on goods trade where we learn very little about either.

In the three months to May 2021, the trade in services surplus fell by £0.2 billion to £28.1 billion.

If you were hoping to find out if it was exports or imports changing I am afraid that was it.

Services Trade

I thought I would scan the data and I return to the issue I raised with the Bean Review. In each of the last 3 sets of 3 months data we have a surplus of around £28 billion. So in a world with the changes we have seen the 3 months to May gives the same answer as the 3 months to February and the 3 months to November 2020. Does anyone actually believe that?

There is one change in that services trade has fallen compared to the peaks in 2019 with exports some £15 billion per quarter lower and imports £18 billion lower.

Why did we get so little May data?

This was singing along with Lyndsey Buckingham.

I think I’m in trouble
I think I’m in trouble

Here are the details and nice effort to blame HMRC ( the tax body).

We identified an error in the UK trade data prior to the planned release on 9 July 2021. The error occurred as we opened up the 2020 year to take on board corrections to HMRC data for non-EU trade which has caused a processing issue for the EU data.

With all the debate over Brexit it was in fact trade outside of it which saw the big move with exports in 2020 revised down by £4.5 billion.

Ironically the numbers improved the view of post full Brexit trade. The moves were more minor but January and February saw a downwards imports revision of £500 million. Then March and April saw an upwards revision of £600 million to exports.

Oh and the HMRC changes were published on the 29th of June so in plenty of time…

Brexit Trade Number Crunching

Regular readers will be aware that some time back I looked at the figures for trade between the US and China. The problem was that you git rather different answers depending on whose figures you looked at. This has been repeated in 2021 as we look for signs as to what a full Brexit has done to UK trade with the EU. Here is the Office for National Statistics.

We have been exploring several possible reasons for the growing disparities between EU and UK trade statistics.

So what is it?

A key reason for the differences we have found is that Trade statistics for imports can be reported on a country of dispatch and country of origin basis. Whereas for exports only country of destination is recorded.

Seems a bit odd that you would count exports and imports differently. So who does what?

For the UK, our main publications for trade statistics shows imports based on country of dispatch and exports on country of destination. This is both for EU and non-EU trade.
The European Union and its Member States will record the country of dispatch and country of origin for non-EU import but will publish their non-EU imports trade based on country of origin.

The finger is pointed at Eurostat as this pre Brexit.

Eurostat statistics record this transaction as £200 imports from UK to NL.

Now becomes this for the same transaction.

Eurostat statistics record this transaction as £200 imports from China to NL.

What does this mean in terms of numbers? Well this was the state of play.

 Just looking at 2020 as an example, the difference between the ONS and Eurostat non-seasonally adjusted datasets were as little as under £100 million in some months, while reaching around £1.5 billion in others.

Which has been replaced by this.

Revisiting the differences now between the UK and Eurostat non-seasonally adjusted datasets, the divergences are much larger, up to £2.7 billion in some months

The areas especially affected are these.

The commodities driving this increased divergence are ‘machinery & transport equipment’ and ‘miscellaneous manufactures’. While a large volume of goods for these commodities, for example cars being finished, pass through the UK, the importing European country receiving the finished good will report country of origin and not country of dispatch.

Comment

This has been a humbling period for official economic statistics. Indeed with the way the the Markit PMIs have got manufacturing so wrong recently we can widen the troubled list. Trade figures have long been amongst the worst and I recall the UK version losing their National Statistics status back in 2014.

This adds to the fact that there has been trouble elsewhere like in the Labour Force Survey.

In addition, a change to the non-response bias means that we appear to have a poorer response from some subsets of the population, in particular those with a non-UK country of birth.

which means this.

Another a distinct but related issue was the fact that the population estimates that feed into published the LFS statistics predate the pandemic, and so do not show its demographic and structural impacts.

Which reminds me of this problem.

Our latest data, using information from the Annual Population Survey (APS), shows that in mid-2020 there were around 3.5 million EU citizens living in the UK, a lot smaller than the 6 million applications for the EU Settlement Scheme.

Are there 6 million? No I do not think so but the 3.5 million is probably wrong too.

Podcast

What are lower bond yields telling us?

