How official inflation measures are designed to mislead you

Over the past year or two even the mainstream media seems to have had flickers of realisation about the problems with official inflation measures. Perhaps their journalists wondered how things could be so expensive with recorded inflation so low? I recall even Bloomberg publishing pieces on exactly that looking at problems in the housing situation in Germany which expressed exactly that with those experiencing reality questioning the official numbers and in more than a few cases suggesting they came from a place far,far away.

Yesterday a member of the Executive Board of the ECB expressed his worries about this area, So let us look at what Yves Mersch had to say.

A prolonged loss of trust in the ECB risks undermining the broad public support that is necessary for central bank independence.

I think he is going a bit far with “broad public support” as most people will only have a vague idea about what the ECB does but let us indulge Yves for now. He goes onto ground which is about as near as central bankers get to admitting the amount of mission-creep that has gone on.

This is of particular concern when the range of non-conventional measures brings monetary policy closer to the realm of fiscal policy and the institutional effects of these policies are becoming more pronounced.

House Prices

This follows a section where he points out this.

The risks arising from strong housing price inflation extend beyond financial stability.

Indeed although the Euro area had lots of problems for financial stability as pre credit crunch house prices in Ireland, Spain and the Baltic States boomed and later bust, which also undermined many banks. However in spite of this he confesses that one way of guarding against this happening again has been ignored.

At present, owner-occupied housing costs are not included in the Harmonised Index of Consumer Prices (HICP) that is used to formulate our inflation aim of below, but close to, 2% over the medium term.

I mean why would you put in something which for many is their largest monthly expenditure? The next sentence covers a lot of ground but the latter part is very revealing.

There are a number of technical explanations for this exclusion, but it is clear that households view the cost of housing as an important part of their lifetime expenditure.

“View”?! The truth is that if we switch to describing it as shelter it is a basic human need. Of course central bankers have a track record in downplaying basic human needs in the way that food and energy are left out of so-called core inflation measures, but this takes things a step further as many of the costs of shelter are completely ignored rather than downplayed. As to the “technical explanations” let us just mark them for now as I will cover them later.

Next we get another example of the central banking obsession with rents.

 Rents represent around 6.5% of the basket used for measuring inflation.

Let me explain why. This is because in their Ivory Tower world people consume housing services whatever they do. This works for those who do rent as their (usually) monthly payment fits with that theory. Actually in practice there are more than a few problems with measuring this accurately as I noted earlier in the reference to Bloomberg Germany in particular. Also there are a lot of complaints concerning Ireland too. So even where it should work there are troubles,

But when you apply consumption of housing services to people who buy their own home be it outright or via a mortgage there is trouble. If someone is fortunate enough to buy outright then you have one large payment rather than a stream of services. Even the highest Ivory Tower should be able to spot that this simply does not work. You might think that using mortgages would work much more neatly after all a monthly payment does have some sort of fit with consuming housing services. But for a central bank there is a problem as it is the main player in what the monthly mortgage costs is these days. In the case of the ECB its negative deposit rate of -0.5% and its QE bond buying operations ( currently 20 billion Euros per month) have reduced mortgage rates substantially.

So there is the “rub”. Not only are they reducing the recorded level of inflation with their own policy which is of course trying to raise inflation! But even worse they are raising house prices to do so and thus inflation is in fact higher. It is not the misrepresentation or if you prefer lying that bother them as after all they are practised at that but even they think they may struggle to get away with it. In a way the speech from Yves reflects this because the background to all this is below.

House prices rose by 4.1 % in both the euro area and the EU in the third quarter of 2019 compared with the same quarter of the previous year.

You see why they might want to keep house prices out of the inflation index when we note that the official HICP measure recorded 1% (twice) and 0.8% in that same quarter.

Yves continues the official swerve with this.

Indeed, the United States, Japan, Sweden and Norway already integrate owner-occupied housing into their reference inflation indices.

You see both Japan and the United States use rents as a proxy for owner-occupied housing costs in spite of the fact that no rents are paid. You might think when Yves has noted the influence of house prices he would point that out. After all using fantasy rents to measure actual rises in house prices will only make this worse.

The gap between perceptions and official measures of inflation can complicate the communication of policy decisions. If households believe that inflation is rampant then they will see little justification for unconventional measures, in particular negative interest rates.

There is no little arrogance here in “believe that inflation is rampant” to describe people who have real world experience of higher prices and hence inflation as opposed to sticking your head in the sand for two decades about an important area.

Comment

Even Yves is forced to admit that the omission of owner-occupied housing costs has made a material difference to recorded inflation.

If it were to be included in the HICP, it could raise measured inflation rates in the euro area by around 0.2 to 0.5 percentage points in some periods. Taking that into consideration, core inflation would lift from its current 1.3% to its long-run trend, or even higher, thereby having a bearing on the monetary policy stance.

You can bet that the numbers have been absolutely tortured to keep the estimate that low. But this also hides other issues of which Eurostat provides a clear example below.

 the annual growth rate of the EU HPI reached a maximum of 9.8 % in the first quarter of 2007

Pre credit crunch Euro area house prices did post a warning signal but were ignored. After all what could go wrong? But more recently let me remind you that the ECB put the hammer down on monetary policy in 2015.

Then there was a rapid rise in early 2015, since when house prices have increased at a much faster pace than rents.

Or to put it another way the Euro area HICP is full of imagination.

Could it be that it’s just an illusion?
Putting me back in all this confusion?
Could it be that it’s just an illusion now?
Could it be that it’s just an illusion?
Putting me back in all this confusion?
Could it be that it’s just an illusion now?

