Does money supply growth feed straight into house prices?

I thought that I would look at things today from a slightly different perspective or to quote the French man in The Matrix series we shall investigate some cause and effect. Let me give you the latest news on the effect.

In Q3 2020, the rise in prices of second-hand dwellings in France (excluding Mayotte) weakened: +0.5% compared to Q2 2020 (provisional seasonally adjusted results), after +1.4% in Q2 and +1.9% in Q1 2019.

Over a year, the rise in prices continued: +5.2%, after +5.6% and +4.9%. As observed since the end of 2016, this increase was more important for flats (+6.5% over the year) than for houses (+4.2%). ( Insee)

The reality of the situation arrives when you look at the overall pattern. We saw negative interest-rates introduced by the ECB in June 2014 and large-scale QE begin in March 2015. After several years of falling house prices we then saw French annual house price growth move into positive territory towards the end of 2015. Since then the rate of growth has tended to rise and is now above 5%. The ECB and Bank of France will of course be noting this down as Wealth Effects a plan which is aided and abetted by the Euro area measure of inflation which conveniently omits owner-occupied housing completely. Apparently the twenty odd years they have had to do something about this is not long enough or something like that.

If we bring this right up to date I am nit especially bothered by the decline in quarterly growth in house prices. After all the background environment is for house price falls and the monetary easing we are about to look at has prevented them so far. Or in an amusing irony we can quote the word “counterfactual” back at the central bankers.

Money Supply

The growth here remains stellar as we look at the measure most affected by all the easing.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, stood at 13.8% in October, unchanged from previous month.

This is a consequence of buying some 25.5 billion Euros of bonds under the original QE programme ( PSPP) and some 62 billion under the new emergency pandemic one or PEPP. Just to mark you cards looking ahead the latter seems to have accelerated recently from around 15 billion per week to around 20 billion in a possible harbinger of the ECB December decision.

This is a game the ECB has been playing since 2015 when it got M1 growth as high as 11.7% which was part of the push on house prices we looked at above. Annual growth had fallen to around 7% before the last act of Mario Draghi last autumn pushed it back above 8% and now the pandemic response pushed it into double-figures. There is another issue here which was described by Kate Bush.

Be running up that road
Be running up that hill
Be running up that building

The 13.8% growth in October is on a much larger amount. Indeed M1 passed 10 trillion Euros in size in October.

Broad Money

If we go wider in monetary terms we see a similar picture.

Annual growth rate of broad monetary aggregate M3 stood at 10.5% in October 2020, after 10.4% in September 2020

The pattern here is different as the previous moves had struggled to get annual growth much above 5% and now well you can see for yourself.Something of a wall of broad money going somewhere but not into the real economy. As you might expect some of this is the tsunami of narrow money.

Looking at the components’ contributions to the annual growth rate of M3, the narrower aggregate M1 contributed 9.4 percentage points (as in the previous month), short-term deposits other than overnight deposits (M2-M1) contributed 0.4 percentage point (as in the previous month) and marketable instruments (M3-M2) contributed 0.7 percentage point (up from 0.6 percentage point).

The ECB will be pleased with the last component of marketable instruments on two counts. Firstly it can point to it as a response to its actions. Secondly growth in such markets will no doubt lead to a growth in sinecures for past central bankers.

Things then get more awkward because it was only the day before yesterday we noted a  savings ratio of 13.5% in Germany on the third quarter. Well from the numbers below it looks as though businesses are saving too and doing it via their bank accounts.

From the perspective of the holding sectors of deposits in M3, the annual growth rate of deposits placed by households increased to 7.9% in October from 7.7% in September, while the annual growth rate of deposits placed by non-financial corporations decreased to 20.5% in October from 21.1% in September. Finally, the annual growth rate of deposits placed by non-monetary financial corporations (excluding insurance corporations and pension funds) decreased to 7.3% in October from 8.2% in September.

It might be more accurate to say they have received money they cannot spend yet as we see a shift in monetary transmission. This is one of the clearest examples of what in economics is called excess money balances I have ever seen. Except right now neither supposed consequence of growth and inflation can happen much.

Credit

With the various support schemes in place it is hard to know what these numbers are really telling us. We do get a pointer to something we know is happening.

The annual growth rate of credit to general government increased to 20.3% in October from 18.9% in September, while the annual growth rate of credit to the private sector stood at 4.9% in October, unchanged from the previous month.

Credit is flowing to governments and some of it is being passed on.

Comment

We can now look more internationally and see examples of monetary policy affecting asset prices. The United States has given us two examples this week alone.

US home prices climbed the most on record in the third quarter as historically low mortgage rates drove outsized demand, the Federal Housing Finance Agency said in a Tuesday report.

Prices gained 3.1% from their prior-quarter levels, according to the report. The jump also places prices 7.8% higher than their year-ago levels. A seasonally adjusted monthly index of prices gained 1.7% in September. ( Business Insider)

And this.

The Dow Jones Industrial Average hit 30000 for the first time on Tuesday, after a rally of more than 60% from its March lows. ( WSJ)

We can also look to Japan where this morning’s Nikkei 225 close at 26,537 compares with more like 8,000 when the Abenomics experiment began.

The catch is that in terms of money supply there are lots of leads and lags in the system. So we can see some things clearly such as the rise in French house price growth but in other areas the rain has not yet gone. For example the CAC-40 has surged in response to the monetary easing but like the UK FTSE 100 is well below past peaks. Of course another asset market which is French sovereign bonds has gone through the roof such that France is being paid to borrow ( ten-year yield -0.34%) in an example of a direct impact.

Switching to the real economy there will be greater lags right now as the Covid-19 restrictions and lockdowns crunch economies regardless of monetary growth. But if you think about it that only raises the inflationary risks and it is not only the Euro area that puts a Nelsonian blind eye to likely developments.

“The government’s plan to replace RPI with CPIH is a clear case of using the wrong tool for the job…” Our CEO @stianwestlake on the news that the RPI will be aligned to the CPIH in 2030 ( Royal Statistical Society)

Happy Thanksgiving.

The UK plans to Spend! Spend! Spend!

There is something of an irony today as the UK faces a Spending Review which is not called a Budget but is set to be more significant than nearly all of the latter. Also we are reminded that previous to this phase we were in uncertain times but that has been squared or even cubed this year. Perhaps the biggest example of that affecting the public finances came with Lockdown 2.0 as the government announced this on Bonfire Night.

Today, we are extending the CJRS until the end of March for all parts of the UK. We will review the policy
in January to decide whether economic circumstances are improving enough to ask employers to
contribute more. The Job Support Scheme is postponed.
Eligible employees will receive 80% of their usual salary for hours not worked, up to a maximum of £2,500
per month.

Interestingly they switched to telling us the cost when the scheme for the self-employed was announced at the same time.

This is £7.3 billion of support to the self-employed through November to January alone, with a further
grant to follow covering February to April. This comes on top of £13.7 billion of support for self-employed
people so far, one of the most comprehensive and generous support packages for the self-employed
anywhere in the world.

The Resolution Foundation has calculated the costs this year as this.

The largest AME components of these increases are the estimated £56 billion spent on the Job Retention Scheme (JRS) and £23 billion on the Self-Employed Income Support
Scheme.

Having checked the numbers on Friday which covered the period until October some £61 billion or so has already been spent to the danger in those numbers looks set to be from the upside. In terms of a total they think this.

We estimate that in the region of £250 billion of additional Covid-related spending will take place in 2020-21. This, and the much smaller economy, combine to mean that the
size of the state relative to GDP is set to sky-rocket this year, from 40 per cent of GDP to around 60 per cent of GDP.