A major story in 2021 so far has been the moves in bond yields. This matters because they have become more significant in economic terms during the credit crunch. A factor in this is the way that the ZIRP era of effectively 0% official interest-rates has pretty much stopped the game there for now. For example the US Federal Reserve is presently trying to stop more US rates going below zero. Even the European Central Bank which has applied negative interest-rates for some years now thinks it is at its limit as we learn from the denial below.

SCHNABEL: #ECB ISN’T AT EFFECTIVE LOWER BOUND BUT IS CLOSER ( @LiveSquawk)

Putting it another way their last move was a paltry 0.1% cut to -0.5% although of course they sneaked in a -1% for the banks.

If we step back and ask why?The answer comes from the early days of the credit crunch when official interest-rates were slashed but economies did not respond as the central bankers hoped they would. In effect they thought they had more economic power than they did as longer-term interest-rates cocked something of a snook at them. So we got QE bond purchases in an attempt to control them as well, but whilst this has been associated with lower bond yields the link has been far from what you might think.

Last Night

Whilst many of us in the UK had our eyes on Wembley last night the Federal Reserve released the minutes of its most recent meeting.

On net, U.S. financial conditions eased further, led by a decline in Treasury yields.

Remember this was from mid-June and in terms of central banker psychobabble you can explain it like this.

Lower term premiums appeared
to be a significant component of the declines, as reflected by lower implied volatility on longer-term interest rates.

There had also been bad news for those using real yields as a measure.

The median 2021 core personal consumption expenditures (PCE) inflation forecast from the Open Market Desk’s Survey of Primary Dealers jumped nearly 1 percentage point from the previous survey. However, median forecasts for 2022 and 2023 each rose less than 0.1 percent, suggesting expectations for inflationary pressures to subside.

The Federal Reserve is of course desperate to emphasis anything agreeing with its claim that inflation will be transitory. But the problem for those seeing things in real yield terms is that the higher inflation forecasts should lead to higher bond yields and we got lower ones. Oh Well! As Fleetwood Mac would say.

Oh and I did point out earlier that the Federal Reserve is trying to stop short-term rates going below zero.

Amid heightened demand and reduced supply for short term investments, the ON RRP continued to maintain a
floor on overnight rates.

Taper 

Here things get a little awkward again. Because any reduction in the current rate of purchases ( $80 billion of US Treasury Bonds and $40 billion of Mortgage-Backed Securities a month) should lead to higher bond yields. Except for all the talk it still seems some way away.

In coming meetings, participants agreed to continue assessing the economy’s progress toward the Committee’s goals and to begin to discuss their plans for adjusting the path and composition of asset purchases. In addition, participants reiterated their intention to provide notice well in advance of an announcement to reduce the pace of purchases.

This backs up this from the statement at the time.

The Committee expects
to maintain an accommodative stance of monetary policy until these outcomes are achieved

Timber!

An exaggeration but there is a point behind it. Highlighted in a way by this from Reuters.

“If we do see a further drop in interest rates, if we do get below that 1.3% level in any kind of meaningful way, that is going to confirm that growth over value has returned and it is not just a head fake,” said Matt Maley, chief market strategist at Miller Tabak.

Actually the US ten-year yield is 1.26% as I type this as we wonder if that is meaningful enough for Mr. Maley? This compares to 1.78% earlier this year as the yield party peaked and 1.6% just after the Federal Reserve meeting and its hints of a couple of interest-rate rises in 2023. So if you have been long bonds well played.

Back to the economic implications and we start with the US government being able to borrow very cheaply again. Related to that is that long bond (30 year ) yield and its impact on mortgage rates.

Mortgage rates have fallen fairly consistently over the past 2.5 weeks with the past 2 days seeing some of the better improvements…….

They have the 30-year at 3.07% with Freddie Mac going below 3% to 2.98%. I doubt today’s fall to 1.88% for the long bond is factored in but of course the day is not over and things might change.

The International Effect

We can see one via Yuan Talks.

#China‘s most-traded 10-year #treasury futures extend gains to more than 0.5% to hit the highest since Aug, 2020. The yield on China’s 10-year govt bonds drops by 6.25 bp and break through 3% mark to hit 2.9925%.