I promised earlier to deal with the technical issues and could write pages and pages of excuses, but instead let me keep it simple. The consumer in general spends a lot on housing so they switch to consumption where purchase of assets is not included and like a magic trick it disappears. Hey Presto! Meanwhile back in the real world ordinary people have to pay it.

Both China and the world economy are being impacted by the Corona Virus

The weekend just gone was one where an epidemic began to have more economic consequences. In a world where there appears to be a Trump Tweet for pretty much everything this one from Friday is not going so well.

China has been working very hard to contain the Coronavirus. The United States greatly appreciates their efforts and transparency. It will all work out well. In particular, on behalf of the American People, I want to thank President Xi!

The media has revved itself up about the Corona virus and is in some cases treating it like a television series I remember from my childhood called Survivors.

 It concerns the plight of a group of people who have survived an apocalyptic plague pandemic, which was accidentally released by a Chinese scientist and quickly spread across the world via air travel. Referred to as “The Death”, the plague kills approximately 4,999 out of every 5,000 human beings on the planet within a matter of weeks of being released. ( Wiki)

Fortunately we are a long way away from that situation although it must be awful for those affected. Let us switch our emphasis to the economic affects as we live up to the description of economics as the dismal science.

China

More and more cities are in lock down and this morning there has been this announcement.

SHANGHAI (Reuters) – The Shanghai government has said companies in the city are not allowed to resume operations before Feb. 9, an official at the municipality announced at a press conference on Monday.

The measure is applicable to government and private companies but is not applicable to utilities and some other firms such as medical equipment companies and pharmaceutical companies, the official said.

China’s cabinet has announced it will extend the Lunar New Year holidays to Feb. 2, to strengthen the prevention and control of the new coronavirus, state broadcaster CCTV reported early on Monday.

This will mean a lot of economic disruption as highlighted here by the Financial Times.

the manufacturing hub of Suzhou has postponed the return to work of millions of migrant labourers for up to a week. Suzhou is one of the world’s largest manufacturing hubs where companies such as iPhone contractor Foxconn, Johnson & Johnson and Samsung Electronics have factories.

One can see a situation where supply chains will be interrupted and presumably inventories will rise until there is not more room to store them. This may add to what has been something of a Perfect Storm for manufacturing over the past year or so.

According to the FT there is another area which has been hit hard.

Railway transport on Saturday, the first day of the lunar new year, fell about 42 per cent compared with the same day last year, according to the transportation ministry. Passenger flights were down by roughly 42 per cent and overall transportation across the country declined about 29 per cent.

If Chinese travel forms are anything like those of the western capitalist imperialists with their rather thin margins it may not be long before some are in trouble which may be why we have seen this being announced.

Companies would receive support “through measures such as encouraging appropriate lowering of loan interest rates, improving arrangements for loan renewal policies and increasing medium-term and credit loans”, the China Banking Regulatory Commission said.

We get an idea of the feared impact on the travel industry worldwide via the @RANSquawk update on share price moves today.

Air France (AF FP) -4.6%

Kering (KER FP) -4.6%

easyJet (EZJ LN) -4.0%

LVMH (MC FP) -3.5%

Ryanair (RYA LN) -3.0%

Airbus (AIR FP) -2.5%

So the initial impact is on manufacturing and consumption especially travel. That will be hitting a Chinese economy that was already slowing with reported economic growth falling to 6.1% at the end of last year.

The World

It may not be the best time for the FT to run with this.

Signs of a global recovery in manufacturing are starting to show

For example should the announcement below come to pass you would think it would have to affect trade between Germany and China.

GERMAN FOREIGN MINISTER MAAS SAYS WE ARE CONSIDERING EVACUATING GERMAN CITIZENS FROM CHINESE REGION AFFECTED BY CORONAVIRUS  ( @DeltaOne )

That is certainly the picture being picked up by the price of crude oil which has been falling the past few days.

The coronavirus could cut into demand by around 260,000 bpd and reduce oil prices by about $3 per barrel, according to a report from Goldman Sachs. However, in the days following the publication of that estimate, oil prices fell by even more than $3. ( OilPrice.com ).

In fact the price of a barrel of Brent Crude Oil has fallen to US $58 as I type this as it tries to factor in lower travel demand and manufacturing. It would be even lower if the disastrous intervention by the West in Libya had not meant its output was so unreliable. Also the medical diagnosis of Dr. Copper is clear as we see it at US $2.63 this morning as opposed to the US $2.87 of as recently as the 16th of this month.

Bond Markets

These have been given yet another leg up as lower growth prospects mean they are more attractive. Although of course that theme is troubled these days as for example in Germany you do not get any yield and instead have to pay! As its bond market rallies we see that its benchmark ten-year yield has fallen to -0.37%. In my home country the UK the situation is also complex as it looks as though we are setting for a Bank of England interest-rate cut later this week as the Gilt market rallies and the ten-year yield falls to 0.53%. But I think it is really following other markets and perhaps trying to price the prospect of lower inflation as oil and commodity prices fall.

Stock Markets

These attract media attention much more.

FTSE 100 ‘in panic mode’ as coronavirus fears push it into red ( City-AM )

Actually it is down a bit over 2% and for context is above 7400 as I type this. so it is an odd type of panic that leaves it not far from the highs. Of course, equity market falls are persona non grata in the era of QE so let us remind ourselves that with the Nikkei 225 index falling 2% in Japan the Tokyo Whale will have had its buying boots on. Thus the Bank of Japan will have edged ever nearer to owning 100% of the exchange traded fund indices it buys.

