The UK looks on course for some house price falls

As ever there is plenty of news about the UK housing market around but let us start with a consequence of government action which led to this reported by the BBC at the end of last week.

The boss of house building firm Persimmon has walked off in the middle of a BBC interview after being asked about his £75m bonus.

“I’d rather not talk about that,” Jeff Fairburn said, when asked if he had regrets about last year’s payout.

The £75m, which was reduced from £100m after a public outcry, is believed to be the largest by a listed UK firm.

The BBC even provides a pretty good explanation of why this is a hot topic.

A combination of rising house prices, low interest rates enabling people to borrow more cheaply and government incentive schemes have been credited with driving all housebuilder shares higher.

In particular we find ourselves looking at a bonus scheme set at £4 compared to a payout based on one of £24 in case you wonder how we got to such an eye watering amount. But the real problem is that Help To Buy provided what is called in economic theory excess profits for housebuilders. We have looked before at how it helped them to make high profits on the sale of each house and it also boosted volumes in a double whammy effect. So in turned into help for housebuilders profits and bonuses. Sadly it also showed the weakness of shareholders these days as only 48.5% of Persimmon shareholders voted against this at their annual general meeting, which begs the question of what would be enough greed to provoke a shareholder revolt.

What about now?

Here is the result of the latest Markit Household Finances survey.

UK households are generally projecting higher
house prices over the forthcoming 12 months in
October, but the degree of optimism regarding
property values dipped to the lowest since the
immediate aftermath of the EU referendum in July
2016.

Sadly for Markit recorded time seems to have started in July  2016 because if we look back we see some interesting developments. For example the reading in early 2014 at around 75 was the highest in that series. This means that those surveyed not only realised the UK economy was picking up but seemingly had figured out the determination of the Bank of England and UK government to drive house prices higher.

Also another piece of news hints at a change. From Financial Reporter.

The proportion of homes in England and Wales bought with cash fell to 29.6% in H1 2018, according to Hamptons International, the lowest figure since its records began in 2007.

In H1 2007, 33.6% of homes were purchased with cash, peaking in H2 2008 at 37.8%.

In H1 2018, 113,490 homes were cash purchases, totalling £25.3 billion in value according to Land Registry – the lowest level in five years and a drop of 21% compared to H1 2017.

You may not be heartbroken at the main reason why.

Hamptons International says the downward trend in the proportion of homes bought with cash reflects a drop off in investor and developer purchases. Countrywide data shows that in H1 2018 investors accounted for 24% of cash purchases, down from 32% in H1 2007 and a peak of 43% in H1 2008.

The same goes for developers who purchased just 2% of the homes bought with cash in H1 2018, down from 6% in H1 2007.

What about the house price indices?

The official data released last Wednesday told us this.

Average house prices in the UK have increased by 3.2% in the year to August 2018 (down from 3.4% in July 2018), remaining broadly stable at a national level since April 2018 .

So a welcome slowing from the period where annual growth remained about 5%. But the truth is that a lot of the change is represented by one place.

 The lowest annual growth was in London, where prices decreased by 0.2% over the year, down from being unchanged (0.0%) in the year to July 2018.

London has affected the area around it to some extent as well but much of the rest of the country has carried on regardless.

A somewhat different picture was provided on Friday by LSL Acadata.

At the end of September, annual house price growth stood at 0.9%, which is the lowest rate seen since April 2012, some
six and a half years ago.

They take the Land Registry data of which 35% is available now and have a model to project that as if 100% was in. They then update the numbers as for example around 80% should now be in for August. So taking what should be, model permitting, the latest data shows a much clearer turn in the market and they expect more.

Our latest outlook for the 2018 housing market suggests that the annual rate of house price growth will be in negative territory by the end of the year.

One reason for that is simply the trend is your friend.

This was the sixth month out of the last seven in which monthly rates have fallen, with the combined decline since February totalling some -2.0%. The average house price in England & Wales now stands at £302,626. This price is already some £2,240, or 0.7%, below the level of £304,866 seen last December, meaning that it will take a number of months of house price increases to make up this shortfall.

Also they point out that this has taken place in spite of the economic environment still being very house price friendly.

All this comes at a time when interest rates are at almost historic lows, mortgage supply is good, the number of people in work is higher than a year earlier, and average weekly earnings have increased by 2.4%, on a year-on-year basis. The housing market should be booming.