If we switch to Europe one of my subjects this week – France- has seen its ten-year yield move to a whisker away from 0% this morning. Germany has a thirty-year of a mere 0.15%.

If we travel to a land down under he get a new sort of insight into QE. This is because the Reserve Bank announced a reduction in the rate of it by around 20% from September. The knee-jerk response saw the ten-year yield rise to 1.48% but only a couple of days later it is 1.3%.

The Global Dunces Cap goes to the Bank of Japan. You may recall that a few months ago Yield Curve Control was all the rage. Maybe even fashionable if an economic concept can be. But by pinning the ten-year yield the Bank of Japan stops it from falling and effectively undertake a sort of reverse Abenomics. So it has only moved within the permitted range from 0.06% to 0.02%. I guess that counts as a big move for JGBs these days.

I suspect that has contributed to today’s rally in the Japanese Yen as it moved through 110 although currencies rarely move for one thing alone.

Comment

The pendulum keeps swinging in 2021. Markets tend to overshoot but even that theory is awkward now as we note how large the narrative is versus how small the bond yield moves have been. I have worked through plenty of occasions where a 0.5% move would not be considered much and one comes to mind ( White Wednesday 1992) when it was happening if not in seconds in minutes.

Is this a cunning triumph by the US Federal Reserve as some argue? I do not think so as that is way over emphasising their ability. Putting it another way if so they have just poured petrol on the house price rise fire via the impact on mortgage rates.

Switching to the UK we see the same themes in play. The fifty-year yield is back below 1% so the government can borrow incredibly cheaply just as theory tells us it should be getting a lot more expensive. Also we may see more of this.

Record low rate on a 60% LTV 2yr fix of 1.15% in June. No wonder that mortgage mover numbers and house prices are up. Average quoted rates are falling on higher LTVs but still higher than pre-pandemic. ( @resi_analyst )

 

Should we raise taxes to deal with the new debt?

The establishment response to the Covid-19 pandemic was to reach for the fiscal policy button and press it. This was in addition to what are called the fiscal stabilisers where more unemployment benefits are paid and less tax is collected. So for example we saw the furlough scheme deployed on a grand scale which was both a new venture and an adventure for the UK. Actually we got some news on it only yesterday.

provisional figures show that the number of employments on furlough has decreased by 1.2 million from 30 April to 2.4 million on furlough at 31 May 2021, down from 3.5 million on 30 April. (These figures do not sum exactly due to rounding.) Numbers on CJRS last peaked at 5.1 million in January and have fallen since. ( HMRC)

In case you were wondering the main falls were as you might expect.

across all more detailed industry sectors, the beverage serving activities group saw the largest reduction in jobs on furlough between 30 April and 31 May: a decrease of 179,700. This was followed by the restaurants and mobile food service activities group which saw a reduction of 133,000.

But for our purposes today the main impact was that these were rather different numbers to what the Office for National Statistics had told us.

The proportion of UK businesses’ workforce who are reported to be on furlough has decreased to 6% (approximately 1.5 million people) in early June 2021; this is the lowest level reported since the furlough scheme began.

It does go into June but as you can see has given us a very different answer as this seems to have misfired.

This number is based on multiplying the BICS weighted furlough proportions by HM Revenue and Customs (HMRC) Coronavirus Government Retention Scheme (CJRS) official statistics eligible employments1 for only those industries covered by the BICS sample.

It posts a warning about economic statistics but also for today it suggests that the path of public borrowing is going to be higher than we were thinking based on the ONS data.

Social Care

The news above may have rattled things a bit at HM Treasury which is always nervous about this sort of thing. A sort of institutional memory if you like. This presumably led to this from the Financial Times.

New health secretary Sajid Javid is to form a powerful alliance with chancellor Rishi Sunak to insist that major reform of England’s creaking social care system must be funded through higher taxes.

Presumably aides for the two politicians wrote the “powerful alliance” bit for the FT. Then we get to the crux of the matter.

Boris Johnson has promised to fix the social care funding crisis — with annual costs estimated at up to £10bn — but his reluctance to raise taxes has caused tensions with Sunak, who wants to tackle the £300bn deficit accumulated during the coronavirus pandemic.

