The cracks at the Bank of England have become fissures

This has been a bad week for the Governor of the Bank of England Mark Carney.  First came the appointment of Professor Silvana Tenreyro to the Monetary Policy Committee which led to even social media to have a brief period of  silence as everyone looked up who she was! Next came a reminder that his Chief Economist Andy Haldane is a modern version of a “loose cannon on the decks” on the edge of going off in almost any direction at any time. Finally last night came a critique from someone Governor Carney went out of his way ( North America) to appoint.

Kristin Forbes

Ms Forbes has given quite a damning account of her time at the Bank of England whilst also confirming several themes of this website.

In July 2014, when I started on the Bank of England’s Monetary Policy Committee, it was widely expected (including by me) that we would begin increasing interest rates soon. It has been almost three years – and growth has averaged a healthy and above trend 2.3% (year-on-year) over this period. Yet interest rates are now lower – instead of higher – than when I started my term.

Fair play to her for the honesty but of course regular readers will be aware that I forecast this outcome back then. The establishment continue only to talk to themselves which is why we get the phrase “widely expected” when they are wrong as they live in an echo chamber. It is an irony that they try to wear the badge of diversity when in fact it is diversity of ideas that they most need and of course they shun.

Ms Forbes continues to land punches on the Bank of England consensus as another of the themes here the woeful forecasting record gets a mention.

A key justification for the large amount of stimulus that many people (albeit not me) supported in August was a forecast for a sharp contraction in growth to near recession levels and sharp increase in unemployment that would leave a meaningful increase in the number of people without a job. That forecast has not materialized.

As I wrote at the time this was perfectly predictable if you looked at the impact of falls in the value of the UK Pound £ which as a reminder is currently equivalent to a 2.75% cut in Bank Rate. If I was to make a one sentence critique of bringing members of the “international economic elite” to the Bank of England it would be that they invariable fail to understand the impact of changes in the UK Pound £. I write that in sad fashion in this instance because it looked for a time that Kristin Forbes did understand.

After the uppercut comes the left cross.

And as the UK economy has held up well since the Brexit vote, why has there been no consensus to tighten
monetary policy – or at least slightly reduce the substantial amount of stimulus provided in August – since
then?

So she thinks that the Bank of England is full of “Carney’s Cronies” as I have labeled them too?

a majority on the MPC does not support reversing a small portion of last August’s stimulus.

As an aside it is also revealing that even she does not seem to in the words of Blockbuster by Sweet “have a clue what to do” about all the QE. Back in September 2013 I wrote an article in City-AM with a suggestion on this front. Returning to the economic theme she points out that the world has changed at least according to the Bank of England so why has policy not changed?

Instead, over the three full quarters since the referendum, GDP has increased by over three times more (by almost 1 percentage point more) than forecast in the August Inflation Report, and unemployment is 0.5 percentage points lower. Put slightly differently, instead of increasing, unemployment has fallen so much that it is now at its lowest level in over 40 years. At the same time, inflation spiked to 2.9% in May. It is expected to continue increasing over the next few months and remain above target for
over three years.

It has been argued by some by the previous Governor Baron King of Lothbury intimidated some MPC members so as you read this next quote please be aware that his term ended in the summer of 2013 as Mark Carney arrived.

This pattern of different views and dissent by all types of committee members, however, seems to have
changed around 2013 – a period when there were a number of changes at the Bank and to the MPC’s remit,
making it hard to pinpoint the cause……… Not a single dissent since 2013 has come from an internal member.

Finally it would appear that someone at the Bank of England has caught up with a point I have been making since the EU Referendum vote.

Sterling’s recent depreciation appears to be shifting the trend component of UK inflation upward quickly, potentially generating more persistent inflationary pressures

This is all rather different to what Governor Carney told us at Mansion House.

This stimulus is working. Credit is widely available, the cost of borrowing is near record lows, the economy has outperformed expectations, and unemployment has reached a 40 year low.

Loose cannon on the decks

For those unaware this saying came from the Royal Navy where in the days of sailing ships a loose cannon was extremely dangerous to say the least. A modern version of this has been the Chief Economist of the Bank of England Andy Haldane which we can see by a simple game of then and now. First just over 11 months ago.

In my personal view, this means a material easing of monetary policy is likely to be needed,…….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…….Given the scale of insurance required, a package of mutually-complementary monetary policy easing measures is likely to be necessary.

And this week.

I considered the case for a rate rise at the MPC’s June meeting.

As ever there is no real confession here about being wrong. After all if Andy had built a plane and it crashed on take-off who would fly on one of his planes again? But the central banking echo chamber is not like that even when they present devastating evidence of their own failure.

Wages have been surprisingly weak for much of the period since the global financial crisis. Chart 1 plots
successive Bank of England forecasts of wage growth since 2012. Wage growth in the UK has persistently
disappointed to the downside, on average by around 1 ¼ percentage points one year ahead.

You see our “loose cannon” knew this last August albeit a year less of it yet he still ignored his own frailties and ploughed ahead in that combination of arrogance and panic that we see from the central banking fraternity at such times. Yet in spite of such failure look what happened only last week.

Andrew Haldane, Executive Director, Monetary Analysis and Statistics, and Chief Economist at the Bank of England, has been reappointed for a further three-year term as a member of the Monetary Policy Committee with effect from 12 June 2017.