They would be even more bullish if they realised wage growth was 2.7% rather than 2.4%. There is also an element of “reality was once a friend of mine” below as we wonder what it would take for them to notice that this has been happening for some time?

While current initiatives (Help-to-Buy and Stamp
Duty relief) have relatively minimal overall effect on prices, as government continues to ratchet up the initiatives, the
risk is that these in turn could simply add to the affordability problem by causing prices to rise

This has particularly affected younger people which they do seem to have noted.

highlighted the falls in home ownership amongst 25-34-year-olds over the last 20 years, despite endless government initiatives to rectify the situation. As the report notes “Since 1997, the average property price in England has risen by 173% after adjusting for inflation, and by 253% in London. This compares with increases in real incomes of 25- to 34-year-olds of only 19% and in (real) rents of 38%.”

Some night think that raising prices some 173% above inflation was quite enough to cause an affordability problem!

Comment

UK house prices have proved to be very resilient and I mean that in the commonly used version of its meaning, not the central banking one. I thought that the real wage decline in 2017 would send annual growth negative but so far it has resisted that. However the LSL data set suggests it may finally be quite near.

As ever the danger is of the UK establishment panicking just like they did in 2012/3 and pumping it up, one more time. Or as LSL Acadata put it.

Announcements on Help-to-Buy, Starter Homes and possibly a Rent-to-Own programme based around giving CGT relief to landlords have all been mooted.

Personally I think we have had way too many announcements and initiatives which via windfalls to existing house owners and especially house builders have made the situation worse rather than better. For now the Bank of England at least seems stymied but of course this is the one area where they can be both inventive and innovative.

 

 

 

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The Bank of England is facing the consequences of its own mistakes

Yesterday brought us some new insights into the thinking of the Bank of England and indeed the UK establishment. This was because what you might consider the ultimate insider gave evidence to Parliament as Sir John Cunliffe joined the Department of the Environment as long ago as 1980. Intriguingly his degrees and lecturing experience in English Literature apparently qualified him to high level roles in HM Treasury. So he is also an example of how HM Treasury established the Bank of England as “independent” but then took back control. Actually I think all the Deputy Governors have been at the Treasury at some point in their careers. Also if we return to his degree we see another feature of modern life where those on the lower rungs have to be highly qualified in their sphere whereas it is no issue at all for those at the top. That is because they are considered to be – by themselves if nobody else – so highly intelligent that qualifications are unnecessary.

Sir John gave us a warning about the future.

One pocket of rapid growth that the FPC is monitoring closely is in leveraged lending which appears to have been driven by strong investor demand for holding the loans,
typically in non-bank structures such as CLOs (collateralised loan obligation funds). Gross issuance of leveraged loans by UK non-financial companies reached a record level of £38 billion in 2017 and a further £30 billion has already been issued in 2018. And lending terms have loosened with only around 20% of leveraged loans now having maintenance covenants, which used to be standard for all loans. The global leveraged loan market is larger than – and growing as quickly as – the US subprime mortgage market was in 2006.

The Bank of England Financial Policy Committee of which Sir John is a member ( he has nearly as many jobs as George Osborne) also posted a warning according to BusinessInsider.

Leveraged lending to corporates has ballooned in recent years, with the global market reaching a value of around $1.4 trillion, according to recent estimates.

Thus we see the establishment at play. Let us note that the ground is being prepared to blame “Johnny Foreigner” and also that as Nicola Duke points out below another deflection technique is at play.

This is how central bankers prepare for the next financial crisis. They take no action while ensuring they have their excuses in order. “We warned you in 2018”.

Let us take her point and see what is actually being done and the answer as usual appears to so far be nothing.

The FPC is planning to assess any implications for banks in the 2018 stress test and we will also review how the
increasing role of non-bank lenders and changes in the distribution of corporate debt could pose risks to financial stability.

As ever this is reactive and frankly a lagged reactive at that. These bodies never act in advance and are invariably asleep at the wheel whilst it is taking place. Of course if their real role is merely to describe what has happened then I may have been mistaken about Sir John’s qualifications for the job as suddenly English Literature becomes useful.

But there is an elephant in the room which is way that the Bank of England itself has fed this. It slashed interest-rates in response to the credit crunch and even now they are only 0.75% or around 4% below where they were previously. It has deployed some £435 billion of conventional QE and £10 billion of corporate bond QE. Then in 2012 it did this too.