So this is the crux of the matter and is why we have seen other tax raising moves floated such as reduction in the tax relief on personal pensions for higher-rate payers. That has various problems though. Firstly it does not apply to those imposing it as they usually have taxpayer funded final or average salary pensions. Next the pension structure has taken various hits around the areas of likely returns and especially the very low level of annuity rates. We have seen it appear before as a suggestion and then disappear although of course the deficit is larger now.

Indeed the drumbeat may even have reached The Sun.

NEARLY 2.5 million Brits are still on furlough as the scheme winds down — with the total bill reaching £66billion.

A conceptual issue here is that governments seem to have lost the power to raise rates for income tax. In the past the response would be to add a penny or two to the basic rate or to raise higher rates. They do seem able not to raise the various thresholds and thus get more money via people getting wage rises but that is about it. So a passive rather than an active move.

They are now thinking of a different route which is a specific tax for a policy.

Javid is sympathetic to a Japanese-style levy on the over-40s to fund social care, according to colleagues, while the Treasury is looking at whether a dedicated tax could be introduced.

The UK does not do this although some still think that National Insurance contributions do pay for the NHS and pensions. Whilst they do help there is no direct link at all as it just goes into one big pot and is then spent. One reason for this is that they do not want people objecting to specific areas such as conscientious objectors saying no to their taxes going to defence.

Actually using a Japanese example rams it  home as they have struggled to raise taxes at all as the two attempts with the Consumption Tax have taken quite some time partly because they have torpedoed the economy. So we may have a touch of The Vapors in more than one respect.

I’m turning Japanese, I think I’m turning Japanese, I really think so
Turning Japanese, I think I’m turning Japanese, I really think so

Oh and I did say that HM Treasury loves this sort of thing.

Nick Macpherson, Treasury permanent secretary from 2005 to 2016, told the Financial Times that now was a good time to introduce a new tax.

They miss out the bit that they always think that! He even has a PR line ready

“The public want greater NHS capacity and a better social care and this can’t be financed by fiddling around the edges of the tax system,” he said. “A social solidarity charge payable by all adults at a rate of 2 to 3 per cent of their income could put the health and social care sector on a sustainable footing.”

He has even dropped the over-40s bit in what no doubt seems a cunning plan to a Treasury Mandarin.

But we return to the question posed by The Jam.

And the public gets what the public wants

Or is it?

And the public wants what the public gets

Comment

The Chancellor is trying to have his cake and eat it here as he tries to manoeuver around this.

Johnson has so far insisted the Conservatives should honour their 2019 election manifesto commitment to freeze the rates of the “big three” taxes: income tax, national insurance and value added tax.

The undercuts to this are that whilst we are borrowing very heavily there are contexts. For example we can borrow very cheaply as the 50-year yield is 1.04% as I type this. As we stand there is more of a risk from higher inflation and our topic of yesterday nudging debt costs higher via our index-linked debt.

Also there is the swerve of our times via all the Bank of England QE purchases where some £808 billion as of the end of June has been if not wiped from the ledger (and there are roads where that is true) charged at a Bank Rate of 0.1%. That is one of the reasons why they are so reluctant to increase it.

Next is the fact that the UK economy is growing quickly and recovering the lost ground. Here though there is a catch, because once we do will we return to the slow growth we had before? That is not so hopeful for the public finances as we find ourselves returning to the Turning Japanese theme.

Will UK inflation exceed 5%?

The last 24 hours have seen the inflation debate move on in the UK and some of that has happened in the last ten minutes as the speech by Governor Andrew Bailey has been released. Many of the issues are international ones and trends so let me open by taking a look at what the Riksbank of Sweden has announced today.

Both in Sweden and abroad, the recovery is proceeding slightly faster than expected and the Riksbank’s forecasts have been revised up somewhat.

So like the Bank of England it has been caught out but its view attracted my attention because it is somewhat different.

Inflation has varied to an unusually large degree during the pandemic. This is partly due to energy prices but also to measurement problems and people’s changed consumption patterns during the pandemic. Inflationary pressures are still deemed moderate and it is expected to take until next year before inflation rises more persistently.