Rewards for failure indeed. As I asked at the time on what ground was he reappointed please?

Comment

There is much to consider here as the themes of the Bank of England being the worst forecasting organisation in the world and the advent of “Carney’s Cronies” have been in play. However in the speech by Kristin Forbes there was also a confession of the earliest theme of this website so let us get to it.

Even more striking is the lack of other countries’ ability to sustain any tightening in monetary policy since the
crisis.

They are in their own junkie culture style trap but as it is Glastonbury weekend let me hand you over to Muse for a description.

I wanted freedom
Bound and restricted
I tried to give you up
But I’m addicted

Now that you know I’m trapped sense of elation
You’d never dream of
Breaking this fixation

You will squeeze the life out of me

 

Of UK Austerity and the Queen’s Speech

Today in a happy coincidence we get both the future plans of the current government in the Queen’s Speech as well as the latest public finances data. It looks as though the atmosphere is for this at least according to the Financial Times.

But he (the Chancellor) is coming under growing pressure from some Tory MPs — who are reeling from the loss of the party’s majority in the House of Commons at the June 8 election — to learn lessons and increase public spending.

Why? Well this happened.

The opposition Labour party pulled off surprise gains in the UK general election by offering voters a vision of higher public spending funded by increased taxes on companies and the rich.

So there is likely to be pressure on this front especially as we will have a government that at best will only have a small majority.

Mansion House

The Chancellor Phillip Hammond also spoke at Mansion House yesterday and told us this.

And higher discretionary borrowing to fund current consumption is simply asking the next generation to pay for something that we want to consume, but are not prepared to pay for ourselves, so we will remain committed to the fiscal rules set out at the Autumn Statement which will guide us, via interim targets in 2020, to a balanced budget by the middle of the next decade.

Is that an official denial? Because we know what to do with those! But in fact setting a target of the middle of the next decade (so 2025) gives enormous freedom of movement in practical terms. You could forecast pretty much anything for then and the Office for Budget Responsibility or OBR probably has. If we look back over its lifespan we see that one error which is that forecasting wage inflation now would be 5% per annum as opposed to the current 2% has had enormous implications. Also we only need to look back to the 3rd of October to see the Chancellor giving himself some freedom of manoeuvre.

“As we go into a period where inevitably there will be more uncertainty in the economy, we need the space to be able to support the economy through that period,” he said. “If we don’t do something, if we don’t intervene to counteract that effect, in time it would have an impact on jobs and growth.”

As later today the media will no doubt be using OBR forecasts as if they are some form of Holy Grail lets is remind ourselves of the first rule of OBR club. That is that the OBR is always wrong.

A 100 Year Gilt

You might think that with all the political uncertainty and weakness from the UK Pound that the Gilt market would be under pressure. My favourite comedy series Yes Minister invariably had the two falling together. But nothing is perfect as that relationship is not currently true. It raises a wry smile each time I type it but the UK 10 year Gilt yield is blow 1% ( 0.98%) as I type this. In terms of recent moves the market was boosted yesterday by the words of Bank of England Governor Mark Carney who with his £435 billion of holding’s is by far its largest investor. In essence the likelihood of more purchases of that sort nudged higher yesterday and thus the market rallied and yields fell.

Also we live in a world summarised by this from Lisa Abramowicz of Bloomberg.

Argentina has defaulted on its external debt seven times in the past 200 years. It just sold 100-year bonds.

Actually it was oversubscribed I believe and I will let readers decide if they think a yield of 7.9% was enough. The UK however could borrow much more cheaply than that as according to the Debt Management Office the yield on our longest Gilt (2068) is 1.52%. Actually as we move from the 2040s to the 2060s the yield gets lower but I will not extend that and simply suggest we might be able to borrow for 100 years at 1.5% which seems an opportunity.

Actually quite a historical opportunity and we could go further as this from the Economist from 2005 ( h/t @RSR108 ) hints.

In 1751 Henry Pelham’s Whig government pulled together the lessons learnt on bonds to create the security of the century: the 3% consol. This took its name from the fact that it paid 3% on a £100 par value and consolidated the terms of a variety of previous issues. The consols had no maturity; in theory they would keep paying £3 a year forever.

I have a friend who has always wanted to own a piece of Consols to put the certificate on his wall so he would be pleased. Assuming of course they still do certificates…..

Today’s data

It was almost a type of Groundhog Day.

Public sector net borrowing (excluding public sector banks) decreased by £0.1 billion to £16.1 billion in the current financial year-to-date (April 2017 to May 2017), compared with the same period in 2016; this is the lowest year-to-date net borrowing since 2008.

So the financial year so far looks rather like its predecessor. Although below the surface there were some changes as for example it is hard to put a label of austerity on this.

Over the same period, central government spent £123.5 billion; around 4% more than in the same period in the previous financial year.

In case you were wondering on what? Here it is.

Of this amount, just below two-thirds was spent by central government departments (such as health, education and defence), around one-third on social benefits (such as pensions, unemployment payments, Child Benefit and Maternity Pay)

This meant that tax revenue had to be pretty good.

In the current financial year-to-date, central government received £110.2 billion in income; including £79.1 billion in taxes. This was around 5% more than in the same period in the previous financial year.