The Funding for Lending Scheme is designed to encourage banks and building societies to lend more to households and businesses. It does this by providing funding to these firms for an extended period, with the quantity of funding we provide linked to their lending performance.

So the system has been flush with cash or to be more technically accurate, liquidity. Can anybody be surprised that like the ship of state the monetary system is a leaky vessel? Or to use a word from a couple of decades or so ago we are seeing another form of disintermediation. But wait there is more.

Since the referendum, the Bank of  England has augmented these capital and liquidity buffers by making available more than £250 billion of liquidity and by lowering banks’ Counter-Cyclical Capital Buffer to facilitate an extra £150 billion of lending.

This is from a speech given by Chief Economist Andy Haldane which was liked so much it was if you recall published twice just to make sure we got the message. Well perhaps the leveraged loans industry did! We’ve got your backs lads ( and lasses). But wait there was even more.

Put differently, I would rather run the risk of taking a sledgehammer to crack a nut than taking a miniature
rock hammer to tunnel my way out of prison – like another Andy, the one in the Shawshank Redemption………And this monetary response, if it is to buttress expectations and confidence, needs I think to be delivered promptly as well as muscularly.

The Bank of England has claimed some 250,000 jobs were saved/created ignoring that it would have been perhaps the fastest response to a monetary policy change in history. That leads it into conflict with the ECB that thinks the response time slowed. But if we return to what we might label in this instance as disintermediation there have been two clear examples.

  1. A surge in unsecured lending pushing into annual growth in the double digits that is still above 8%
  2. Corporate lending now increasingly leveraged with underwriting standards dropping like a stone.

Peter Gabriel may have done this but the Bank of England merely repeated the same old song.

I’ve kicked the habit
shed my skin
this is the new stuff

I go dancing in, we go dancing in

Comment

There are plenty of familiar themes at play today as we look again at how the establishment operates. There is a clear asymmetry between the way a move sees even fantasies proclaimed as triumphs but failures get ignored. It is the same way that “vigilant” means asleep and “we will also review” means a review will be necessary as by then it will probably have blown up. Fortunately we can then claim to be experts and specialists ( in failure to quote Jose Mourinho ) and sit on the various committees set up to discover what went wrong? That will of course make sure that those asleep at the wheel do not get the blame, as long as they can manage to stay awake during the meetings of the new committee.

Meanwhile the UK economy continues to bumble along. Whilst today’s headline may appear not so good it is in fact pretty strong.

In September 2018, the quantity bought declined by 0.8% when compared with August 2018, due mainly to a large fall of 1.5% in food stores; the largest decline in food store sales since October 2015.

That made the Office of National Statistics uncomfortable enough to delay it to the third paragraph of the release. But actually with a little perspective and somewhat amazingly the UK consumer continues to spend.

In the three months to September 2018, the quantity bought in retail sales increased by 1.2% when compared with the previous three months………When compared with September 2017, the quantity bought in September 2018 increased by 3.0%, with growth across all sectors except department stores.

Presently in economic terms ( as opposed to political) the main dangers to the UK economy have been created by the Bank of England.

Core Finance TV

 

 

 

 

 

Of hot air, wind power and UK real wages

Today brings us to the latest UK labour market data but before we get there we see two clear features of these troubled times. One is in fact a hardy perennial referred to in Yes Prime Minister by Jim Hacker over thirty years ago although he was unable to arrange one. From Kensington Palace..

Their Royal Highnesses The Duke and Duchess of Sussex are very pleased to announce that The Duchess of Sussex is expecting a baby in the Spring of 2019.

Who says the UK has no plans for Brexit when a Royal Baby is in the process of being deployed?

Next comes some intriguing news from Scottish Power reported by the BBC like this.

Scottish Power to use 100% wind power after Drax sale

My first thought was to wonder what happens when the wind does not blow? Or only weakly as for example if we look at UK electricity production this morning where according to Gridwatch it is 5 GW out of a maximum of around 12.5 GW? There is little extra on this to be found in the detail.

Scottish Power plans to invest £5.2bn over four years to more than double its renewables capacity.

Chief executive Keith Anderson said it was a “pivotal shift” for the firm.