Not the inflation technicalities which are a generic but the fact they expect it next year which is different to the US view for example of “transitory” from now. We already ready know from one Fed member that “transitory” has gone from 2/3 months to 6/9 but more next year is a different view. Also “persistently” is the sort of language that will get you banned from central banking shindigs.

Andy Haldane

The Bank of England’s chief economist gave us his view on inflation trend yesterday which started with philosophy.

The first, nearer-term, is discomfort at whether continuing monetary stimulus is consistent with central banks hitting their inflation targets on a sustainable basis.

The fact he is publicly asking the question means he thinks it isn’t. But then we get the gist of his views for 2021.

With public and private financial fuel being injected into a macro-economic engine already running hot, the result could well be macro-economic overheating. When resurgent, and probably persistent, demand bumps up against slowly-emerging, and possibly static, supply, the laws of economic gravity mean the prices of goods, services and assets tend to rise, at first in a localised and seemingly temporary fashion, but increasingly in a generalised and persistent fashion.

As you can see he too uses the word “persistent” and does so twice, which is about a revolutionary as a 32 year bank insider can get I think. Then we see significantly added into the mix.

This we are now seeing, with price surges across a widening array of goods, services and asset markets. At present, this is showing itself as pockets of excess demand. But as aggregate excess demand emerges in the second half of the year, I would expect inflation to rise, significantly and persistently.

Actually aggregate excess demand is not what it was. What I mean by that is the change to us predominantly being a service economy means that there is a much wider range of responses to demand now.

For instance, hairdressing and personal grooming inflation was strong in particular, at an annual rate of 8%, and saw a 29 year high.

This is one example ironically in a way from Governor Bailey’s speech where there is a clear limit as hairdressers can work harder but only so much. Whereas other areas in the services sector may not be far off no limits at all. Oh and after him being on TV during the England game versus Germany I suspect we are onto the 2021 look now.

Pent-up demand, essential need, or recreating the early 1990s David Beckham look, I leave that to others to judge.

Returning to Andy Haldane his musings lead him to conclude this.

By the end of this year, I expect UK inflation to be nearer 4% than 3%. This increases the chances of a high inflation narrative becoming the dominant one, a central expectation rather than a risk. If that happened, inflation expectations at all maturities would shift upwards, not only in financial markets but among households and businesses too.

That has been reported as 4% which is not quite what he said but by the time one converts it from CPI to Retail Prices Index ( a 1%+ rise as for example it was 1.2% in May) we arrive at the 5% of my headline.

What does Governor Bailey think?

The opening part of the section on the economic recovery illustrates something of a closed mind on the subject.

what conclusions can we draw on the temporary nature of the causes of higher inflation

The next bit is a type of PR after thought.

and what should we look out for to judge if those causes might be more sustained?

Under his plan we look set to go to stage four of the Yes Minister response which is “It’s too late now”. One area where there is plenty of inflation is in the use of the word temporary.

There are plenty of stories of supply chain constraints on commodities and transport bottlenecks, much of which ought to be temporary.

Those dealing in shipping costs seem much less clear about that.

International #container #freight rates cont. their almost vertical ascent with the Drewry global composite rising to $8k some 6X the normal rate. Routes out of China surging on #SupplyChains disruptions, some temporarily triggered by Covid-19 outbreaks reducing loadings ( @Ole_S_Hansen)

Another problem is that the Bank of England has under estimated both the UK economy recovery and consequent inflation.

CPI inflation rose to 2.1% in May, just above the MPC’s target and above where we thought it would be in the MPC’s May forecast.

In the May forecast they said it would be below 2% in both the second and third quarters. I do not know about you but I would not be assuring people inflation will be temporary when these are in play.

 Further up the supply chain, food input prices were up, and producer input inflation was around a 10-year high.

Also if we look at the absolute disaster area the concept of rebalancing was for his predecessor it is brave and perhaps courageous to deploy it again.

Over time, this should lead to an easing of inflation as spending is redirected towards sectors with more spare capacity. But, initially, that rebalancing may be uneven.

I note that he is already tilling the ground should he be wrong.

His first point is no more than stating he might be wrong ( rather likely on his track record). Next up we get this.

Second, we could see demand pressures on either side of the most likely outcome.