In case you are wondering about the gap some £20 billion or so is National Insurance which is not counted as a tax.

How much debt?

The amount of money owed by the public sector to the private sector stood at just above £1.7 trillion at the end of May 2017, which equates to 86.5% of the value of all the goods and services currently produced by the UK economy in a year (or gross domestic product (GDP)).

Actually some of this is due to the Bank of England something which we did not hear about yesterday from Governor Carney.

£86.8 billion is attributable to debt accumulated within the Bank of England, nearly all of it in the Asset Purchase Facility. Of this £86.8 billion, £63.3 billion relates to the Term Funding Scheme (TFS).

Comment

There is much to consider about austerity UK style. Ironically in the circumstances we would qualify under one part of the Euro area rules as our deficit is less than 3% of GDP. But of course that is a long way short of the horizon of surpluses we were promised back in the day. Please remember that later today as all sorts of forecasts appear, as the George Osborne surplus remained 3/4 years away regardless of what point in time you were at. As we have run consistent deficits is that austerity? For quite a few people the answer is yes as some have lost jobs or seen very low pay rises as we note it represented a switch. The switch concept starts to get awkward if we look at the Triple Lock for the basic state pension for example.

Moving onto other matters it was only yesterday that Governor Carney was boasting about the credit boom and I pointed out the unsecured portion. Well already the news has not gone well for him.

Provident Financial said recent collections performance had “deteriorated”, particularly in May. ( New York Times)

Presumably they mean the month and not Theresa. Also there was this in the Agents Report about the car market.

Increases in the sterling cost of new cars and decreases in the expected future residual values of many used cars had put some upward pressure on monthly finance payments on Personal Contract Purchase (PCP) plans.

If there was a canary in this coal mine well look at this.

Car companies had sought to offset this in a
number of ways, including increasing the length of PCP
contracts.

As the can gets solidly kicked yet again we wait to see if finance in this area is as “secured” as Governor Carney has assured us.

The Longest Day

The good news for us in the Northern Hemisphere is that this is the longest day although the sweltering heat in London it felt like a long night! So enjoy as for us it is all downhill now if not for those reading this Down Under. I gather it is also the Day of Rage apparently which may be evidenced when the Donald spots this.

Ford Motor Co (F.N) said on Tuesday it will move some production of its Focus small car to China and import the vehicles to the United States ( Reuters )

The Mark Carney experience at the Bank of England

This morning Mark Carney has given his Mansion House speech which was delayed due to the Grenfell Tower fire tragedy. One thing that was unlikely to be in the speech today was the outright cheerleading for the reform of the banking sector which was the basis of his speech back on the 7th of April as the news below emerged.

Barclays PLC and four former executives have been charged with conspiracy to commit fraud and the provision of unlawful financial assistance.

The Serious Fraud Office charges come at the end of a five-year investigation and relate to the bank’s fundraising at the height of 2008’s financial crisis.

Former chief executive John Varley is one of the four ex-staff who will face Westminster magistrates on 3 July.

Firstly let me welcome the news that there will be a trial although the conviction record of the Serious Fraud Office is not good. The problem is that this has taken around nine years about something ( £7 billion raised from Qatar ) which frankly looked to have dubious elements when it took place. What you might call  slooooooooooooow progress of justice.

What about UK interest-rates?

We first got a confession about something we discovered last week.

Different members of the MPC will understandably have different views about the outlook and therefore on the potential timing of any Bank Rate increase.

Actually that is an odd way of saying it as five members voted for no change with some more likely to vote for a cut that a rise in my opinion. Although of course Mark Carney has had trouble before with rises in interest-rates which turn out to be cuts!

Next we got a confirmation of the Governor’s opinion.

From my perspective, given the mixed signals on consumer spending and business investment, and given
the still subdued domestic inflationary pressures, in particular anaemic wage growth, now is not yet the time
to begin that adjustment

Indeed he seems keen to kick this rather awkward issue – because it would mean reversing last August’s Bank Rate cut – as far into the future as possible.

In the coming months, I would like to see the extent to which weaker consumption growth is offset by other components of demand, whether wages begin to firm, and more generally, how the economy reacts to the prospect of tighter financial conditions and the reality of Brexit negotiations.

Indeed if we are willing to ignore both UK economic history and the leads and lags in UK monetary policy then you might be able to believe this.

This stimulus is working. Credit is widely available, the cost of borrowing is near record lows, the economy has outperformed expectations, and unemployment has reached a 40 year low.

Missing from the slap on the back that the Governor has given himself is the most powerful instrument of all which is the value of the UK Pound which has given the UK economy and more sadly inflation a boost. Indeed the initial response to the Governor’s jawboning was to add to the Pound’s fall as it fell below US $1.27 and 1.14 versus the Euro. Should it remain there then the total fall since the night of the EU leave vote then it is equivalent to a 2.75% fall in UK Bank Rate which is a bazooka compared to the 0.25% peashooter cut provided by the Bank of England. So if you believe Mark Carney you are likely not to be a fan of Alice In Wonderland.

“Why, sometimes I’ve believed as many as six impossible things before breakfast.”

Also if he is going to take credit for er “Credit is widely available” then he will be on very thin ice when he next claims the surge in unsecured credit is nothing to do with him.