“We are leaving carbon generation behind for a renewable future powered by cheaper green energy. We have closed coal, sold gas and built enough wind to power 1.2 million homes,” he said.

As you can see the issue of when the wind does not blow gets entirely ignored in the hype. Indeed one part of its past production which could help to some extent by being used when the wind does nor blow which is hydro power has just been sold! As to the claims I see that this provides cheaper electricity that is rather Orwellian as we know that the green agenda is driving prices higher but tries to hide it. Still the good news for Scottish Power customers is that if all the statements are true then there will be no more price rises because energy costs are now pretty much fixed.

As you might expect raising such thoughts on social media leads to some flack. According to @Scottishfutball I am a stupid man although that tweet has now disappeared. Here is a longer answer to show the other side of the coin from Is anybody there on Twitter.

When the wind doesn’t blow they have hydroelectric power, wave power, solar, biomass, pumped hydro storage. Add in micro grids, battery storage and deferred demand and it’s very achievable.

The hydro power they just sold? And what’s “deferred demand”?

Wages

Here the news was a little better.

Latest estimates show that average weekly earnings for employees in Great Britain in nominal terms (that is, not adjusted for price inflation) increased by 3.1% excluding bonuses, and by 2.7% including bonuses, compared with a year earlier.

So we see that on this three-monthly measure total pay has risen at a 0.1% faster rate and basic pay by 0.2%. The balancing item here is bonuses which fell by 1.3% in August on a year before.

Let us take a look at this as the Bank of England wants us to. Here is its Chief Economist Andy Haldane from last week.

A year on, I think there is more compelling evidence of a new dawn breaking for pay growth, albeit with the
light filtering through only slowly……….Looking beneath the headline figures, evidence of an up-tick in pay is clearer still. Private sector pay growth (again excluding bonuses) has been grinding through the gears; it recently hit the psychologically-important 3% barrier. Private sector wage settlements so far this year are running at 2.8% and in some sectors, such as construction and IT, are running well in excess of 3%.

Someone needs to tell Andy that if an average is 3% some will be above and some will be below. Also is the growth 3% or 2.8%? But let us ignore those and Andy’s lack of enthusiasm for bonuses, no doubt influenced by his own personal experience. On this measure we see that private-sector pay growth is now 3.1% so another nudge higher and with July and August both registering 3.3% we could see another rise next time. The trouble is that whilst this is welcome we are back at the old central banking game of cherry picking to data to produce an answer you arrived at before you looked at it. Also one cannot avoid noting that the theory Andy so loves – and has led him regularly up the garden path over the past 5 years or so – would predict this wage growth to be more like 5%. Or to put it another way the view shown below seems not a little desperate and the emphasis is mine.

This evidence suggests the pulse of the Phillips curve has quickened as the labour market has tightened.
Unlike over much of the past decade, estimated wage equations are now broadly tracking pay.

So the new “improved” models are just the old ones in a new suit?

Some reality

If we switch to total pay we see that over the course of 2018 it is much harder to pick a clear pattern.  Whilst we are a little higher than a year ago as 2.7% replaces 2.4% it is also true that we opened the year at 2.8%. Next month should be better as the May 2% reading drops out but it is a crawl at best. If we switch to real wages we are told this.

Latest estimates show that average weekly earnings for employees in Great Britain in real terms (that is, adjusted for price inflation) increased by 0.7% excluding bonuses, and by 0.4% including bonuses, compared with a year earlier.

Here comes my regular reminder that even such small gains rely on using an inflation measure that is not fit for purpose. This is because the CPIH measure relies on imputed rents which are a figment of statistical imagination and which, just by chance of course, invariably lower the reading. We will be updated on the inflation numbers tomorrow but it was 2.4% compared to the 2.7% of its predecessor ( CPI ) and the 3.5% of the one before that ( RPI)  as we try to detect a trend. Even using it shows that the last decade has been a lost one in real wage terms.

For August 2018, average total pay (including bonuses), before tax and other deductions from pay, for employees in Great Britain was: £523 per week in nominal terms, up from £508 per week for a year earlier……..£492 per week in constant 2015 prices, up from £489 per week for a year earlier, but £30 lower than the pre-downturn peak of £522 per week for February 2008.

As you can see even using the new somewhat deflated inflation number there will be another lost decade for real wages at the current rate of progress.