Comment

We see a form of domino theory here.There are clear impacts on the travel and manufacturing sectors of China in particular. This will reduce economic growth although there will be an offset from the medical sector which will be at a maximum. Those who rely on Chinese economic output will be the first affected and once we move beyond airlines it is hard not to think of the South China Territory otherwise known as Australia. Lower iron ore demand for instance.

World manufacturing supply chains will be affected and as we have already noted this is another problem for that sector. If we look at a specific example all sorts of things may or may not happen to the planned Tesla gigafactory in Shanghai. Meanwhile central banking Ivory Towers are being instructed to research whether QE and lower interest-rates can battle the Corona virus.

Podcast

The Bank of England has got itself in a pickle

Today is a Bank of England day of a different sort and it comes from this spoken by ones of its policymakers Gertjan Vlieghe on the 13th of this month.

Gertjan Vlieghe, an external MPC member, said his view on whether to keep waiting for an economic revival or vote to lower rates from 0.75 per cent to 0.5 per cent would depend on survey data released towards the end of January.

At this time this combined with a speech a day before by Bank of England Governor Mark Carney revved up expectations of a Bank Rate cut next week. What Gertjan was doing was reflecting something of a shift in the reaction function of the Bank of England for which we can look at a speech given by the absent-minded professor Ben Broadbent back in early October 2016.

But human instinct in this area isn’t always so rational. We’re prone to over-interpret noisy events, seeing
structure and determination when, very often, there isn’t any

Indeed as he tries to make the policy error he had just made look reasonable. The link is that the Bank of England panicked in response to the Markit PMIs back then. Not only did it cut it’s official interest-rate to 0.25% and add an extra £60 billion of QE it gave Forward Guidance of a further interest-rate cut to 0.1%. In case you are wondering why 0.1%? That is as low as it thinks it can go ( lower bound) because it is terrified of what a zero interest-rate would do to the creaky IT infrastructure of the UK banking sector.

In another link to the present the absent-minded professor told us this.

It’s also that many economic indicators are in general very noisy, even at the best of times.
Retail sales, for example, are estimated to have fallen by 0.2% between July and August. Is this meaningful?
Not really. The index is extremely volatile – the average monthly change in retail sales volumes is over a
percentage point – and poorly correlated with quarterly GDP, even with consumption growth specifically.

So Deputy-Governor Broadbent would apparently overlook the weak retail sales data the UK saw in December. Indeed relying on PMI data back then got him spinning around more than Kylie Minogue, and the emphasis is mine.

All that said, there’s little doubt that the economy has performed better than surveys suggested immediately
after the referendum and, although we aimed off those significantly, somewhat more strongly than our nearterm forecasts as well.

That is a laugh out loud moment as we note that they planned to cut interest-rates as much as they could and as another example were so enthusiastic about Corporate Bond QE they had to buy bonds from foreign companies such as Maersk to make up the numbers ( £10 billion).

It just got better as we were advised not to do what Ben and his colleagues just had done.

Why might that be? Well, again, one shouldn’t rush to judgement here.

Let us move on after noting that using the PMI data misled the Bank of England back then and that apparently Ben Broadbent struggles with the past as well as the present and future.

And even after the event, it may not be clear
why a particular out-turn has differed from the central prediction, in one direction or the other.

What were the numbers?

The numbers may well have had Governor Carney spilling his morning espresso ( no milk as it is bad for climate change) in surprise.

January data from the IHS Markit / CIPS Flash UK Composite PMI® highlighted a decisive change of direction for the private sector economy at the start of 2020. Business activity expanded for the first time in five months, driven by the sharpest increase in new work since September 2018.

For these times that is like the “Boom! Boom! Boom!” of the Black-Eyed Peas. Or as you can see below what may well be a Boris Bounce.

The latest reading was the highest for almost one-and-a-half years and signalled a moderate expansion of business activity across the UK private sector economy. There were widespread reports that reduced political uncertainty following the general election had a positive impact on business and consumer spending decisions at the start of the year.

Looking into the detail we see first something familiar which is service sector strength and something welcome which is an improvement in the manufacturing sector.

Service providers experienced solid increases in business
activity and incoming new work in January. Meanwhile,
the performance of the manufacturing sector stabilised in
comparison to the end of 2019, but still trailed behind the
service economy amid ongoing weakness in export markets.

This was backed up by a suggestion that the positive labour market data we looked at on Tuesday may well be continuing.

Employment numbers increased for the second month running in January, with marginal growth seen in both the manufacturing and service sectors. Additional staff hiring was supported by a sustained rebound in output growth projections for the next 12 months, with business optimism reaching its highest level since June 2015.

The latter bit seems especially hopeful but of course may turn out to be Hopium.

Maybe manufacturing has returned to stagnation which is far from ideal but much better than where we were.

Manufacturing production meanwhile fell at a much slower
pace than in December, with the latest reduction only marginal and the smallest since the current phase of decline began in June 2019.

Putting it all together we are told this.

“The survey is indicative of GDP rising at a quarterly rate of approximately 0.2% in January, representing a welcome
revival of growth after the malaise seen in the closing months of 2019. Hiring has also picked up.”

Comment

The situation is now not a little confused. The Bank of England has gone out of its way to warm financial markets up for an interest-rate cut leading to speculation about next week. For example the benchmark ten-year Gilt yield which as recently as the 10th of this month was 0.8% is now 0.59%. This new trend  has had real world effects as Henry Pryor pointed out earlier.