Carney’s Cronies

Ironically in a way the foreign exchange market was a day late as you see the real change came yesterday.

​The Chancellor of the Exchequer has announced the appointment of Professor Silvana Tenreyro as an external member of the Monetary Policy Committee (MPC).  Silvana will be appointed for a three year term which will take effect from 7 July 2017.

There are several issues here, if I start with British female economists then that is another slap in the face for them as none have been judged suitable for a decade. Next came the thought that I had never previously heard of her which turned to concern as we were told she came from “academic excellence” in an era where Ivory Towers have consistently crumbled and fallen along the lines of Mount Doom in the Lord of the Rings. But after a little research one could see why she had been appointed. From a survey taken by the Centre For Macroeconomics.

Question Do you agree that the benefits of reforming the monetary system to allow materially negative policy interest rates outweigh the possible costs?

Agree. Confident. Reforming the monetary system to allow negative policy interest rates will equip the BoE with an additional tool to face potential crises in the future.

Does “reforming the monetary system” sound somewhat like someone who will support restrictions on the use of cash currency and maybe its banning? She is also a fan of QE ( Quantitative Easing ) style policies.

Question Do you agree that central banks should continue to use the unconventional tools of monetary policy deployed in response to the global financial crisis as part of monetary policy under normal economic conditions?

Agree. Confident. A wider set of policy tools would give mature and credible central banks like the BoE more flexibility to respond to changing economic conditions.

What is it about her apparent support for negative interest-rate and QE that attracted the attention of Mark Carney? Of course in a world after the woeful failure of Forward Guidance and indeed the litany of forecasting errors he was probably grateful to find someone who still calls the Bank of England “credible”!

Comment

We have a few things to consider and let me start with the reaction function of foreign exchange markets. The real news was yesterday as a fan of negative interest-rates was appointed to the Bank of England but the UK Pound waited until Mark Carney repeated his views of only Thursday to fall!

Meanwhile there was this from Governor Carney.

Monetary policy cannot prevent the weaker real income growth likely to accompany the transition to new
trading arrangements with the EU. But it can influence how this hit to incomes is distributed between job losses and price rises.

His views on the EU leave vote are hardly news although some are trying to present them as such. You might think after all the forecasting errors and Forward Guidance failures he would be quiet about such things. But my main issue here is the sort of Phillips Curve way we are presented a choice between “job losses” and “price rises” Just as all credibility of such thinking has collapsed even for those with a very slow response function in fact one slow enough to be at the Serious Fraud Office. He is also contradicting himself as it was only a few months ago we were being told by him that wage growth was on the up. Although that February Inflation Forecast press conference did see signs that the normally supine press corps were becoming unsettled about a Governor previously described as a “rockstar central banker” and “George Clooney” look a like.

Governor, back in August the forecast for GDP for this year
was 0.8%. Now it’s being forecast at 2.0%. That’s a really
hefty adjustment. What went wrong with your initial
forecast?

He may not be that bothered as you see much of today’s speech was in my opinion part of his job application to replace Christine Lagarde at the IMF.

With many concerned that global trade is taking local jobs, protectionist sentiments are once again rising
across the advanced world. Excessive trade and current account imbalances are now politically as well as
economically unsustainable.

Number Crunching

The problems facing inflation targets

Today I wish to discuss something which if it was a plant we would call a hardy perennial. No I do not mean Greece although of course there has been another “deal” which extends the austerity that was originally supposed to end in 2020 to 2060 in a clear example along the lines of To Infinity! And Beyond! Nor do I mean the Bank of Japan which has announced it will continue to chomp away on Japanese assets. What I mean is central bankers and members of the establishment who conclude that an inflation target of 2% per annum is not enough and it needs to be raised. The latest example has come from the chair of the US Federal Reserve Janet Yellen. From Reuters.

Years of tepid economic recovery have Fed Chair Janet Yellen and other central bankers considering what was once unthinkable: abandoning decades-long efforts to hold inflation down and allowing price expectations to creep up.

I am not sure if the author has not been keeping up with current events or has been drinking the Kool Aid because since early 2012 the US Federal Reserve has been trying to get inflation up to its 2% per annum target. It managed it for the grand sum of one month earlier this year before it started slip sliding away again. Indeed for a while the inflation target was raised to 2.5% which achieved precisely nothing which is why the change has mostly been forgotten. From December 2012.

inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal,

Of course the Bank of Japan has been trying to raise inflation pretty much since the lost decade(s) began. Anyway here is Reuters again on the current thinking of Janet Yellen.

In remarks on Wednesday, Yellen called an emerging debate over raising global inflation targets “one of the most important questions facing monetary policy,” as central bankers grapple with an economic rut in which low growth, low interest rates and weak price and wage increases reinforce each other.

There is a clear problem with that paragraph as this week’s UK data has reminded us “weak price” increases boosted both retail sales and consumption via the way they boosted real wages. The rationale as expressed below is that we are expected to be none too bright.

The aim would be a change of households’ and businesses’ psychology, convincing them that prices would rise fast enough in the future that they would be better off borrowing and spending more today……..Raising that target to 3 or even 4 percent as some economists have suggested would shift the outlook of firms in particular, allowing them to charge more for goods and pay more for labor without the fear that a central bank would step on the brakes.