So there is an element of today being a bit after the Lord Mayor’s Party so let me lighten the atmosphere with some examples of the first rule of OBR Club.

GDP growth in the third quarter of 2020: the level of GDP was 7 per cent higher than the OBR had expected in July

That is a pretty spectacular fail and there is another.

Since that forecast, unemployment has risen
only slightly, as shown in Figure 4: unemployment in 2020 Q3 was 4.8 per cent, less than half that expected in the OBR’s central scenario.

There are two issues here which in my opinion the Resolution Foundation miss. They treat OBR forecasts seriously and hang their view on the future off them when as you can see the future is very unlikely to be as forecast. Also the unemployment definition has failed us and we should be looking at underemployment measures such as hours worked to get a much better view of the state of play.

What about today?

The Financial Times gives us an example of government by leak.

Rishi Sunak will on Wednesday set out a £4.3bn plan to tackle the threat of mass unemployment as the chancellor braces Britain for the brutal economic fallout from the coronavirus crisis. Mr Sunak will tell MPs in his spending review that his “number one priority is to protect jobs and livelihoods”.

What does this mean in practice?

Mr Sunak will announce £2.9bn of spending over three years on a “Restart” programme to help Britons find jobs, plus £1.4bn of new funding to increase the capacity of the Jobcentre Plus network to help more people back to work. The Restart scheme, offering regular and intensive “tailored” job support, is particularly aimed at older workers who are most likely to be left facing “the scarring effects” of long-term unemployment.

Let us hope that this works although it relies on there being jobs to go to. The Jobcentre Plus scheme has seen famine after 2015 but now is back to feast so I wonder how effectively it can be expanded? Sadly the FT continues the media obsession with the fairly useless unemployment numbers.

The latest official statistics show that an estimated 1.6m people were unemployed in the three months to September — 318,000 more than a year earlier. The unemployment rate stands at 4.8 per cent of the workforce.  With many companies pressing ahead with redundancy plans, unemployment is set to rise further in the coming months.

The BBC takes a wider view including other measures some of which have already been announced.

These include an extra £3bn for the NHS in England to help tackle the backlog of operations delayed due to Covid, an increase in defence spending and a £4.6bn package to help the unemployed back to work.

So whoever leaked this to the BBC has added some £300 million to the unemployment plan compared to the leak to the FT. Also there is something of a difference into the issue of future austerity. The FT suggests it is a can to be kicked into the future wheres the BBC gives examples of it already beginning.

The government is expected to announce a cut in the UK’s overseas aid budget to 0.5% of national income, down from the legally binding target of 0.7%……There have also been reports that the chancellor is considering a pay freeze for all public sector workers except frontline NHS staff.

There are even reports that this will extend to Members of Parliament.

Comment

The main issue here I think is what is the role of government? I am not particularly thinking of the size of it here. What I mean is what can it do about employment and unemployment? It can make a major difference if it can pock out which are the viable jobs that need support for say a year and can then thrive. We win out of that via future tax payments before we get to other issues. The problem is that the credit crunch was far from the best example of this as we ended up protecting the banks with a The Precious! The Precious perspective only for them to then retrench anyway and have a zombie business model. Along the way inflating the housing market was a consequence too, although that has become an international game.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, covering all nine U.S. census divisions, reported a 7.0% annual gain in September, up from 5.8% in the previous month.

As to whether we can afford it then as I pointed out as recently as Monday we can borrow very cheaply. We are paid to borrow at the shorter end and even the fifty-year yield is a mere 0.73%. So it has completely ignored the expected spending increases. That requires a so far,as back in the Gordon Brown days it used to wait until late afternoon on the day. Our reputation may be damaged by the announcement on the RPI that I reported on last week.

Massive day for the UK index-linked gilt market. Today we get the government’s response to the RPI Reform Consultation: likely that RPI will be aligned to CPIH from 2030, with no compensation for investors. Some even think this might be moved forward to 2025. ( @bondvigilantes )

If I was in charge I would scrap that plan and I would look to strengthen our position by issuing some one hundred year bonds. As Steve Winwood so aptly put it.

While you see a chance
Take it

 

Can the UK afford all the extra debt?

I thought that it was time to take stick and consider the overall position in terms of the build up of debt. This has come with a type of economic perfect storm where the UK has begun borrowing on a grand scale whilst the economy has substantially shrunk.So an stand alone rise in debt has also got relatively much larger due to the smaller economy. Hopes that the latter would be short and sharp rather faded as we went into Lockdown 2.0. Although as we look to 2021 and beyond there is increasing hope that the pace of vaccine development will give us an economic shot in the arm.

In terms of scale we got some idea of the flow with Friday’s figures.

Public sector net borrowing (PSNB ex) in the first seven months of this financial year (April to October 2020) is estimated to have been £214.9 billion, £169.1 billion more than in the same period last year and the highest public sector borrowing in any April to October period since records began in 1993.

The pattern of our borrowing has changed completely and it is hard not to have a wry smile at the promises of a budget balance and then a surplus. Wasn’t that supposed to start in 2016? Oh Well! As Fleetwood Mac would say. Now we face a year where if we borrow at the rate above then the total will be of the order of £370 billion.

If we switch to debt and use the official net definition we see that we opened the financial year in April with a net debt of 1.8 trillion Pounds if you will indulge me for £500 million and since then this has happened.

Public sector net debt excluding public sector banks (PSND ex) rose by £276.3 billion in the first seven months of the financial year to reach £2,076.8 billion at the end of October 2020, or around 100.8% of gross domestic product (GDP); debt to GDP ratios in recent months have reached levels last seen in the early 1960s.

You nay note that the rise in debt is quite a bit higher than the borrowing and looking back this essentially took place in the numbers for April and May when the pandemic struck. Anyway if we assume they are now in control of the numbers we are looking at around £2.2 trillion at the end of the financial year if we cross our fingers for a surplus in the self assessment collection month of January.

The Bank of England

How does this get involved? Mostly by bad design of its attempts to keep helping the banks. But also via a curious form of accountancy where marked to market profits as its bond holdings are counted as debt.

If we were to remove the temporary debt impact of these schemes along with the other transactions relating to the normal operations of the BoE, public sector net debt excluding public sector banks (PSND ex) at the end of October 2020 would reduce by £232.9 billion (or 11.3 percentage points of GDP) to £1,843.9 billion (or 89.5% of GDP).

So on this road we look set to end the fiscal year with a net debt of the order of £2 trillion.

Quantitative Easing

This is another factor in the equation but requires some care as I note this from the twitter feed of Richard Murphy.

Outside Japan QE was unknown until 2009. Since then the UK has done £845 billion of it. This is a big deal as a consequence. But as about half of that has happened this year it’s appropriate to suggest that there have been two stage of QE, so far. And I suggest we need a third.

Actually so far we have done £707 billion if you just count UK bond or Gilt purchases. That is quite a numerical mistake.As we look ahead the Bank of England plans to continue in this manner.

The Committee voted unanimously for the Bank of England to continue with the existing programme of £100 billion of UK government bond purchases, financed by the issuance of central bank reserves, and also for the Bank of England to increase the target stock of purchased UK government bonds by an additional £150 billion, financed by the issuance of central bank reserves, to take the total stock of government bond purchases to £875 billion.

We see that this changes the numbers quite a lot. There are a lot of consequences here so let me this time agree with Richard Murphy as he makes a point you on here have been reading for years.