A 95% LTV two-year fix at 2.77% and a 90% LTV five-year fix at 2.33% are currently the lowest available on the market. @Yorkshire_BS  launches record-low first-time buyer rates.

Yet we have seen the UK economic data show signs of improvement as for example this week both the labour market numbers and the tax receipt data for December suggested this. Against that was the weak retail sales number for December but as I pointed out earlier the Bank of England has previously stated it is an erratic indicator.

So we are left with the PMI business survey which has come in a fair bit stronger both in absolute and relative terms. As it happens we are now doing around 2 points better than my subject of yesterday the Euro area and according to the PMI have some growth. This has caught expectations on the hop and left a Bank of England which has guided us to it in a pickle because I believe they have wanted to cut interest-rates for a while. It seems the UK Gilt market thinks so too because nearly 2 hours have passed since the PMI number and it has not fallen as you might expect.

There are two undercuts to this. Firstly I would not base a policy decision on a PMI business survey. They have been rather unreliable for the UK as the summer of 2016 showed and also as one is supposed to be looking up to two years ahead then January 2020 matters but not that much. Next comes the issue that an interest-rate cut from 0.75% to 0.5% will do little good in my opinion and may even make things worse. After all we have had lots of interest-rate cuts but looking at where we are suggests they have not achieved much.

The ECB Review should put house prices in its inflation measure

Today brings the Euro area and European Central Bank into focus as the latter announces its policy decision. In terms of a change today I am not expecting anything as policy was set for the early part of the tenure of Christine Lagarde as ECB President by her predecessor Mario Draghi when he cut the main interest-rate to -0.5% and restarted QE bond purchases late last year. If you think about it that was quite revelaing as to what Mario thought about the capabilities of his “good friend” Christine. But whilst the surface may be quiet there is quite a bit going on underneath as highlighted by this from the Financial Times.

Lagarde’s legacy building begins at the ECB

I would say that this is an extraordinary level of sycophancy but then this is standard for the FT which of course called Bank of England Governor a “rock star”. Still I guess the media have to compete for priority at the various press conferences. After all the idea was a classic political style tactic of playing for time. But the catch is that it seems likely to end up with actual changes just as the time when the ECB is at its most intellectually lightweight. Also there is something of a swerve in that the ECB is in effect being allowed to set its own exam paper. Most of us wish we could have done that at school, college and university! More seriously central bank mandates are supposed to be set by elected politicians. Now whilst the ECB is headed by politicians these days ( Lagarde and De Guindos) they have been appointed rather than elected.

What is going on?

This is really extraordinary stuff because if you think about it Mario Draghi acquired a legacy by responding to events ( Whatever it takes to save the Euro…) whereas wht we have now is self-chosen as described above,

 Every good central banker needs a legacy. Mario Draghi, the former head of the European Central Bank, is widely credited with rescuing the eurozone from a debt crisis. Today his successor, Christine Lagarde, will kick off the search for a defining cause of her own.

Also this “Every good central banker needs a legacy” provokes the question why? Before we note that this is very damning of a former FT favourite Mark Carney who is leaving without one.

Oh and did I mention buying time?

Ms Lagarde will launch the second strategic review in the 20-year history of the ECB — a process that she has said will last until December as it turns “every stone” in search of ways to fine tune its monetary policy toolkit.

Also just like we have seen in various wars if your main priority is going badly it is time for some mission creep.

One of the most controversial ideas Ms Lagarde has proposed for the review is to make tackling climate change a “mission-critical” priority of the ECB. It is easy to see why this idea appeals to Ms Lagarde, with extreme weather events increasing in frequency and intensity every year — the latest being the wildfires raging across Australia — and pushing green issues to the top of the political agenda.

Indeed it is with the Euro area economy struggling. A diversion is badly needed.

With the Ivory Tower style economic modelling in so much trouble you might think this is really rather cruel and heartless.

For a start, the ECB could integrate climate-related risks into all its modelling and take more account of them when valuing collateral it accepts from financial institutions, as proposed by Banque de France governor François Villeroy de Galhau.

Collateral is a potentially explosive issue as the Bank of England discovered early in the credit crunch when it found that it had received “Phantom Securities” ( the clue is in the name). This is even more likely in a fashionable cause such as climate change.

A problem with this is that it would lead to central bankers choosing which stocks to favour which even the equity loving Tokyo Whale tries to avoid.

Environmental campaigners are calling on the ECB to do even more and repurpose its €2.6tn asset-purchase programme, known as quantitative easing (QE), by divesting “brown” bonds issued by carbon-intensive companies while increasing purchases of green bonds…….Critics say it is up to politicians, not central banks, to decide which companies to favour and which to penalise.

Meanwhile back on the day job.

Growth expectations have been scaled down.

If we switch to CNBC we see something which is quite damning for an ECB which has been so expansionist and interventionist. After negative interest-rates and all the QE this is the result.

Monetary policy action in Frankfurt is not expected by some market watchers for the whole of 2020. With inflation sluggish and no real economic rebound in sight, the majority of economists expect the ECB to adopt a “wait and see” approach.

The International Perspective

This matters on an international perspective as has been revealed by the head of the Swiss National Bank today.

“We know that negative rates also have side effects, that is the reason why we changed the threshold,” Jordan told CNBC, referring to the SNB raising the limit before the charge of -0.75% applied to commercial bank deposits at the central bank.