Then.

Third, we could also see wage pressures arising if the number of people in work or seeking work does not return to pre-Covid levels, and inactivity remains at a higher level. A return of labour supply is therefore important.

The last sentence is rather curious in the circumstances. And finally.

Fourth, a further challenge would arise if these temporary price pressures have a more persistent impact on medium-term inflation expectations, which shift to a higher level inconsistent with the target.

That is a type of psychobabble as it is based on what exactly?

Comment

We have here the two main courses of the inflation debate with a side order from the Riksbank. The main debate has been about this year and it is the first to break ranks about 2022.  If we start with the Governor’s view we see the asymmetry problem repeated yet again.

It is important not to over-react to temporarily strong growth and inflation, to ensure that the recovery is not undermined by a premature tightening in monetary conditions.

So if things go well you wait and if they are not going well you wait too, oh hang on.

Over the last sixteen months we have used monetary policy decisively to respond to an unprecedented crisis which was disinflationary.

Decisively on one side and on the other “we watch” is the new “vigilant”.

But it is also important that we watch the outlook for inflation very carefully, which of course we do at all times, particularly for signs of more persistent pressure and for a move of medium term inflation expectations to a higher level.

There is also an elephant in the room that everyone seems to be ignoring in the same manner as the UK inflation target does. So let us remind ourselves of how we started Tuesday.

Annual house price growth accelerated to 13.4% in June,
the highest outturn since November 2004. While the
strength is partly due to base effects, with June last year
unusually weak due to the first lockdown, the market
continues to show significant momentum. Indeed, June saw
the third consecutive month-on-month rise (0.7%), after
taking account of seasonal effects. Prices in June were almost 5% higher than in March. ( Nationwide).

Also remember inflation will be higher when the tax cuts ( VAT and Stamp Duty) expire.

Let me end with some good economic news via Sky but with the kicker that it is in an area that has proved highly inflationary.

Nissan announces £1bn ‘gigafactory’ boosting electric car production and creating thousands of jobs.

The Covid Pandemic poses new challenges for the use of GDP

This week has brought rather a flurry of news about UK GDP as we have changed this century and today the last quarter. Let us start with this morning’s headline.

UK gross domestic product (GDP) is estimated to have decreased by 1.6% in Quarter 1 (Jan to Mar) 2021, revised from the first estimate of a 1.5% decline.

The level of GDP is now 8.8% below where it was pre-pandemic at Quarter 4 (Oct to Dec) 2019, revised from a first estimate of 8.7% below.

So a marginal downgrade but not much in the scheme of things. However there is a fair bit going on below the surface including something which I was the first to point out last summer.

Nominal GDP fell by a revised 0.2% in Quarter 1 2021, while the implied deflator increased by 1.4%. Compared with the same quarter a year ago, the implied GDP deflator increased by 4.8%, mainly reflecting an increase in the implied price change of government consumption.

The nominal GDP issue is a consequence so let us zero in on a cause which is the way that the widest inflation measure in the economy has been bounced around by the way we measure real government consumption. Compared to other inflation measures a quarterly rise of 1.4% and an annual one of 4.8% is a lot. For example we were being told back then there was very little consumer inflation.

The Consumer Prices Index (CPI) rose by 0.7% in the 12 months to March 2021, up from 0.4% to February.

Education Education Education

The famous phrase from former Prime Minister Tony Blair has echoed in the GDP numbers.

The downward revision in education output reflects a monthly reprofiling of education output across the first quarter of 2021 because of updated attendance data, and estimates reflecting the effect of remote learners.

We end up with an Alice Through The Looking-Glass situation caused by this.

In volume terms, the measurement of education output is based on cost-weighted activity indices.

In theory a good idea but in practice this has happened.

have required us to keep innovating…….we have reviewed and aligned our measurement approaches …….We have also adapted our measurement for the further school closures and change in policy regime in the first few months of 2021,

Whilst these are worthy efforts you get big swings as for example the initial impact of the changes was to reduce the numbers by £2.3 billion or to reduce that quarters GDP by 0.5%. This time around the change had a smaller impact but it was still this.