The first shenanigan is that the so-called independence of the Bank of England from the Treasury is blown apart by the fact that the Treasury completely controls the APF and the whole QE process. QE is a Treasury operation in practice, not a Bank of England one. ( APF = Asset Protection Fund)

Actual Debt Costs

These are extraordinarily low right now. Indeed in some areas we are even being paid to borrow. As I type this the UK two-year yield is -0.03% and the five-year yield is 0%. Even if we go to what are called the ultra longs we see that the present yield of the fifty-year is a mere 0.76%. To that we can add the pandemic effect on the official rate of inflation.

Interest payments on the government’s outstanding debt were £2.0 billion in October 2020, £4.4 billion less than in October 2019. Changes in debt interest are largely a result of movements in the Retail Prices Index to which index-linked bonds are pegged.

As an aside this also explains the official effort to neuter the RPI measure of inflation and make it a copy of the CPIH measure so beloved of the UK establishment via the way they use Imputed Rents to get much lower numbers. I covered this issue in detail on the 18th of this month.

So far this financial year we have paid £24.1 billion in debt costs as opposed to the £33.9 billion we paid in the same April to October period last year.

Comment

The elephant in the room here is QE and by using it on such a scale the Bank of England has changed the metrics in two respects. Firstly the impact on the bond market of such a large amount of purchases has been to raise the price which makes yields lower. That flow continues as it will buy another £1.473 billion this afternoon. Having reduced debt costs via that mechanism it does so in another way as the coupons ( interest) on the debt it has bought are returned to HM Treasury. Thus the effect is that we are not paying interest on some £707 billion and rising of the debt that we owe.

Thus for now we can continue to borrow on a grand scale. One of the ways the textbooks said this would go wrong is via a currency devaluation but that is being neutered by the fact that pretty much everyone is at the same game. There are risks ahead with the money supply as it has been increased by this so looking ahead inflation is a clear danger which is presumably why the establishment are so keen on defining it away.

I have left until the end the economy because that is so unpredictable. We should see some strength in 2021 as the vaccines kick in.But we have a long way to go to get back to where we were in 2008. On a collective level we may need to face up to the fact that in broad terms economic growth seems to have at best faded and at worst gone away.

Podcast

 

 

The UK shopper strikes yet again!

This morning has brought an example of something which is both remarkable and familiar. You might argue that you cannot use those two words together but 2020 is a year that continues to defy convention. What I am referring too is more good news for the UK economy from this sector.

In October 2020, retail sales volumes increased by 1.2% when compared with September; the sixth consecutive month of growth in the industry.

This means that the annual picture looks really rather rosy too.

In October, the year-on-year growth rate in the volume of retail sales saw a strong increase of 5.8%, with feedback from a range of businesses suggesting that consumers had started Christmas shopping earlier this year, further helped by early discounting from a range of stores.

In recent times the pattern has changed with for example Black Friday being in a week’s time and there is also Cyber Monday. Some Black Friday offers seem to have already started, if the advertising I see is any guide. So the structure underlying seasonal adjustment has been changing and maybe there has been another shift this year. Thus there may be a hangover from these numbers but we simply do not know how much it will be?

If we try to compare we the period pre the pandemic we see another strong recovery and then boom.

Looking at October’s total retail sales values (excluding fuel), which is a comparable measure to our online series, sales increased by 7.9% when compared with February; driven by a strong increase in sales online at 52.8% in comparison to reduced store sales at negative 3.3%.

From all the deliveries I see happening the online numbers are hardly a surprise, but with Lockdown 2.0 now adding to the problems I fear for quite a bit of the high street.

So we do have a V-shaped recovery for one part of our economy and I guess the orders for the economics text books are already on their way to the printers.

What this has done is out the switch to the online world on speed with food sales seeing a particular boom. That will be fed by the stories that Covid-19 is being spread by supermarket visits.

In October, we can see that online sales for all sectors increased when compared with February. Online food sales nearly doubled, with an increase of 99.2% in comparison with food store sales, which saw a fall of 2.1%. Overall, total food sales increased by 3.4% when compared with February.

Clothing stores, with an overall decline of 14.0% in value sales, increased their online sales by 17.1% but saw the biggest fall in store sales at negative 22.1%.

The area which has most struggled does not really have an option for online sales.

In October, fuel sales still remained 8.8% below February’s pre-lockdown level, while car road traffic reduced by an average 14.2%.

Looking at the overall picture it is also a case of Shaun 1 Bank of England 0 because my case that lower prices lead to growth has got another piece of evidence in its favour.

This was the sixth consecutive month of growth resulting in value and volume sales 5.2% and 6.7% higher respectively than in February 2020, before coronavirus (COVID-19) lockdown restrictions were applied in the UK.

With value growth or if you prefer expenditure in Pounds lower than volume growth there has been disinflation or price falls combined with volume growth. For newer readers I first made the point formally on here on the 29th of January 2015.

Looking ahead that boost may now fade as October gave a hint of a change of trend.

All measures in the total retail sales industry saw an increase in October 2020. The monthly growth rate for value sales was 1.4% and for volume sales 1.2%.

It may take a while to note anything like that as Lockdown 2.0 will affect the December and particularly the November numbers.

Public Finances

These too were numbers that the forecasters got wrong by quite a bit. So today was yet another failure as Retail Sales were supposed to flat line and borrowing be much higher.

Public sector net borrowing (excluding public sector banks, PSNB ex) is estimated to have been £22.3 billion in October 2020, £10.8 billion more than in October 2019, which is both the highest October borrowing and the sixth-highest borrowing in any month since monthly records began in 1993.

Of course, we are borrowing extraordinary amounts so this is relatively good news rather than being outright good. As you can see below a more than half of the rise is extra central government spending.

Central government bodies are estimated to have spent £71.3 billion on day-to-day activities (current expenditure) in October 2020, £6.4 billion more than in October 2019; this growth includes £1.3 billion in Coronavirus Job Retention Scheme (CJRS) and £0.3 billion in Self Employment Income Support Scheme (SEISS) payments.

Also revenues have fallen and some of that is deliberate with the VAT and Stamp Duty cuts.

Central government tax receipts are estimated to have been £39.7 billion in October 2020 (on a national accounts basis), £2.7 billion less than in October 2019, with falls in Value Added Tax (VAT), Business Rates and Pay As You Earn (PAYE) income tax.

You might think that the balancing amount was local councils especially after the blow up in Croydon, which for those unaware is below.

Cash-strapped Labour-run Croydon Council has imposed emergency spending restrictions with “immediate effect”, the BBC has learned.

The Section 114 notice bans all new expenditure at Croydon Council, with the exception of statutory services for protecting vulnerable people.

A document seen by the BBC said “Croydon’s financial pressures are not all related to the pandemic”.

It is under a government review amid claims of “irresponsible spending”.

Section 114 notices are issued when a council cannot achieve a balanced budget. ( BBC News)

However the main other recorded component was the Bank of England at £2.8 billion. This is really rather awkward as it has not actually borrowed anything at all! But a Monty Python style method records it as such and it is the first time I can recall an issue I have regularly flagged about the national debt so explicitly affecting the deficit as well.

National Debt

So without further ado here is the misleading headline that much of the media has gone with today.

Public sector net debt (excluding public sector banks) rose by £276.3 billion in the first seven months of the financial year to reach £2,076.8 billion at the end of October 2020, £283.8 billion more than in October 2019.

This is misleading because it includes the activities of the Bank of England which are not debt. I am no great fan of the Term Funding Scheme but recording its £120 billion as all being debt is quite extraordinary and is a major factor leading to this.