That is an awkward one for Christine Lagarde to mull as she imposes negative interest-rates but there is more.

ordan’s colleague Andrea Maechler said on Wednesday the SNB would end negative interest rates “as soon as we are able,” when asked about the central bank’s ultra-loose monetary policy aimed at curbing the Swiss franc’s over-valuation.

In essence it is the ECB that runs Swiss monetary policy as another ECB interest-rate cut seems likely to push the SNB to -1% as an official interest-rate. There is a similar state of play in Denmark. As to Sweden it’s central bank has been something of an unguided missile in the way it has raised interest-rates into an economic slow down so who knows what it will do next?

Comment

The opening issue is how did the ECB end up with its review being headed by someone known for incompetence ( Greece and then Argentina) as well as having a conviction for negligence in a fraud case?

Perhaps the fact above is related to a state of pay where nobody seems to be discussing the actual mandate or what we might call the day job. This is to keep consumer inflation as defined by HICP ( what we call CPI in the UK) below but close to 2% per annum. This was later refined by former President Jean-Claude Trichet to 1.97%, mostly because that is what it averaged in his watch.

There is a warning there because the apparent success on Trichet’s watch was combined with the credit crunch. Ooops! More specifically there were the house price booms and then busts in Spain and Ireland in particular. This allows me to suggest a fix which is to put house prices in the inflation index to help avoid that occurring again. Also it would represent not only a tightening of policy but adding an area that somehow they have managed to mean to include but forget for two decades now. Otherwise they had better keep playing Elvis on their loudspeakers.

We’re caught in a trap
I can’t walk out
Because I love you too much baby

UK tax receipts hint that economic growth is better than GDP tells us

Today the UK Public Finances are in the news and that is before we even get to the data release. This is because there has been a flurry of announcements on transport policy and the railways in particular. According to LBC we should soon get some clarity on out subject from a couple of days ago.

The Transport Secretary said he was making the biggest infrastructure decision taken in the UK in peacetime and promised it in “weeks rather than months”.

Mr Shapps told LBC: “We are nearing the conclusion. I am now in the final stages of gathering all the data together for HS2, so it’s a mega decision for this country.

“It’s maybe the biggest infrastructure project, certainly in Europe, and the biggest this country’s ever taken, certainly in peacetime. So we’ve got to get that right.

Bigger than when the Victorians built the railways? As opposed to one line! Also there were some announcements to help deal with what has been the headliner of the problems with UK railways.

Network Rail is being investigated over its poor service on routes used by troubled train operators Northern and TransPennine Express.

The government-owned firm has been put “on a warning” for routes in the North West and central region of England, the Office of Rail and Road (ORR) said.

The regulator said it was “not good enough” in those areas and was probing Network Rail’s contribution to delays.

Network Rail apologised for “very poor service” in the Midlands and the North. (BBC )

The solution to that problem according to the Transport Minister is to build a new railway for somewhere above £10 billion and in the meantime spend some £2.9 billion on improving the existing line. That is rather vague as it lacks timescales and will we be making improvements just in time to close them? But the issue here for the public finances is that the UK government is more willing to spend than it was. There is also an issue as to why if traffic on these railways has expanded so much why money has not been spent along the way to help it cope? That of course goes much wider as we note energy infrastructure where yet again we see an enormously expensive project after years and indeed decades of little action.

Today’s Data

We open with something against the recent trend.

Borrowing (public sector net borrowing excluding public sector banks, PSNB ex) in December 2019 was £4.8 billion, £0.2 billion less than in December 2018.

Maybe it is just a quirk that we borrowed less as the monthly numbers are volatile. But we do perhaps get a little more from this.

Central government receipts in December 2019 increased by £2.2 billion (or 3.7%) to £62.2 billion, compared with December 2018, while total central government expenditure increased by £1.7 billion (or 2.7%) to £63.9 billion.

As you can see the rise in receipts even if we use the highest inflation measure ( RPI) hints at a better growth rate than we are expecting from the GDP data. This does tie in with the employment and wages numbers we looked at yesterday. But only in a broad sweep because of this.

Central government receipts were boosted by increases in National Insurance contributions (NICs) of £0.5 billion, interest and dividends receipts of £0.3 billion, and across many of the taxes on production (such as Value Added Tax (VAT), tobacco duty and stamp duty) totalling £1.1 billion.

Taxes on income and wealth saw a small reduction (less than £0.0 billion), with an increase in petroleum revenue tax of £0.3 billion being offset by decreases in both Corporation Tax and Income Tax receipts of £0.3 billion and £0.1 billion respectively.

The highlighted part is because after yesterday’s data you might reasonably expect higher income tax payments and I was asked this question yesterday. Yet as you can see we got 0! It may be that due to the changes in the Personal Allowance that the National Insurance numbers are a better measure. So my answer goes from a no, to definitely,maybe.

There is also some awkwardness with the production receipts when we are being told production is struggling and in the latter part of 2019 retail moved from growth to decline. So let us note that these numbers hint at a stronger economy than we otherwise would have thought.

So far you might reasonably be wondering where the fiscal stimulus has gone? Well if you add the number below back in you can see that the deficit number was in fact driven by lower inflation rather than lower general government spending.

Interest payments on the government’s outstanding debt decreased by £1.1 billion, compared with December 2018.

Perspective

If we look back we see stronger signs of a fiscal boost than seen in December alone.

Borrowing in the current financial year-to-date (April 2019 to December 2019) was £54.6 billion, £4.0 billion more than in the same period last year.