The move to remote learning for the majority of pupils was the largest contributor to the 2.1% fall in services output in Quarter 1 2021

Education went from -0.86% to -1.06% in the services numbers via the latest revision.

Nominal GDP

There is a bit of a defeat here for the methodology as we are guided towards ones with no inflation measure or deflator at all.

Nominal GDP estimates – which may be more comparable –show that Canada and the United States are now above their Quarter 4 2019 levels.

There are two sides to this as for example it makes no difference ( okay 0.1%) for Japan as you might expect, But if you compare the UK with Spain it makes an enormous difference. Using the real GDP numbers we have both seen falls of around 9% but using nominal GDP the UK has seen a fall of 3% and Spain 8.7%.

Trade

These numbers regularly see significant revisions and we have both the pandemic and the final Brexit move to add to the issues. So we are about as uncertain as we ever are about the latest numbers so let me switch to another issue highlighted in the deeper series.

The UK’s net international investment position liability position narrowed by £56.4 billion to £582.9 billion as the revaluation impact on UK debt securities decreased the value of UK liabilities more than the fall in the value of UK assets.

They do their best but they simply do not know this as it gets worse as you delve deeper.

In Quarter 1 2021, the gross asset and liability positions decreased by £446.5 billion and £502.8 billion respectively. This was mostly because of a large decrease in financial derivative activity as market volatility continued to recede from the height of the coronavirus (COVID-19) pandemic.

So I suggest you take any investment position data with the whole salt cellar. The numbers depend entirely on assumptions which frankly have a tenuous grip on reality and sometimes not even that.

Telecommunications

There has been a deeper review of things and it has led to this which does feed into one of my themes. That is that things were not as good pre credit crunch as was recorded at the time.

average annual volume GDP growth over the period 1998 to 2007 is now 2.7%, revised down from 2.9%; average annual volume GDP growth stands at 2.0% from 2010 to 2019, revised up from 1.9%.

A factor in play here has been something I have mentioned before which has been the work of Diane Coyle on inflation in the telecoms sector.

In addition, we have introduced new ways of removing the effects of price changes in both the telecoms and clothing industries. These mean ‘real’ GDP (where we’ve removed the impact of price changes) grew a little less than we previously estimated in the years before the financial crisis and a little more in the years after it.

They hope this will allow them to allow for inflation more accurately.

To give an example, when previously estimating the value of goods produced from a furniture maker over time we would measure the value of the tables being sold, remove the cost of the wood, then adjust for inflation by removing the changing cost of the tables only. Under the new system we will separately be removingthe impact of inflation from the changing cost of the wood and the changing cost of the tables, giving an improved and more detailed estimate of changes in the economy.

That will be interesting to follow but sadly will not help with the education issue because the problem there is that there is no price in the first place.

Also  this change should help with the issue I reported to the Bean Review which was over the lack of detail in services data and trade especially.

we will also introducea new Financial Services Survey, which will give much more detailed information about the activities and outputs of the financial sector, which makes up around 7% of GDP.

Comment

As you can see there is much more doubt than we are usually told and we can take a sideways look at another issue. Remember my official complaint about the claimed surge in wages? Well it would appear that the GDP numbers agree with me.

Wages and salaries increased by 0.4% in Quarter 1 2021,

Looking at this series wages growth over the past year is 3% in nominal terms as opposed to the 4.5% in the average earnings series.

Let me switch now to a subject in the news if you follow military matters which in my opinion is an issue for GDP.

New light tanks that have so far cost the army £3.2 billion have been withdrawn for a second time after more troops reported suffering hearing loss during trials,has learnt.All trials involving the Ajax armoured vehicle were paused in mid-June on “health and safety grounds” amid concerns that mitigation measures put in place to protect soldiers — including ear defenders — were not sufficient. ( The Times)

This may end up being a debacle like the Nimrod programme. But how do you measure it in GDP terms? For the income version it is easy as people have been paid so you count it. But for the output version we face the prospect that there will not be any. If you are feeling generous you might make an R&D allowance but of what 10% of what has been spent…. It seems some aspects of military procurement love their Arcade Fire.

If I could have it back
All the time that we wasted
I’d only waste it again
If I could have it back
You know I would love to waste it again
Waste it again and again and again