If we were to remove the temporary debt impact of these schemes along with the other transactions relating to the normal operations of the BoE, public sector net debt excluding public sector banks (PSND ex) at the end of October 2020 would reduce by £232.9 billion (or 11.3 percentage points of GDP) to £1,843.9 billion (or 89.5% of GDP).

It makes quite a difference especially for fans of debt to GDP ratios as we go from 89.5% to “around 100.8% of gross domestic product” on this really rather odd road.

Comment

The continued growth of UK retail sales is good news as we see an area that has recovered strongly. This comes with two caveats. The first is that with out enthusiasm for imports it poses a danger for the trade figures. The second is that in a tear with so many changes I doubt any survey is completely reliable so we are more uncertain that usual.

Switching to the public finances and taking a deeper perspective we are posting some extraordinary numbers.

Public sector net borrowing (PSNB ex) in the first seven months of this financial year (April to October 2020) is estimated to have been £214.9 billion, £169.1 billion more than in the same period last year and the highest public sector borrowing in any April to October period since records began in 1993.

We seem set to keep spending more in some areas ( defence) but want to cut back in others ( public-sector pay) so all we can do at the moment is be grateful we can borrow so cheaply. Even the fifty-year Gilt yield is a mere 0.77% and as I have written before at these levels I would issue some one hundred year ones as the burdens are not going away anytime soon.

My theme that low inflation helps economies also gets support from the public finances.

Interest payments on the government’s outstanding debt were £2.0 billion in October 2020, £4.4 billion less than in October 2019. Changes in debt interest are largely a result of movements in the Retail Prices Index to which index-linked bonds are pegged.

The Bank of England never gets challenged as to why it keeps trying to raise our debt costs in this area. Also you see another reason why the establishment wants to neuter the Retail Prices Index ( RPI)

 

 

 

 

 

The UK Plan is to turn a good inflation measure (RPI) into a bad one ( CPIH)

A feature of these times is that we see so many official attempts to hide the truth. In the UK at the moment one of the main efforts is around the inflation numbers and next week on the 25th we will get an announcement about it. The official documentation shows the real reason for the change albeit by accident.

Since 2010, the measured rate of RPI annual inflation has been on average one percentage point per annum above the CPIH.

They want to get rid of the RPI for that reason that it gives a reading some 1% higher as they can then tell people inflation is 1% higher at a stroke. The “independent” UK Statistics Authority and National Statistician have  thoroughly embarassed themselves on this issue. There have been 2 main efforts to scrap the RPI both of which have crumbed under their own inconsistencies and now the plan is to neuter it by applying some Lord of the Rings style logic.

One Ring to rule them all, One Ring to find them, One Ring to bring them all, and in the darkness bind them.

In the future we will only have one inflation measure and it will be the one that has been widely ignored since its introduction in spire of desperate attempts to promote it.

The Authority remains minded to address the shortcomings of the RPI by bringing the methods and data sources from the National Statistic, the CPIH, into the RPI. In practice this means that, from the implementation date, the RPI index values will be calculated using the same methods and
data sources as are used for the CPIH. Monthly and annual growth rates will then be calculated directly from the new index values.

So the “improvement” will involve including rents which do not exist and they comprise quite a bit of the index.

Given that the owner occupiers’ housing costs (OOH) component accounts for around 16% of the CPIH, it is the main driver for differences between the CPIH and CPI inflation rates.

For those unaware if you own your own home you are assumed to pay yourself rent and then increases in the rent you do not pay are put in the inflation numbers. Even worse they have little faith in the numbers used ( from actual renters) so they “smooth” them with an average lag of about 9 months. So today’s October rent numbers reflect what was happening around January and are therefore misleading. Putting it another way if you wish to have any idea of what is happening in the UK rental sector post pandemic do not look here for clues.

The supposedly inferior RPI uses house prices via a depreciation component ( a bit over 8%) and mortgage interest-rates ( 2.4%). Apparently using things people actually pay is one of the “shortcomings”. Meanwhile back in the real world if I was reforming the RPI I would put house prices in explicitly.

I find myself in complete agreement with the TUC on this.

Nobody is claiming the RPI is perfect. But it remains the best measure for living costs and would be straight forward to modernise.

As has been shown across Europe it would be perfectly possible to have RPI existing in parallel to CPIH (​or CPI) and have the latter measure focus on guiding monetary policy.

We are disappointed that expert calls to retain the RPI have been repeatedly ignored. The Royal Statistical Society and House of Lords Economic Affairs ​Committee have both presented compelling evidence for keeping it.

The basic issue is that the inflation numbers will be too low.In addition measures of real wages will be distorted too. These things echo around the system as for example when RPI was replaced by CPI in the GDP data the statistician Dr. Mark Courtney calculated that GDP was then higher by up to 0.5% a year. If you cant change reality then change how it is presented.

Today’s Data

We see that inflation is starting to pick up.

The Consumer Prices Index (CPI) 12-month rate was 0.7% in October 2020, up from 0.5% in September.

Remember that prices are being depressed right now by the VAT cut.

On 8 July 2020, the government announced that it would introduce a temporary 5% reduced rate of VAT for certain supplies of hospitality, hotel and holiday accommodation, and admissions to certain attractions.

I appreciated it last night when I bought a cooked chicken which has become cheaper. In terms of the inflation numbers we do have measures which allow for this. They are at 2.3% ( if you exclude indirect taxes called CPIY) and 2.4% ( if you have constant indirect tax rates or CPI-CT). We do not know exactly how prices would have changed without it but we do know that inflation would be a fair bit higher and would change the metric around Bank of England policy and its 2% inflation target.

The major movers were as follows.

Clothing; food; and furniture, furnishings and carpets made the largest upward contributions (with the contribution from these three groups totalling 0.16 percentage points) to the change in the CPIH 12-month inflation rate between September and October 2020………These were partially offset by downward contributions of 0.06 and 0.04 percentage points, respectively, from the recreation and culture, and transport groups.

You may note they have sneaked CPIH in there as it is the only way they can get it a mention as it is so poor it is widely ignored.

Another point of note is that the inflation measured by CPI is in services at 1.4% whereas good inflation is 0%.

If we look at the RPI we see another reason why it is described as having “shortcomings”. It has produced a higher number as it has risen from 1.1% in September to 1.3% in October.

The trend

In terms of the 2 basic measures we see that opposite influences are at play. The UK Pound £ has been reasonably firm and is just below US $1.33 as I type this so mo currency related inflation is on the way and maybe a little of the reverse. However the price of crude oil has been picking up lately with the January futures contract at US $44.27. Whilst this is around 30% below a year ago the more recent move this month has been for a US $7 rise.

In terms of this morning’s release there was a hint of a change.

The headline rate of output inflation for goods leaving the factory gate was negative 1.4% on the year to October 2020, up from negative growth of 1.7% in September 2020……The price for materials and fuels used in the manufacturing process showed negative growth of 1.3% on the year to October 2020, up from negative growth of 2.2% in September 2020.

So less negative and at this point crude oil was still depressing the prices so we can expect much more of a swing next time around if we stay at present levels.

Petroleum products and crude oil were the largest downward contributors to the annual rate of output inflation and input inflation respectively.

House Prices

I think you can see immediately why they want to keep house prices out of the official inflation measures.

UK average house prices increased by 4.7% over the year to September 2020, up from 3.0% in August 2020, to stand at a record high of £245,000.

They much prefer to put this in.

Private rental prices paid by tenants in the UK rose by 1.4% in the 12 months to October 2020, down from an increase of 1.5% in September 2020.

Just as a reminder home owners do not pay rent so this application of theory over reality conveniently reduces the headline inflation number called CPIH.