Although care is needed as the numbers well they keep seeing ch-ch-changes.

ONS revisions again significantly lowered estimated borrowing in the earlier months of the
financial year. Last month, borrowing was revised down by £5.2 billion for earlier months while
this month’s release reduced borrowing by a further £1 billion.  The ONS has also revised down 2018-19 borrowing by £3.3 billion in this month’s release. ( OBR last month)

Assuming the numbers are accurate we see that the rise in borrowing so far this year has not only been caused by more spending but also by weakish receipts.

In the current financial year-to-date, central government receipts grew by 2.3% on the same period last year to £548.2 billion, including £402.7 billion in tax revenue.

On that road we see again a hint of a pick-up in the economy in December.

The National Debt

This turns out to be a complex issue and the simple version is this.

Debt (public sector net debt excluding public sector banks, PSND ex) at the end of December 2019 was £1,819.0 billion (or 80.8% of gross domestic product, GDP); this is an increase of £35.5 billion (or a decrease of 0.9 percentage points) on December 2018.

Actually the Bank of England managed to make things even more complex as one of its bank subsidies ended up boosting the national debt.

Debt at the end of December 2019 excluding the Bank of England (BoE) (mainly quantitative easing) was £1,644.2 billion (or 73.0% of GDP); this is an increase of £48.0 billion (or a decrease of 0.1 percentage points) on December 2018.

Actually it was the Term Funding Scheme which was badly designed rather than QE as the release seems to realise later.

The introduction of the Term Funding Scheme (TFS) in September 2016 led to an increase in public sector net debt (PSND), as the loans provided under the scheme were not liquid assets and therefore did not net off in PSND (against the liabilities incurred in providing the loans). The TFS closed for drawdowns of further loans on 28 February 2018 with a loan liability of £127.0 billion.

Unfortunately I seem to be the only person who ever calls out the Bank of England about this.

Comment

There are three lessons from today’s numbers. The first is that there is an ongoing fiscal boost especially if we allow for the impact of lower debt costs via lower inflation ( RPI). Next we again see a hint of the UK economy being stronger than indicated by economic output or GDP if December’s receipts data are to be relied upon. However and thank you to Fraser Munro of the Office for National Statistics for replying there is always doubt as the December income tax receipts are a forecast rather than a known number.

PAYE in December is based on HMRC’s cash forecast for January so we could see a revision next month.

So the truth is that the numbers are a rather broad brush and on that theme let me end with some national debt numbers which are internationally comparable.

General government gross debt was £1,821.9 billion at the end of the financial year ending March 2019, equivalent to 84.0% of gross domestic product (GDP) and 24.0 percentage points above the reference value of 60.0% set out in the protocol on the excessive deficit procedure.

Me on The Investing Channel

 

The UK Labour Market continues to look strong

This week has already seen a fair flurry of new information on the UK economy, so let us start with what will have caught the eye of Mark Carney and the Bank of England.

LONDON (Reuters) – Asking prices for British houses put on sale in the five weeks to Jan. 11 rose by a record amount for the time of year, property website Rightmove said on Monday, adding to signs of a post-election bounce in consumer and business confidence…….Rightmove said average asking prices of property marketed between Dec. 8 and Jan. 11 jumped 2.3% in monthly terms, the biggest increase for that period since the survey started in 2002.

The cautionary note is that it is asking prices ( you can ask what you want…) and not sold or traded prices but those looking for a post election bounce will add it to the Halifax numbers.

Yesterday also brought positive news on UK household finances as well.

“Latest survey data certainly show some post-election
bounce for UK households, with the headline index up
to a one-year high and house price expectations at their
strongest since October 2018. That said, cooling inflation
was most likely the real driving force, propping up real
earnings and disposable incomes” ( Markit )

So there are various surveys suggesting optimism for house prices and one saying something similar for household finances. This is really rather awkward for a Bank of England not only warming up for a Bank Rate cut with Gertjan Vlieghe explicitly saying he will look at sentiment measures. Of course Friday’s Retail Sales showed weakness but they can be unreliable and erratic.

Employment

This morning has brought both good and not so good news on the employment situation. So let us start with the positive.

Facebook says it is to create 1,000 new jobs in the UK this year, delivering a vote of confidence in the UK economy ahead of Brexit.

The tech firm issued a long-term commitment to the country as it made the announcement, in the run-up to a speech to be made in London later on Tuesday by its chief operating officer Sheryl Sandberg.

Facebook said the new roles would take its UK workforce beyond 4,000 people. ( Sky News)

Meanwhile the Financial Times is doing some scaremongering about HS2.

Hundreds of employees could face job cuts, while companies working on HS2 have been told to slow down work as uncertainty mounts over the fate of Britain’s most ambitious infrastructure project

I do not wish for people to lose their jobs but in this instance we have the issue of what are they actually producing?

UK Labour Market Release

We saw another in a long-running series where there was strong employment growth.

There was a 208,000 increase in employment on the quarter. This was, again, mainly driven by quarterly increases for full-time workers (up 197,000; the largest increase since September to November 2015) and for women (up 148,000; the largest increase since February to April 2014). The quarterly increase in women working full-time (up 126,000) was the largest since November 2012 to January 2013.

The tilt towards female employment was also to be found in the annual comparison where of an increase of 349,000 full-time jobs some 317,000 were for women.

This meant that there was another record.

The UK employment rate was estimated at a record high of 76.3%, 0.6 percentage points higher than a year earlier and 0.5 percentage points up on the previous quarter.