They are relying on us being unable to spot that the extra money buys less. Oh and after the utter failure of central bank Forward Guidance particularly in the UK you have my permission to laugh at the Ivory Tower style idea that before they do things consumers and businesses stop to wonder what Mark Carney or Janet Yellen might think or do next!

The theme here is along the lines set out by this speech from John Williams of the San Francisco Fed last September.

The most direct attack on low r-star would be for central banks to pursue a somewhat higher inflation target. This would imply a higher average level of interest rates and thereby give monetary policy more room to maneuver. The logic of this approach argues that a 1 percentage point increase in the inflation target would offset the deleterious effects of an equal-sized decline in r-star.

In John’s Ivory Tower there is a natural rate of interest called r-star.

Meanwhile in the real world

Whilst I am a big fan of Earth Wind and Fire I caution against using their lyrics too literally for policy action.

Take a ride in the sky
On our ship, fantasize
All your dreams will come true right away

You see if we actually look at the real world there is an issue that in spite of all the monetary easing of the credit crunch era we have not seen the consumer inflation that central bankers were both planning and hoping for. The Federal Reserve raised its inflation target as described above in December 2012 because it was expecting “More,More, More” but it never arrived. For today I will ignore the fact that inflation did appear in asset markets such as house prices because so many consumer inflation measures follow the advice “look away now” to that issue.

If we move to the current situation and ignore the currency conflicted UK we see that there is a danger for central bankers but hope for the rest of us that inflationary pressure is fading. A sign of that has come from Eurostat this morning.

Euro area annual inflation was 1.4% in May 2017, down from 1.9% in April.

Tucked away in the detail was the fact that energy costs fell by 1.2% on the month reducing the annual rise to 4.5% from the much higher levels seen so far in 2017. As we look at a price for Brent Crude Oil of US $47 per barrel we see that if that should remain there then more of this can be expected as 2017 progresses. That is of course an “if” but OPEC does seem to have lost at least some of its pricing power.

Actually today’s data posed yet another problem for the assumptions of central bankers and the inhabitants of Ivory Towers. We have been seeing am improvement in the Euro area economy as 2016 moved in 2017 so we should be seeing higher wage increases according to economics 101. From Eurostat.

In the euro area, wages & salaries per hour worked grew by 1.4%…., in the first quarter of 2017 compared with the same quarter of the previous year. In the fourth quarter of 2016, the annual change was +1.6%

What if our intrepid theorists managed to push inflation higher and wages did not rise? A bit like the calamity the Bank of England ignored back in 2010/11. As an aside a particular sign that the world has seen a shift in its axis is the number from Spain which for those unaware is seeing a burst of economic growth. Yet annual wage growth is the roundest number of all at 0%.

Comment

Much has changed in the credit crunch era but it would appear that central bankers are at best tone-deaf to the noise. We have seen rises in inflation target as one was hidden in the UK switch to CPI from RPI ( ~0.5% per annum) and the US had a temporary one as discussed above and a more permanent one when it switched from the CPI to PCE measure back in 2000 ( ~ 0.3% per annum). I do not see advocates of higher inflation target claiming these were a success so we can only assume there are hoping we will not spot them.

The reality is quite simple the logical response to where we are now would be to reduce inflation targets rather than raise them. Another route which would have mostly similar effects would be to put house prices in the various consumer inflation measures.

Oh and something I thought I would keep for the end. have you spotted how the US Federal Reserve sets its own targets? I wonder how that would work in the era of the Donald?!

Music for traders

My twitter feed has been quite busy with suggestions of songs for traders. All suggestions welcome.

 

Problems mount for Mark Carney at Mansion House

The UK’s central bank announces its policy decision today and it faces challenges on several fronts. The first was highlighted yesterday evening by the US Federal Reserve.

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 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

UK monetary policy is normally similar to that in the US as our economies often follow the same cycles. This time around however the Bank of England has cut to 0.25% whilst the Federal Reserve has been raising interest-rates creating a gap of 0.75% to 1% now. In terms of the past maybe not a large gap but of course these days the gap is large in a world of zero and indeed negative interest-rates. Also we can expect the gap to grow in the future.

The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate;

There was also more as the Federal Reserve made another change which headed in the opposite direction to Bank of England policy.

The Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.

So the Federal Reserve is planning to start the long journey to what used to be regarded as normal for a central bank balance sheet. Of course only last August the Bank of England set out on expanding its balance sheet by another £70 billion if we include the Corporate Bond purchases in what its Chief Economist Andy Haldane called a “Sledgehammer”. So again the two central banks have been heading in opposite directions. Also on that subject Mr.Haldane was reappointed for another three years this week. Does anybody know on what grounds? After all the wages data from yesterday suggested yet another fail on the forecasting front in an ever-growing series.

Andrew Haldane, Executive Director, Monetary Analysis and Statistics, and Chief Economist at the
Bank of England, has been reappointed for a further three-year term as a member of the Monetary Policy
Committee with effect from 12 June 2017.

For those interested in what Andy would presumably call an anti-Sledgehammer here it is.

( For Treasury Bonds) the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month…… ( for Mortgage Securities) the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.

Whilst these really are baby steps compared to a balance sheet of US $4.46 trillion they do at least represent a welcome move in the right direction.