As ever there are regional differences in house price growth.

Average house prices increased over the year in England to £262,000 (4.9%), Wales to £171,000 (3.8%), Scotland to £162,000 (4.3%) and Northern Ireland to £143,000 (2.4%)….London’s average house prices hit a record high of £496,000 in September 2020.

Comment

Next week we will get the result of the official attempt to misrepresent inflation in the UK. All inflation measures have strengths and weaknesses but the UK establishment is trying to replace what is a strong measure (RPI) with a poor one ( CPIH). I think it is particularly insidious to keep the name RPI but in reality to make it a CPIH clone. A group that will be heavily affected is first time buyers of property who will be told there is little inflation because of a theoretical manipulation involving imputed rents but face a reality of much higher house prices.

“It takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!” ( Mad Hatter )

If you set out to destroy trust in national statistics then they are on the right road.

A curious treatment of inflation has knocked more than 3% off UK GDP

This morning has brought us up to date on the UK economy in the third quarter of this year. These days we get the numbers with a bit more of a delay than in the past and in this confused pandemic period our official statisticians must be grateful for it. It gives them more time to check matters and collect a fuller set of quarterly data.

Following two consecutive quarters of contraction, UK gross domestic product (GDP) is estimated to have grown by a record 15.5% in Quarter 3 (July to Sept) 2020. This is the largest quarterly expansion in the UK economy since Office for National Statistics (ONS) quarterly records began in 1955.

So we see quite a bounce back, but it is also true that momentum was lost.

The monthly path of GDP in Quarter 3 2020 reveals that there has been a slowdown of growth in August and September as momentum has eased through the quarter. GDP increased by 6.3% in July, driven by accommodation and food services as lockdown restrictions were eased.

That was the peak followed by this.

GDP grew by 2.2% in August, driven by accommodation and food services because of the combined impact of easing lockdown restrictions and the Eat Out to Help Out Scheme, as well as growth in the accommodation industry as international travel restrictions boosted domestic “staycations”.

Of course, there is a different perspective to the Eat Out to Help Out Scheme as we mull how much it contributed to the second wave of the Covid-19 pandemic and thus reduced GDP later on. Fortunately we continued to grow in September as some thought we might not.

In September, GDP further slowed to 1.1% where professional, scientific and technical activities had the largest contribution and legal activities, accounting and advertising saw strong growth after a muted August.

Actually September saw a swing back in something I drew attention to in the second quarter data where the UK statisticians treated education in a really rather odd way. From August 12th.

The implied deflator strengthened in the second quarter, increasing by 6.2%. This primarily reflects movements in the implied price change of government consumption, which increased by 32.7% in Quarter 2 2020.

That as I pointed out at the time was really quite bizarre and led to around 5% being subtracted from UK GDP. This time around they put some of it back as I note this in the September detail.

Education also had a large positive contribution in September as schools made further advances in returning to a level of teaching similar to before the lockdown started on 23 March 2020, primarily through increased attendance.

The state sector in GDP

This has long been a problem in GDP numbers which rely on prices and therefore hit trouble in areas where you do not have them.With much of UK education and health provision being state provided there is not a price mechanism and instead we see all sorts of often dubious assumptions. As a reminder I recall Pete Comley telling me that he had looked into the inflation measure for this sector ( called a deflator), when I provided some technical advice for his book on inflation  and felt they simply made the numbers up. Well in that vein remember the deflator which surged by 32.7%, well in Question of Sport style what happened next? We get a hint from the nominal data.

Nominal GDP increased by 12.6% in Quarter 3 2020, its largest quarterly expansion on record

So a 2.9% gap between it and the real GDP number with this causing it.

The implied deflator fell by 2.5% in the third quarter, the first quarterly decline since Quarter 4 (Oct to Dec) 2015. This primarily reflects movements in the implied price change of government consumption, which fell by 7.0% in Quarter 3 2020.

So we got a bit under a quarter of it back. The explanation would have been described by the Alan Parsons Project as Psychobabble.

This decrease occurred because the volume of government activity in the third quarter increased at a much greater rate than nominal government expenditure. This is partly because of the unwinding in some of the movements that occurred in the second quarter, which saw a fall in the volume of government activity at the same time as an increase in government expenditure in nominal terms.

This really is a bit of a dog’s dinner.

 In education, the large fall in the volume of education activity in the second quarter followed by the large increase in the third quarter help explain the most recent quarterly movement in the implied deflator.

The same happened to health.

In the third quarter, nominal spending on health was largely unchanged, while volumes increased, which has impacted upon the growth rate of the implied deflator in the third quarter.

Applying normal metrics to abnormal times has them singing along with Kylie Minogue.

I’m spinning around, move out of my way
I know you’re feeling me ’cause you like it like this
I’m breaking it down, I’m not the same
I know you’re feeling me ’cause you like it like this.

We can compare this with others to see the scale of what has happened here. We do not have numbers for the full Euro area but Germany for example saw its deflator rise by 0.5% in the second quarter and then returned to a slightly lower level in the third quarter. So very different. France saw more of a move with its deflator rising by 2.4% but has now reduced it to below the previous level. Spain saw barely any change at all

A Trade Surplus

The UK finds itself maybe not quite in unknown territory but along the way.

In the 12 months to September 2020, the total trade balance, excluding non-monetary gold and other precious metals, increased by £35.9 billion to a surplus of £5.2 billion.

Yes you did see the word surplus which is a rare beast for annual data for the UK and we can continue the theme.

The UK total trade surplus, excluding non-monetary gold and other precious metals, decreased £3.4 billion to £4.2 billion in Quarter 3 (July to Sept) 2020, as imports grew by £17.3 billion and exports grew by a lesser £13.8 billion.

However the theme does hit rougher water with the latest monthly data.

The total trade balance for September 2020, excluding non-monetary gold and other precious metals, decreased by £3.6 billion to a deficit of £0.6 billion; imports increased by £3.6 billion while exports remained flat.

Comment

The pandemic has created all sorts of issues but in terms of economics we find ourselves here, or rather this is where we were at the end of the third quarter.

the level of GDP in the UK is still 9.7% below where it was at the end of 2019. Compared with the same quarter a year ago, the UK economy fell by 9.6%.

In spite of the media obsession with recessions this is a depression and we should call it such. Looking ahead we know that things will be depressed by the four week lockdown we are presently in meaning the economy looks set to shrink again in this quarter. There are some newer official surveys for October which suggest we had lost more growth momentum as restrictions began again.

BICs for 5-18 October 2020, found that of businesses currently trading, 45% reported their turnover had decreased below what is normally expected for October, compared to 48% reporting decreases in September……While it is not clear exactly how strong a relationship there is between GDP and BICs, the business survey data suggests the outlook has improved only modestly, if at all, as we moved into October. ( @jathers_ONS )

However if we return to the overall pattern for 2020 we see that a decision by the Office for National Statistics has depressed the way it records UK GDP and that it is ongoing with less than a quarter being reversed. This makes international comparisons very difficult especially for those unaware of the situation. We need I think to add at least 3% to the UK number when we try to compare internationally.

On a statistical level I regularly find the ONS justifying things on the basis of “international standards” so it needs in my opinion to explain why it has taken such a different path this time.

 

 

 

 

 

UK hours worked have fallen 12% since the Covid-19 pandemic began

This morning has brought the focus back on the UK and the labour market release has brought some better news. Sadly the unemployment numbers are meaningless right now so we need to switch to the hours worked data for any realistic view.