I will look at the broader consequences of this later but for the moment let us stay in the labour market and note the influence of what with apologies to those in it is something of a residual category.

The UK economic inactivity rate was estimated at a record low of 20.6%, 0.4 percentage points lower than the previous year and the previous quarter.

Okay so what is going on here?

Estimates for September to November 2019 show 8.51 million people aged between 16 and 64 years not in the labour force (economically inactive). This was 145,000 fewer than a year earlier and 587,000 fewer than five years earlier. The annual decrease was driven by women, with the level down 157,000 to reach a record low of 5.18 million.

So it is another case of let’s hear it for the girls where women have stopped being recorded as inactive and are now employed instead. There is a combination of good news and the influence of the raising of the state pension age at play here. As an aside the broad sweep has been women moving from inactivity to employment since these records began in 1971. The timing of the recent move also suggests that there was an influence from students as well.

There were fears of a rise in unemployment but as you can see below they were unfounded.

For September to November 2019, an estimated 1.31 million people were unemployed. This is 64,000 fewer than a year earlier and 618,000 fewer than five years earlier……The UK unemployment rate was estimated at 3.8%, 0.2 percentage points lower than a year earlier but largely unchanged on the previous quarter.

Wages

The previous release had seen a fall but this was not repeated.

Estimated annual growth in average weekly earnings for employees in Great Britain remained unchanged at 3.2% for total pay (including bonuses), and slowed to 3.4% from 3.5% for regular pay (excluding bonuses).

There was a switch towards bonus payments although slightly confusingly less than last year!

The annual growth in total pay was weakened by unusually high bonus payments paid in October 2018 compared with more typical average bonus payments paid in October 2019.

Let me now switch to the official view on real pay.

In real terms, annual pay growth has been positive since December 2017 to February 2018, and is now 1.6% for total pay (compared with 1.5% last month) and 1.8% for regular pay (unchanged from last month).

Sadly this relies on the woeful CPIH inflation measure and if we now switch from good news ( real wage growth) to the overall picture we get some bad news.

The equivalent figures for total pay in real terms are £503 per week in November 2019 and £525 in February 2008, a 4.1% difference.

Regular readers will be aware of my views on the inflation measure so let me present the issue another way today. The offiicial release points us towards the numbers for real regular pay. Can you guess which of the lines below that one is and no cheating?!

https://pbs.twimg.com/media/EOy_EsTXsAEsM8G?format=jpg&name=900×900

The chart was provided by Rupert Seggins and as you can see rather changes both the narrative and the perspective.

Comment

We find that if we look back the sequence of strong UK employment data started in 2012 and it is ongoing. There is a particular context to this though and let me illustrate with a tweet from Chris Dillow of the Investors Chronicle.

ONS also says hours worked rose 0.5% in Sep-Nov. With GDP rising only 0.1%, this means productivity fell. Might be partly a Brexit effect (uncertainty cut output but encouraged labour hoarding). But it reinforces the picture of long-term stagnation.

The issue here is that with the numbers we have productivity fell. But it is also true that last time the UK labour market and GDP diverged like we are seeing now it was the ( more positive) labour market which was correct as GDP later rose. It is another problem for the economics 101 view that the labour market responds in a lagged fashion as back then it led and GDP followed. More specifically we often see these days that employment is a driver of the economy rather than a follower.

Moving to wages we see that finally the employment growth gave us real wage growth but it took so long we have a bit of a mountain to climb. That is really quite a devastating critique of the Ivory Tower “output gap” thinking that has as many holes in it as I am hoping Arsenal’s defence will have tonight. Yet only last week Bank of England policymakers were repeating their output gap mantra. On that subject they have something of a problem again because they have got us ready for an interest-rate cut just in time for most of the data to be good. The bad bit was the retail sales numbers from Friday which now look out of phase with the employment numbers making me wonder if their seasonality algorithm has had a HAL-9000 moment? Whilst there is an intra-market shift in their favour as well maybe Aldi thinks do if this is any guide.

Aldi plans to increase pay for its staff by just over 3%, making it one of the best-paying supermarkets in the UK.

The discounter said its minimum hourly pay rates will rise from £9.10 an hour to £9.40, with workers inside the M25 getting £10.90 an hour instead of £10.55…….Aldi, Britain’s fifth-largest supermarket, also said it would be hiring 3,800 new employees for store level positions.

 

HS2 should be scrapped before more money is wasted

Today has brought two of our themes into focus as we have an opportunity to see a real world example of fiscal expansionism and rampant inflation in action. So let us get straight to it via the Financial Times.

The cost of Britain’s new HS2 high-speed rail project could rise to as much as £106bn, according to an official government review which gives only lukewarm backing to the project. The review, seen by the Financial Times, says there is “considerable risk” that the scheme’s price will rise as much as 20 per cent beyond the £81-£88bn range set out in a report by the current HS2 chairman Allan Cook last September.

Both our themes are in play here because if we look back to July 17th 2017 on here we raise fears of a type of pork barrel politics and inflation.

But critics say the £56bn project will damage the environment and is too expensive.

So it is on its way to being twice as expensive and at the current rate of increase that may not take too long. Back in 2017 I expressed my concerns about the danger of this.

Actually more and more doubts are emerging over the final cost. From The Independent. The HS2’s first phase between London and Birmingham will cost almost £48bn, according to expert analysis commissioned by the Department for Transport (DfT).

Even what seemed eye-watering numbers back then are being exceeded. Also there is the issue of what we might get from it.