Comment

Today has mostly been a journey of comparing wish-fulfillment with reality, or the use of liberal quantities of hopium. Still perhaps it will be found at a fulfillment center, whatever that is. From CNBC.

Tech giant Amazon is set to install solar panels at its fulfillment centers across the U.K.  ( H/T @PaulKingsley16 )

If we switch back to the Bank of England which of course is also full of rhetoric on the climate change front, as after all someone has to offset all the globetrotting of Governor Carney, we return to wages again. Actually it has reined in its views quite a bit.

The rise in wages projected by the Bank is, to coin a phrase, limited and gradual. Private sector pay is
assumed to rise from 3% currently to around 3 ¾% three years hence, or around 25 basis points per year.

The catch is the implied assumption that we will always grow because any slow down would then knock real wages further. But even on that view once we allow for likely inflation it looks as if there will be only a little progress at best.

 

 

 

 

 

UK annual unsecured credit growth “slows” to 8.1%

Today brings us to the latest UK data on both the money supply and the manufacturing sector. Both of these are seeing developments. If we start with something which has boosted the UK money supply by some £445 billion there is of course the QE bond purchases of the Bank of England. Having given my thoughts on Friday here is David Smith of the Sunday Times who seems to have bought the Bank of England rhetoric hook,line and sinker. Firstly let me correct an early misconception.

At first, as in America, the process of running off QE assets is being achieved by not reinvesting the proceeds of maturing bonds.

That implies that the UK is no longer reinvesting its maturing Gilt holdings and if it were true would be a policy I support having originally suggested it some five years ago. This would, however be news to the Monetary Policy Committee.

The Committee also voted unanimously to maintain the stock of UK government bond purchases,

Moving back to how things might play out the musical theme is “Don’t Worry Be Happy” by Bobby McFerrin.

We are still, of course, some way away from the unwinding of the Bank’s £435bn of QE. It will not happen until interest rates reach 1.5%, and they are currently only half that level. It remains possible that, in the event of a rocky, no-deal Brexit, the Bank will think it is obliged to launch a further tranche of QE. But it will eventually be reversed. And there is no reason why we should be unduly worried about that.

So suddenly we are no longer reversing it, and we will not do so until Bank Rate reaches 1.5%. In case you are wondering if there is something especially significant about 1.5% there is not apart from the fact that the associated higher Gilt yields will mean a lower value for the holdings. Oh and we might get more! But don’t worry “it will eventually be reversed”  although using the strategy suggested, which of course has not started, it would not be until 2065.

As to what good it has done? We seem to just have to accept the line it has saved us.

any marginal increase in wealth inequality looks like a small price to pay for avoiding more serious economic damage and deflation.

Money Supply

This month’s data was a little bit of a curate’s egg but let us start with something that has become very familiar. From the Bank of England.

The annual growth rate of consumer credit slowed further in August, to 8.1%, reflecting weaker monthly lending flows. The annual growth rate was the lowest since August 2015, and well below the peak of 10.9% in November 2016. Within this, and consistent with lower monthly net flows over the past few months, other loans and advances growth fell to 7.7%, the lowest since December 2014. Credit card growth has been broadly stable for the past 18 months at close to 9%.

The official view can be seen quite clearly here, and if we take the £838 million of July and the £1118 million of August that is lower than the circa £1500 million previously. The catch is the annual growth rate of 8.1% as can anybody thing of anything else in the UK economy growing at that sort of rate? After all it compares with real wage growth which is somewhere around zero and an annual rate of economic growth of between 1% and 2%. Although I am reminded that Sir Dave Ramsden of the Bank of England called an annual growth rate of 8.3% “weak” earlier this year.

Also if you look at the date of the peak you see that the “Sledgehammer QE” and Bank Rate cut of August 2016 did seem to achieve something, which was a peak in unsecured borrowing. Oddly we do not see the Bank of England trying to bathe itself in this particular piece of glory…..

Mortgage Lending

This has been fairly stable for a while now. The Funding for Lending Scheme got net monthly lending positive in 2013 and since then both the banks and our central bank have been happy. At the moment we mostly see net lending of around £3 billion per month.

Lending to business

There are two clear trends here.Let me open by pointing out the impact of the Funding for Lending Scheme on the metric it was loudly proclaimed to influence.

Annual growth in lending to small and medium-sized businesses remained close to zero for the eighth consecutive month.