The Inflation Conundrum

This has several facets for the Bank of England. The most obvious is that it eased policy last August as inflation was expected to rise and this month we see that the inflation measure it is supposed to keep around 2% per annum ( CPI ) has risen to 2.9% with more rises expected. It of course badged the “Sledgehammer” move as being expansionary for the economy but I have argued all along that it is more complex than that and may even be contractionary.

Today’s Retail Sales numbers give an example of my thinking so let me use them to explain. Here they are.

In May 2017, the quantity bought in the retail industry was estimated to have increased by 0.9% compared with May 2016; the annual growth rate was last lower in April 2013…..Month-on-month, the quantity bought was estimated to have fallen by 1.2% following strong growth in April 2017.

So after a strong 2016 UK retail sales have weakened in 2017 but my argument is that the main driver here has been this.

Average store prices (excluding fuel) increased by 2.8% on the year; the largest growth since March 2012.

It has been the rise in prices or higher inflation which has been the main driver of the weakness in retail sales. A factor in this has been the lower value of the Pound which if you use the US inflation numbers as a control has so far raised UK inflation by around 1%. This weakness in the currency was added to by expectations of Bank of England monetary easing which of course were fulfilled. You may note I say expectations because as some of us have been discussing in the comments section the main impact of QE on a currency happens in the expectations/anticipation phase.

On the other side of the coin you have to believe that a 0.25% cut in interest-rates has a material impact after cuts of over 4% did not! Also that increasing the Bank of England’s balance sheet will do more than adding to house prices and easing the fiscal deficit. A ten-year Gilt yield of 0.96% does not go well with inflation at 2.9% ( CPI) and of course even worse with RPI ( 3.7%).

House Prices

I spotted this earlier in the Financial Times which poses a serious question to Bank of England policy.

Since 1980, the compounded inflation-adjusted gain for a UK homeowner has been 212 per cent. Before 1980 house price gains were much tamer over the various cycles either side of the second world war. Indeed, in aggregate, prices were largely unchanged over the previous 100 years, once inflation is accounted for.

A change in policy? Of course much of that was before Mark Carney’s time but we know from his time in Canada and here that house price surges and bubbles do happen on his watch. The article then looks at debt availability.

The one factor that did change, though, and marked the start of that step change in 1980, is the supply of mortgage debt……….has resulted in a sevenfold increase in inflation-adjusted mortgage debt levels since then.

This leads to something that I would like Mark Carney to address in his Mansion House speech tonight.

Second an inflation-targeting central bank, which has delivered a more aggressive monetary response to each of the recent downturns, because of that high debt burden.

On that road we in the UK will see negative interest-rates in the next downturn which of course may be on the horizon.

Comment

There is much to consider for the Governor of the Bank of England tonight. If he continues on the current path of cutting interest-rates and adding to QE on any prospect of an economic slow down then neither he nor his 8 fellow policy setting colleagues are required. We could replace them with an AI ( Artificially Intelligent ) Robot although I guess the danger is that it becomes sentient Skynet style ( from The Terminator films ) and starts to question what it is doing?

However moving on from knee-jerk junkie culture monetary policy has plenty of problems. It first requires both acknowledgement and admittal that monetary policy can do some things but cannot do others. Also that international influences are often at play which includes foreign monetary policy. I have looked at the Federal Reserve today well via the Far East other monetary policy applies. Let me hand you over to some research from Neal Hudson of Residential Analysts on buyers of property in London from the Far East.

However, anecdotal evidence suggests that many of these buyers have been using local mortgages to fund their purchases.  The limited evidence I have suggests that around half of Hong Kong and Singaporean buyers use a local mortgage while the majority of mainland Chinese buyers use one.

Okay on what terms?

The main difference is that the mortgage rate tends to be slightly higher (London Home Loan comparison) and local lenders allow borrowers to have far higher debt multiples.

These people are not as rich as might previously have been assumed and we need to throw in changes in the value of the UK Pound £ which are good for new buyers but bad for existing ones. Complicated now isn’t it?

On a personal level I was intrigued by this.

Last year I visited a development in Nine Elms and the lobby felt more like a hotel than a residential block. There were significant numbers of people appearing to pick up and drop off keys with suitcases in tow.

You see I live in another part of Battersea ( the other side of the park) and where i live feels like that as well.

 

 

 

UK Real Wages took quite a dip in April

As we looked at the inflation data yesterday it was hard not to think of the implications for real or inflation adjusted wages from the further rise in inflation. There were quite a few such stories in the media about a fall in real wages although they were a little ahead of events because the inflation data was for May and even today we will only get wages data up to April. However there is an issue here that has been building in the credit crunch era where real wages fell heavily as the Bank of England looked the other way as inflation went above 5% in the autumn of 2011. Sadly they relied in their Ivory Tower models which told them that wages would rise in response. Not only did that not happen but the recovery since has been weak and was in fact driven much more by low inflation than wage growth. This is different to past recessions as this from the Resolution Foundation shows.

As you can see the pattern has been very different from past recessions. Real pay rebounded very strongly after 1979 and did well after 1990 but on the same timescale in remains in negative territory this time around. A lot of care is required with long term data like this but this is a performance that looks the worst for some time.

The Napoleonic war period seems especially grim for real wages. If I recall correctly we were imposing a blockade on much of Europe which seems to have our economy hard as well.