Between April to June 2020 and July to September 2020, total actual weekly hours worked in the UK saw a record increase of 83.1 million, or 9.9%, to 925.0 million hours.

Average actual weekly hours worked saw a record increase of 2.7 hours on the quarter to 28.5 hours.

This is our first real look at a fullish set of data for the third quarter as we do not get the Gross Domestic Product or GDP numbers until Thursday. Will they also show a bounce of around 10%? Our official statisticians seem to have lost a bit of faith in their own figures as they quote the Markit PMI as back up.

The IHS Markit states that the recovery in business activity, which continued across the manufacturing and service sectors in September 2020, reflects the record increase in total hours worked on the quarter to September.

Perhaps they are unaware of the reduction in credibility for that series. However we can sweep this section up by noting that whilst we have much better news we are in a situation described by Foreigner.

But I’m a long, long way from home

That is because the numbers are still 12% below the pre pandemic peak of 1,052.2 million hours.

Redundancies

We had feared a rise in these, and sadly they have been coming.

Redundancies increased in July to September 2020 by 195,000 on the year, and a record 181,000 on the quarter, to a record high of 314,000 (Figure 3). The annual increase was the largest since February to April 2009.

In terms of what they tell us? We have an issue because we were seeing rises ahead of the further wind down and then end of the Furlough scheme which then saw a U-Turn extension to March. So much for another form of Forward Guidance. So the real message here is somewhat confused.

Using the tax system

This is a new innovation designed to give more timely data and to that extent it helps as we get a signal for October.

Early estimates for October 2020 indicate that the number of payrolled employees fell by 2.6% compared with October 2019, which is a fall of 763,000 employees……..In October 2020, 33,000 fewer people were in payrolled employment when compared with September 2020 and 782,000 fewer people were in payrolled employment when compared with March 2020.

These numbers have proved useful for a direction of travel but again due to the furlough scheme are much too low in scale. Also the wages numbers are best filed in the recycling bin.

Early estimates for October 2020 indicate that median monthly pay increased by 4.6%, compared with the same period of the previous year.

What they are most likely telling us in that job losses have been concentrated in the lower paid which has skewed the series.

Unemployment

Sadly the BBC seems not to be aware that these numbers are way of the mark and so are actively misleading.

The UK’s unemployment rate rose to 4.8% in the three months to September, up from 4.5%, as coronavirus continued to hit the jobs market.

The reason for that is the furlough scheme.

Experimental estimates based on returns for individual weeks show that the number of people temporarily away from work rose to around 7.9 million people in April 2020 but has fallen to around 3.9 million people in September 2020. There were also around 210,000 people away from work because of the pandemic and receiving no pay in September 2020; this has fallen from around 658,000 in April 2020.

Following international guidelines has led us up the garden path.

Under this definition, employment includes both those who are in work during the reference period and those who are temporarily away from a job.

Wages

We can now switch to the price of labour where according to out official statisticians there has also been some better news.

Annual growth in employee pay continued to strengthen as more employees returned to work from furlough, but pay growth was still subdued as some workers remained furloughed and employers were paying less in bonuses…..Growth in average total pay (including bonuses) among employees for the three months July to September 2020 increased to 1.3%, and growth in regular pay (excluding bonuses) increased to 1.9%.

As you can see below there were hard times still for some sectors.

During the early summer months, the industry sectors accommodation and food services and construction had seen the largest falls in pay, down more than 10% in April to June; in July to September, both recovered some loss although their average total pay growth remained down, at negative 1.8% and negative 3.9% respectively.

Actually the construction numbers seem curious as in my part of London it all seems to have got going again, but as ever London may not be a good guide.

We can see who is doing relatively well by switching to the most recent single month numbers which are for September. Here we see public-sector total pay was up 4.4% on a year ago. Also that the services sector has risen to 3,5%. Switching to manufacturing we see that annual growth has finally become positive but is at a mere 0.6%.

The improvement has followed through into the real wages data at least according to the Office for National Statistics.

In real terms, total pay in July to September grew at a faster rate than inflation, at positive 0.5%, and regular pay growth in real terms was also positive, at 1.2%.

In terms of actual pay those numbers mean this.

For September 2020, average total pay, before tax and other deductions, for employees in Great Britain was estimated at £553 per week in nominal terms. When expressed in real terms (constant 2015 prices), the figure in September 2020 was £509 per week, notably higher than the £488 per week estimated in June 2020.

It may be notably higher than June but is still below the pre credit crunch peak of £522 for the constant price series from February 2008. Actually that number looks a bit of a freak or more formally an outlier but even if we discount it we are still below some of the others from around then.

Comment

We find ourselves again mulling the way that conventional economic metrics have failed us. To be specific we see that underemployment measures are much more useful that unemployment ones as a 12% fall in hours worked gives a much more realistic picture than a 4.8% unemployment rate. In the short-term the improvement in the situation will clash with the November lock down and thus get worse. Although with the Hopium provided by the positive vaccine news from Pfizer there are now more realistic hopes for a better 2021.

Switching to the wages numbers I think there is a compositional effect making them also unreliable or rather more unreliable than usual. We even have an official denial to confirm this.

 that is, if the profile (percentage within each industry) of employee jobs had not changed between July to September 2019 and July to September 2020, the estimates of growth in total pay and regular pay would have been 0.1% lower than reported in this bulletin.

In my opinion the numbers are not accurate enough to claim that. So we know more but much less than some try to claim.

By the way those pushing the 4.8%  unemployment rate ( and thereby believing it) surely they should be pushing for the Bank of England to raise interest-rates as it is well below the levels it was supposed to?

 

The UK house price boom is facing higher mortgage rates

This morning will have brought sounds of high excitement and smiles to the Bank of England. It would have been too early to raid its excellent wine cellar but a liveried flunkey will have brought its best coffee to Governor Andrew Bailey as he peruses the latest news from the Halifax on UK house prices.

The average UK house price now tops a quarter of a million pounds (£250,547) for the first time in history, as annual
house price inflation rose to 7.5% in October, its highest rate since mid-2016. Underlying the pace of recent price
growth in the market is the 5.3% gain over the past four months, the strongest since 2006.

Governor Bailey will no doubt issue a satisfied smile and may mimic the end of the television series Frasier which had an “I did that” at the end. He may even be pleased that he has helped to do this without getting a mention from the Halifax.

This level of price inflation is underpinned by unusually high levels of demand, with latest industry figures showing
home-buyer mortgage approvals at their highest level since 2007, as transaction levels continue to be supercharged
by pent-up demand as a result of the spring/summer lockdown, as well as the Chancellor’s waiver on stamp duty for properties up to £500,000.

I find the “pent-up demand” bit curious as surely there will also have been pent-up supply? Bur we do see signs of a an active market.

HMRC Monthly property transactions data shows a fifth consecutive monthly rise in UK home sales
in September. UK seasonally adjusted residential transactions in September 2020 were 98,010 – up by
21.3% from August. The latest quarterly transactions (July-September 2020) were approximately 63.6%
higher than the preceding three months (April-June 2020). Year on year, transactions were 0.7% lower than
September 2019 (2.4% higher on a non seasonally adjusted basis). (Source: HMRC, seasonally-adjusted
figures)

Although I do note that whilst we have seen high rates of monthly growth it only brings us back to around what were last years levels. The picture on mortgage approvals is more clear-cut.

Mortgage approvals rose in September to the highest level seen in 13 years. The latest Bank of England figures show the number of mortgages approved to finance house purchases, rose by 7% from August to 91,454, down from a rise of 27% reported in August. Year-on-year, the September figure was 39% above September 2019.