That highlights two problems. If we start with costs then if this report is accurate we will have the most expensive railway in the world at £1.25 billion per mile on the first bit from Euston to Old Oak Common. The next is that by 2026 if everything is on time we will only have a new railway to Birmingham which is way short of the “Northern Powerhouse” promises. Assuming that the bits to Leeds and Manchester are eventually built will it all be out of date by then?

The latter sentence echoes as I read this bit in the FT.

and then to Leeds and Manchester by 2040, seven years later than the original target.

That is rather a toxic combination of costs ballooning and any benefits receding into the distance. At that speed it could be obsolete before it ever opens. We of course knew that this would happen because back in July 2017 we got an official denial and we know what that means!

Mr Grayling told the BBC’s Today programme that the high-speed rail network will be “on time, on budget” and the government has “a clear idea of what it will cost”.

Where do we stand now?

The review seems to have lost the faith.

The review led by Doug Oakervee, a former chairman of HS2, also recommends that work on phase 2b of the project from the West Midlands to Manchester and Leeds be paused for six months for a study into whether it could comprise a mix of conventional and high speed lines instead. “On balance”, it says that ministers should proceed with the 250mph railway, which would stretch from London’s Euston station to Birmingham in its first phase and then to Leeds and Manchester by 2040, seven years later than the original target. But although the final draft of the review recommends that the project should proceed, this is subject to “a number of qualifications,” it says.

In the coded language of an official review ( after all those doing the review are usually chosen to give the answer required) this is really rather damning. The idea of a 250 mph railway seems attractive but it is also true that there are doubts about whether it can achieve what is promised.

 It points out that no other high speed line in the world runs 18 trains per hour and recommends reducing it to 14.

Also if this was a football match the crowd would be chanting “You don’t know what you’re doing” in the background.

There are also concerns over the project’s management with more scrutiny needed from the Treasury, and its Infrastructure Projects Authority, as well as the Department for Transport. “The review has not seen convincing evidence that HS2 Ltd, especially the phase one construction team, have the level of control and management of the construction normally associated with major projects,” it says.

So we have costs out of control, the results seeming less and less likely all of course oiled by incompetent management in some sort of replay of the UK’s problems in the 1970s.

Meanwhile I notice @hancocktom on twitter has provided an international perspective.

Using the upper bound of the World Bank’s estimate of costs per km, in China a line of the same length would cost £3.7bn at market exchange rates……..(thats for the 225km phase 1, phase 2 would cost about $8.5bn in China).

Smart Meters

This is another area of waste. In fact the relative level of waste is even higher. The principle sounds good but offers so little over merely checking your bill if you have concerns. Then sadly it gets worse. From the BBC last September.

Nearly a third of all energy companies fitting smart meters are still installing old technology…….

However, eight companies still installing first generation smart meters say the network is not reliable enough to switch customers on to.

In fact the first range of Smart Meters were really rather dumb.

The second generation of meters is supposed to be able to connect remotely to a national network, which should make switching supplier possible, for the first time for many customers.

Aircraft Carriers

I follow various military blogs and what is clear from them is that not only were the 2 large aircraft carriers for the Royal Navy very expensive they bring a lot of extra costs with them. The obvious ones are the aircraft which are very expensive but there are others around the escorting ships. It is an area where HM Treasury should hold its head in shame because not only were the aircraft carriers more expensive due to the way it delayed the project, the carriers will be escorted by “£1 billion” destroyers because in doing the same to the Type 45 destroyer project it raised the costs there too. We could probably have had 8 destroyers rather than the 6 we ended up with for the same total.

It is a familiar theme of grand designs which overrun and then end up not reaching their goal as we may never sail them with a full complement of aircraft.

Comment

Let me start with the inflation issue as it is unlikely to get much of an airing elsewhere. Public spending has a big problem with inflation as they are usually valued on what is spent not what you get and an example is the “£1 billion destroyer”. But there are many other examples simply because by its nature ( free education. free NHS) there is no price for us to measure. Also there is often no measure of output. Thus a £106 billion HS2 sounds initially better than a £56 billion one when in fact it shows rampant inflation! If you look through the public-sector you see that the inflation measures are frankly like waving a finger in the air.

Next comes a theme of the times which are the calls for more fiscal policy with central bankers in the van. It is historically cheap ( the UK 50 year Gilt yield is a mere 1.08%) leading to support for their suggestions. However the examples today show cases where not only is money wasted but via the mechanism in the previous paragraph it is claimed to be real growth when it is not. This is exhibited in a reply to the FT by Saccharine.

Public infrastructure projects are not like a general consumer building an extension to their house.
“Overspend” doesn’t mean the money vanishes into oblivion like so many would have you think; it is wealth that cycles back into the economy through the salaries of those working on it.

What could go wrong?

Even worse there is this as the FT puts on its establishment trousers.

Despite the caveats, the report warns there are no alternative “shovel-ready” projects ready and that, with £8bn spent so far, it should proceed.

Perhaps they are fans of Arcade Fire.

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

There is a move in the UK to send more public spending to the North which links at least in theory with HS2 but we have been there before as Yes Prime Minister satirised back in the 1980s. Here is the Chief off the Defence Staff on the army being based in the North.

I suppose other ranks, junior officers, but you can’t ask senior officers to live permanently in the north! The wives wouldn’t stand for it for one thing.

What about Harrods? What about Wimbledon? Ascot? Henley? The Army and Navy Club? I mean civilisation, generally! It’s just not on!

RIP Derek Fowlds

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