Today’s data

We see that wage growth has faded a bit in the latest numbers.

Between February to April 2016 and February to April 2017, in nominal terms, regular pay increased by 1.7%, slightly lower than the growth rate between January to March 2016 and January to March 2017 (1.8%)……..Between February to April 2016 and February to April 2017, in nominal terms, total pay increased by 2.1%, lower than the growth rate between January to March 2016 and January to March 2017 (2.3%). The annual growth rate for total pay, in nominal terms, has not been lower than 2.1% since October to December 2015.

This is of course happening at the same time that inflation is rising and leads to this situation.

The rate of wage growth slowed in the 3 months to April 2017; adjusted for inflation, annual growth in total average weekly earnings turned negative for the first time since 2014.

That is rather ominous when we consider the first chart above as it means that we are getting further away from regaining where we were in 2008 rather than nearer so let us look deeper. The emphasis is mine.

Average weekly earnings, including bonuses, grew by 2.1% in the same period and are the weakest since the December to February 2016 period. Taking into account recent increases in inflation, real average weekly earnings decreased by 0.4% including bonuses and by 0.6% excluding bonuses in the 3 months to April 2017 compared with the same period a year earlier. This is the first annual decline in total real average weekly earnings since 2014.

Of course they are using the new lower headline measure of inflation called CPIH which uses Imputed Rents to estimate owner-occupied housing costs. So the goal posts have been moved a little and this happens so often these days that we should be grateful that so many goal posts now come with wheels.

Where does this leave us overall?

The situation is as follows according to our official statisticians. They are using constant 2015 prices so they are real numbers.

average total pay (including bonuses) for employees in Great Britain was £487 per week before tax and other deductions from pay, £35 lower than the pre-downturn peak of £522 per week recorded for February 2008.

Number Crunching

We can go deeper because there are numbers for the month of April on its own. In that month total pay only rose at an annual rate of 1.2% because whilst regular pay rose by 1.8% bonuses fell by 5.8%. Care is needed as if we look back April has been an erratic month for bonuses but we see that real wages were falling at an annual rate of 1.5% if we use CPI inflation. 1.4% if we use CPIH and 2.3% if we use RPI. Even if we ignore the bonus numbers we see -0.9% for CPI, -0.8% for CPIH and -1.5% for RPI.

The sectors which seem to have impacted in April are the finance and construction ones which both saw total pay fall at an annual rate of 0.5%.

Is the UK labour market tight

Conventional analysis based on such theories as the Phillips Curve will be telling us that the UK labour market is “tight”. An example of this is below from Andy Verity of the BBC.

Unemployment: a 42-year low (1.53m, 4.6%); work force: another record high (31.95m people). But tight labour market isn’t pushing up pay.

If we put some more meat on those bones there are things heading in that direction as this shows below.

The number of people in work increased by 109,000 in the 3 months to April 2017 compared with the previous 3 months, to 31.95 million, with an increase in full-time employment (162,000) partly offset by a fall in part-time employment (53,000) . The employment rate reached a joint record high of 74.8%.

This looks good and indeed is but questions remain. For example having checked I know that there is not a clear definition of full-time work it is something that responders to the survey decide for themselves. Added to this is the issue of self-employment and how much work they are actually doing.

self-employed people increased by 103,000 to 4.80 million (15.0% of all people in work).

Just as a reminder the self-employed are excluded from the official wages data. There is more reinforcement for the labour market being tight here.

Total hours worked per week were 1.03 billion for February to April 2017. This was 0.7 million more than for November 2016 to January 2017 and 15.4 million more than for a year earlier.

We are left with the concept of underemployment here I think which measures the gap between the work that people are doing and what they would like to do. Sadly the UK does not have an official measure of this unlike the US with its U-6 data. We only have flickers of insight via the growth of self-employment which needs to be sub-divided into positive and negative and the rise of zero hours contracts. In terms of influencing pay there seems to have been an associated rise in job insecurity but we have no clear measure of this.

Comment

The real wage squeeze we feared for this year is now upon us and we face the grim reality that it has been more than a lost decade for them.

Looking at longer term movements, average total pay for employees in Great Britain in nominal terms increased from £376 a week in January 2005 to £502 a week in April 2017; an increase of 33.5%. Over the same period the Consumer Prices Index including owner occupiers’ housing costs (CPIH) increased by 31.8%.

The cross-over was in early 2006. This poses all sorts of problems for the Ivory Towers who will look at the employment numbers and forecast much stronger wage growth. Of course they were usually responsible for the increasingly inadequate employment data as we note that one thing they are certainly very poor at is adapting to ch-ch-changes.

Grenfell Tower

Let me express my deepest sympathies for anyone involved in the dreadful fire there which started this morning.

 

 

Imputed Rents do their job of slowing rises in UK inflation

Today we find ourselves reviewing the data on the rise in inflation in the UK in 2017. This has been caused by a couple of factors. The first is something of a world-wide trend where the price of crude oil stopped falling and being a disinflationary influence. The second has been the fall in the value of the UK Pound which accelerated following the vote for the UK to leave the European Union just over a year ago. If we look back a year then the current US $1.269 has replaced the US $1.411 back then. So the inflation which was supposedly dead ( if you recall the Deflation hype and paranoia..) came back on the menu.