Monetary Policy

We can now switch to what I call the Talking Heads question. From Once In A Lifetime.

And you may find yourself living in a shotgun shack
And you may find yourself in another part of the world
And you may find yourself behind the wheel of a large automobile
And you may find yourself in a beautiful house, with a beautiful wife
And you may ask yourself, “Well… how did I get here?”

The Bank of England’s role in us getting here started with the interest-rate cuts in response to the credit crunch. Then as they realised how interest-rates actually worked they added on bond buying in the form of what is called QE to reduce longer-term interest-rates too. It is easy to forget now but this did not do the trick for house prices so in the summer of 2012 we got what the then Chancellor George Osborne called credit easing. This was the Funding for Lending Scheme where the Bank of England channeled cheap cash ( Bank Rate was 0.5%) to the banks so that they did not have to indulge in the no doubt tiresome business of competing for depositors.

This was a crucial change in 2 respects. The first is access to funds at Bank Rate but in many ways more crucial is the access to large amounts of funds. So a quantity issue. This allowed banks to reduce mortgage-rates and I recall pointing out that mortgage-rates fell by 0.9% quite quickly and the Bank of England later claimed they fell by up to 2%.

Bringing this up to now we have the Term Funding Scheme operating that role and in its original form it has supplied £70.6 billion and the new pandemic era version has supplied some £49.6 billion. So as you can see the Bank of England keeps the banks supplied with cash and these days it can get it as cheap as the present Bank Rate of 0.1%. On this road we see that the cut in Bank Rate is not especially significant in itself these days but comes more into play via the Term Funding Scheme.

Next as more people moved to mortgages with fixed interest-rates ( around 92% of new mortgages last time I checked) QE also came back into play as an influence on mortgage rates via its impact on UK bond or Gilt yields. So this part of yesterday’s announcement matters.

The Committee voted unanimously for the Bank of England to continue with the existing programme of £100 billion of UK government bond purchases, financed by the issuance of central bank reserves, and also for the Bank of England to increase the target stock of purchased UK government bonds by an additional £150 billion, financed by the issuance of central bank reserves, to take the total stock of government bond purchases to £875 billion.

There are issues with the stock but for our purposes today in looking at the mortgage market it is the flow ( presently £4.4 billion a week) that matters. It has helped keep my proxy for fixed-rates, which is the five-year bond yield negative since mid June now apart from one brief flicker. As I type this it is -0.06%.

Comment

So the theme starts singing along with Steve Winwood for house prices.

I’ll be back in the high life again
All the doors I closed one time will open up again

However all the government and Bank of England pumping has the problem that it means that they are ever more socially distanced from wages and earnings. So many are on 80% wages from the furlough scheme and real wages have been falling. There has to be some sort of reckoning here in the end. As well there are signs that the pumping system is creaking.

As you can see mortgage rates for those with lower amounts of equity or if you prefer high loan to value numbers have risen quite sharply. So the heat is on especially for those with only 5% equity where they have gone above 4% which really rather contradicts all the official rhetoric of low interest-rates.  So I see trouble ahead which to be frank I welcome. I do not wish anyone ill in financial terms but we do need lower house prices to help first-time buyers.

Meanwhile something I have long warned about looks to have come true this week.

The Bank of England is investigating a potential leak of Thursday’s QE announcement ( @fergalob)

I do like the description of it being in The Sun as a “potential leak”……

Will the Bank of England give us negative interest-rates?

Later today the members of the Monetary Policy Committee ( MPC) of the Bank of England will cast their votes as to what they think monetary policy will be and as I shall explain this is a live meeting. As in I expect changes today. Unfortunately due to a change made by the previous Governor Mark Carney we will not know the result until tomorrow at midday. Remember when all of this began to be called Super Thursday and then invariably turned out to be anything but?! Tomorrow will be one as we also get the Inflation Report to update us on what is expected for the economy. But the crucial point here is that the preference for bureaucratic convenience means that we are at risk of “some animals being more equal than others” as George Orwell put it so aptly. That risk is added to by the way the ship of state is such a leaky vessel these days.

The economy

The Minutes from the September meeting suggested things were better than expected.

UK GDP in July was around 18½% above its trough in April and around 11½% below its 2019 Q4 level. High-frequency payments data suggest that consumption has continued to recover during the summer and is now at around its start-of-year level in aggregate, stronger than expected in the August Report. Investment intentions have remained very weak and uncertainties among businesses are elevated. For 2020 Q3 as a whole, Bank staff expect GDP to be around 7% below its 2019 Q4 level, less weak than had been expected in the August Report.

Since then some of that has remained true as for example UK Retail Sales have continued to be strong. But as time passed we began to see more and more Covid-19 restrictions applied, first regionally and now including as of midnight all of England.

This morning’s Markit PMI business survey tells us this.

October data indicates that the UK service sector was close
to stalling even before the announcement of lockdown 2
in England, with tighter restrictions on hospitality, travel
and leisure leading to a slump in demand for consumer facing businesses. This was only partly offset by sustained expansion in areas related to digital services, business-to business sales and housing market transactions.

So the existing restrictions had clipped the tails of the service sector. So we are left with a pattern of a manufacturing recovery and very slow services growth followed by an expectation of this.

November’s lockdown in England and a worsening
COVID-19 situation across the rest of Europe means that the UK economy seems on course for a double-dip recession this winter and a far more challenging path to recovery in 2021.

There are issues with the credibility of the PMIs after some misfires but they are relevant because the Bank of England follows them. Some of you may recall Deputy Governor Ben Broadbent guiding us towards sentiment indices like them in the autumn of 2016. The absent-minded professor seems untroubled by the fact that led him up the garden path. Also I am intrigued by them discussing the risk of a double-dip recession when this is in fact a depression with the only issue being how long it will last?

Impact of Lockdown 2

The National Institute for Economic and Social Research or NIESR thinks this.

The second wave of the virus, and newly announced November lockdown, are likely to further increase the fall in 2020 GDP to around 11-12 per cent. This includes a fall of
around 3 per cent in the fourth quarter of 2020, with additional public borrowing but a slower rise in unemployment due to the extension of the furlough scheme.

Later they refine some of this although we are in the territory of spurious accuracy.

Saturday’s announcement of a further he November lockdown in response to resurgent Covid-19 will push
growth in the fourth quarter negative, to an estimated -3.3 per cent.

So we have a change to what we were expecting because we had our concerns about the end of the furlough scheme and its impact on employment and wages which would have knock-on effects elsewhere in the economy. That now will come in early December (probably as we are not sure when the lockdown will end) but in the meantime the lockdown will push economic output around 3% lower.

Another consideration for the Bank of England will be the labour market explicitly.

Our main case scenario was for unemployment to rise to above 7 per cent in the final quarter of 2020 and 8 per cent in the first half of 2021 as the Coronavirus Job Retention Scheme (CJRS) ends: the extension in November will have reduced this at the end of 2020 but may just have
postponed it. Unemployment is expected to rise above 5 per cent until 2024, with long-term persistent unemployment exacerbated by the prospect of a long and uncertain recovery.

Of course it has been a troubled area for them as back in the early days of Forward Guidance they established an unemployment rate of 6.5% as being significant for interest-rate rises and then ignored it.

Looking ahead which is what the Bank of England should be doing today, this looks rather tenuous on the vaccine front. We do not know when or indeed if one will be ready? Also individuals may be less than keen on being injected with something about which the long-term implications cannot be known.

Comment

The analysis suggests more easing is on its way and the first part is easy. These days the role of monetary policy is primarily to encourage fiscal policy by making it as cheap as possible. Today will see another £1.473 billion spent by the Bank of England buying UK government bonds aiming at that objective. But it is running out of road on its present plan because as of the end of today it will have spent some £697 billion out of the £725 billion it has authourised. That is only about another 6 weeks worth at the current rate. Just for the avoidance of doubt the £745 billion figure often quoted includes  £20 billion of corporate bonds which is now all over bar the shouting.

So the easy bit is a vote in favour of another £100 billion of QE which kicks the can comfortably into 2021. They could do more but that takes away some of the opportunity to act or rather looking like they are acting in the future. Regular readers will know I have been expecting an extra £100 billion for a while now as this is simply implicit funding of the government.

The path for Bank Rate is more complex. I still think a move is unlikely but cannot rule out they might be silly enough to cut Bank Rate to 0%. After all with all the rate cuts we have seen another 0.1% would be pretty much laughable. As to a cut into negative interest-rates that would look rather silly when their enquiry into them is not yet complete. However some of the MPC would vote for them and the way things are looking they could easily panic and give us a negative Bank Rate in 2021. Just as a reminder we already have negative bond yields in the UK out to the 6 year maturity. Due to the way that fixed-rate mortgages have become much more popular they are as significant as Bank Rate these days.

 

 

 

Central bank Digital Coins are to enforce negative interest-rates

The weekend just gone produced quite a lot of news. Another lockdown in the UK is in the offing and there is of course the not so small matter of tomorrow’s US election. But something that does not make such headlines was also very significant and it came from ECB President Christine Lagarde.

We’ve started exploring the possibility of launching a digital euro. As Europeans are increasingly turning to digital in the ways they spend, save and invest, we should be prepared to issue a digital euro, if needed. I’m also keen to hear your views on it.

Actually it looks as though they have already decided and are launching a public consultation as cover for the exercise. After all most will not understand what are the real consequences of this especially as it will be presented as being modern and something which is happening anyway. The Covid-19 pandemic has provided a push for electronic forms of payment which is really rather convenient for this purpose. So they have a good chance of getting support and if they do not well they will simply ignore it. I must say it is hard not to laugh at the “if needed” because it is the central bankers as I shall explain who need it and not the Euro areas consumers and savers.

The real problem is highlighted here.

The outbreak of the coronavirus pandemic came as a deep shock to all of us and warranted fast policy responses. I’m proud to say that we’ve delivered: our measures have been providing crucial support to the eurozone economy and to European citizens.

It is the first sentence which applies here although I have to say the tone deaf nature of “we’ve delivered” in the second is pretty shocking. The ECB already had problems with the Euro area economy as the “Euroboom” faded and growth was not only poor but the largest economy and indeed bell weather Germany was struggling. Then the pandemic hit and made everything worse.

The ECB’s Problem

This arises from the fact that in response to the issues above it has used so many monetary policy options. It was as long ago as June 2014 that it introduced negative interest-rates and there have been further reductions since. Its Deposit Rate is now -0.5% and via the TLTROs it has reduced its interest-rates for the banks to -1%. This is a crucial point in today’s narrative because they feel they cannot keep interest-rates at these negative levels without throwing some free fish to the banks. There is a lot of irony here because interest-rates were cut to help the banks but the supposed cure has turned out to be poison at the dosages required. You do not need to take my word for it just tale a look at bank’s share prices. For example my old employer Deutsche Bank has a share price which has nudged over 8 Euros this morning which is around half of what it was in early 2017 and well you do the maths in the fall from this.

The all-time high Deutsche Bank Aktiengesellschaft stock closing price was 159.59 on May 11, 2007. ( macrotrends.net )

So the banks are struggling with negative interest-rates as they are which poses a problem for a central bank wanted to go lower or in the new buzzword be “recalibrated”.

The Plan

Actually the ECB was part of a group of central banks which asked the Bank for International Settlements to look into this issue in January.

In jurisdictions where cash use is declining and digitalisation is increasing, CBDC could also play an important role in maintaining access to, and expanding the utility of, central bank money. ( CBDC = Central Bank Digital Coin)

As that is not a problem they are up to something else here. Also they are worried that it might make the problem they are supposed to stop worse.

There are two main concerns: first that, in times of financial crisis, the existence of a CBDC could enable larger
and faster bank runs; and second, and more generally, that a shift from retail deposits into CBDC
(“disintermediation”) could lead banks to rely on more expensive and less stable sources of funding.

In the end it is always about the banks in their role as The Precious. I think we get more of the truth here.

CBDC may offer opportunities that are not possible with cash. A convenient and accessible
CBDC could serve as an alternative to potentially unsafe forms of private money, offer users privacy, reduce
illegal activity, facilitate fiscal transfers and/or enable “programmable money”. Yet these opportunities may
involve trade-offs and unless these have a bearing on a central bank’s mandate (eg through threatening
confidence in the currency), they will be secondary motivations for central banks.

To my mind the opportunities are for central bankers and not for us.

The IMF lets the cat out of the bag

Back in February 2019 it told us this.

In a cashless world, there would be no lower bound on interest rates. A central bank could reduce the policy rate from, say, 2 percent to minus 4 percent to counter a severe recession.

I am sure you have already spotted why the ECB is now on the case. As to cash it turns out it has a feature which makes central bankers hate it. This is simply that it offers 0% which as the IMF explains below is a barrier to central bank “innovation”,

When cash is available, however, cutting rates significantly into negative territory becomes impossible. Cash has the same purchasing power as bank deposits, but at zero nominal interest. Moreover, it can be obtained in unlimited quantities in exchange for bank money. Therefore, instead of paying negative interest, one can simply hold cash at zero interest. Cash is a free option on zero interest, and acts as an interest rate floor.

There is an irony in this as by doing nothing it has turned out to be a powerful tool. The central bankers will be furious at the advice given by the rather prescient Steve Miller Band.

Hoo-hoo-hoo, go on, take the money and run
Go on, take the money and run
Hoo-hoo-hoo, go on, take the money and run
Go on, take the money and run.

Banning a song usually only makes it more popular. That would also be true of cash I suspect.

Comment

As so often what we are told is very different to what is the plan. A central bank digital coin is a way of imposing even deeper negative interest-rates. The IMF gave a template for this below.

To illustrate, suppose your bank announced a negative 3 percent interest rate on your bank deposit of 100 dollars today. Suppose also that the central bank announced that cash-dollars would now become a separate currency that would depreciate against e-dollars by 3 percent per year. The conversion rate of cash-dollars into e-dollars would hence change from 1 to 0.97 over the year. After a year, there would be 97 e-dollars left in your bank account. If you instead took out 100 cash-dollars today and kept it safe at home for a year, exchanging it into e-money after that year would also yield 97 e-dollars.

This brings us back to the ECB which last week told us this.

this recalibration exercise will touch on all our instruments. It is not going to be one or the other. It is not going to be looking at one single instrument. It will be looking at all our instruments, how they interact together, what will be the optimal outcome, and what will be the mix that will best address the situation.

It fears that further interest-rate cuts could cause a bank run. I agree with that and have written before that somewhere around -1.5% to -2% seems likely to be the threshold. Thus any more cuts will bring them near that especially as the LTRO rate is already -1%. So in their view a new plan is required and some of you may already be mulling their existing plan to phase out the 500 Euro note which is their highest denomination.

Putting this another way they are worried by two developments. One is Bitcoin which potentially challenges the monopoly power of central banks and also the demand for cash is rising not falling. In the Euro area it was 1.33 trillion Euros in September as opposed to 1.2 trillion a year before.

Podcast