The UK establishment responds

If you do not want the public to realise that inflation is rising but do not wish to introduce any policies to stop it then the only option available to you is to change the way the numbers are measured. Last Autumn the UK statistical establishment began quite a rush to increase the use of rents in  a new headline UK inflation measure. There is of course a proper use for rents which is for those who do rent, however the extension was for those who own their house and do not actually rent it out. So yes imputed rents were required to fill the gap. Here is the official explanation.

However, it does not include the costs associated with owning a home, known as owner occupier housing costs. ONS decided that the best way to estimate these costs is a method known as ‘rental equivalence’. This estimates the cost of owning a home by calculating how much it would cost to rent an equivalent property. A new index based on CPI but including owner occupier housing costs – CPIH – was launched in 2013.

How has that gone?

This new index had some problems in 2014,

Also there is this.

We have still not yet addressed all of the necessary requirements for CPIH to become a national statistic.

So why the rush? Well last week’s numbers on rents from Homelet will have raised a wry smile for many.

UK rental price inflation fell for the first time in almost eight years in May, new data from HomeLet reveals. The average rent on a new tenancy commencing in May was £901, 0.3% lower than in the same month of 2016. New tenancies on rents in London were 3% lower than this time last year…..May’s decrease in average rental values marks a significant moment for the rented property sector. This is the first time since December 2009 the HomeLet Rental Index has reported a fall in rents on an annualised basis.

So rents were rushed in as part of the “most comprehensive measure” of UK inflation just in time for them to fall! Those who believe that rental inflation is related to wage growth will no doubt be thinking that wage growth and hence likely rental growth is lower these days. This is all rather different to house prices where lower mortgage rates can set off more price rises and inflation. I have met those responsible for this and pointed out that the word “comprehensive” is misleading as they do not actually measure the owner occupied housing market they simply impute from the rental one.

Today’s data

We see this.

The Consumer Prices Index (CPI) 12-month rate was 2.9% in May 2017, up from 2.7% in April………The Consumer Prices Index including owner occupiers’ housing costs (CPIH, not a National Statistic) 12-month inflation rate was 2.7% in May 2017, up from 2.6% in April.

So not only is the new measure again below the older one we see that the gap has now widened from 0.1% to 0.2%. As the difference must be the imputed rental section let us take a look.

Private rental prices paid by tenants in Great Britain rose by 1.8% in the 12 months to May 2017; this is unchanged from April 2017.

As you can see whilst the official data does not have the falls indicated by Homelet it is a drag on the overall inflation measure. Sir Humphrey Appleby would have a broad smile on his face right now. Oh and the reason why it is not showing falls is that the numbers are what might be called “smoothed”. The actual monthly  numbers are quite erratic ( which of course would lead to doubts if people saw them) so in fact the numbers are over a period of time and then weighted. The ONS has been unwilling to reveal the length of the period used but it used to be around 18 months. This is of course another reason why this methodology is flawed and a bad idea because rents from a year ago should be in last years indices not this months.

I have argued for a long time ( this debate began in 2012) that house prices should be used as they are of course actually paid rather than being imputed. Also they behave very differently to rents as a pattern and are more timely which is important. So what are they doing?

Average house prices in the UK have increased by 5.6% in the year to April 2017 (up from 4.5% in the year to March 2017).

As you can see house price inflation is currently treble that of rental inflation. Can anybody think why the UK establishment wanted rents rather than house prices used in the consumer inflation measure?

Our past measure

The Retail Price Index used to be used in the UK.

The all items RPI annual rate is 3.7%, up from 3.5% last month.

So the pattern of higher inflation measures being retired continues. Although it does at least serve two roles. The first is for indexation of things people pay such as mobile phone bills as my contract rises by it as of course do student loans. The second is for the indexation of Bank of England pensions where it seems strange that the establishment attack on RPI somehow got forgotten

Looking ahead

Fortunately we see that the main push is beginning to fade.

The annual rate of factory gate price inflation (output prices) remained at 3.6% for the third consecutive month and slowed on the month to 0.1%, from 0.4% in March and April……….The annual rate of inflation for materials and fuels (input prices) fell back to 11.6% in May, continuing its decline from 19.9% in January 2017 following the recent strength of sterling.

There is still momentum to push the annual rate of inflation higher which will not be helped if the post General Election dip in the value of the UK Pound persists. But the main push has now been seen. We should be grateful that the price of crude oil is around US $48 per barrel in Brent Crude terms.

Comment

The latest attempt by the UK establishment to “improve” the UK measurement of consumer inflation is being shown up for what it is, an attempt to manipulate the numbers lower. I guess things we receive will no longer be indexed to CPI they will be switched to CPIH! Also will the Bank of England switch its inflation target? If so it will complete a journey which has lowered the measure from 3.9% ( where what is called RPIX now is) to 2.7% or a 1.2% change when the target was only moved by 0.5%. In these times of lower wage rises, interest-rates and yields then 0.7% per annum matters quite a bit over time.

An answer to this would be to put the asset price which the Bank of England loves to inflate, house prices, in the inflation index. Let me leave you today with the price of a few basic goods if they had risen in line with them.

 

As I am off later to buy a chicken for dinner I am grateful it has not risen at such a rate.