This has been the pattern since it began which is why the central banking version of the  nuclear deterrent or the word “counterfactual” has been deployed. It tells us that however bad things are they would have been worse otherwise, so things are in fact a success. If we look at the breakdown we see that of the £166 billion or so, some £50 billion is for real-estate as opposed to the £10 billion for manufacturing, which tells us something about the way the UK economic wind blows.

Another is that businesses are shifting away from banks which is a trend which would make my late father very happy if he was still with us.

Businesses can raise money by borrowing from banks or from financial markets (in the form of bonds, equity and commercial paper). The total amount outstanding of businesses’ borrowing from these sources increased by £3.2 billion in August. Within this, net finance raised from banks remained positive, but weak, at £1.0 billion.

Over the past six months the average raised from banks has been £1 billion but £1.5 billion has been raised from other sources of credit.

Money Supply

These are the curate’s egg part this month. This is because the actual monthly data was better.

The total amount of money held by UK households, businesses and non-intermediary other financial corporations (NIOFCs) (Broad money or M4ex) rose by £6.9 billion in August. This was above the £0.7 billion in July and the £2.6 billion average of the previous six months.

However the annual rate of M4ex fell to 2.8% which is poor and a further slowing. But if we look for perspective the problem months were July as you can see above and even more so June where it shrank by £2.6 billion. So we know the overall trend has been weak but we are a bit unsure about what is about to take place.

Manufacturing

There was some rather welcome news from this sector today as Markit published its PMI business survey.

Domestic market demand strengthened, while increased orders from North America and Europe helped new export
business stage a modest recovery from August’s
contraction. Business confidence also rose to a three-month
high.

The reading of 53.8 following an upwardly revised 53 for August shows some welcome growth and is rather different to the media perspective and coverage. Let us hope it bodes well.

Comment

The UK money supply data have been weak for a while now and on Friday we noted again that so has the economy.

Compared with the same quarter a year ago, the UK economy has grown by 1.2% – revised down slightly from the previously published 1.3%.

That makes the Bank Rate rise in August look even odder to me. Of course there is an exception which is unsecured credit which is charging along albeit not quite a fast as before. The total has now reached £214.2 billion.

We are left hoping that the better manufacturing surveys will add to the GDP data for July and give us if not the economic equivalent of the long hot summer at least some solid growth. After all clouds are gathering around at least some of Europe (Italy) if not its golfers.

Meanwhile our official statistician rather than working on known problems seem determined to produce numbers which are meaningless in my opinion.

In 2017, the UK’s real full human capital stock was £20.4 trillion, equivalent to just over 10 times the size of UK gross domestic product (GDP).

Perhaps there is a clue telling us where the author lives.

the average real human capital stock of those living in West Midlands fell the most, by 5% in 2017 to £568,168, the biggest drop in six years, reflecting negative real earnings growth. By contrast, the average real human capital stock of those living in East Midlands with a degree or higher qualification rose by 9% in 2017 to £564,790.

 

 

 

The Bank of England is struggling badly on the subject of the impact of QE

This week has brought us more opinions from the Bank of England.Yesterday saw the man who Time magazine decided was one of the 100 most influential people in the world in 2014. Sadly it has been rather a slippery slope since then for the Bank of England’s Chief Economist Andy Haldane who did at least offer some variety on the apochryphal story about the two-handed economist. From Reuters.

Bank of England Chief Economist Andy Haldane said on Thursday that the central bank could decide to raise interest rates or to cut them if there was a disorderly, no-deal Brexit.

Although much more of a clue was given in the follow-up detail.

“on the balance of factors such as a fall in the value of the pound and the reduction in supply………just as it did pre-referendum,”

If we assume he has confused the word pre and post we see he is signalling us towards a fall in the pound £ he ignored and the way he panicked and demanded a cut in interest-rates as well as more QE. Also according to @LiveSquawk he told the audience this.

BoE Haldane: Impact Of Rate Hikes So Far Modest

That might be because in net terns there has only been one as the move in November simply reversed the 2016 mistake.

I note these days that those who tell us how intelligent he is, seem to have disappeared, and even the Reuters piece is accompanied by a picture of him looking a bit wild-eyed. The mainstream view that he is/was a deep thinker has been replaced by the view he is deep in something else. As to his campaign to be the next Governor of the Bank of England? You find out all you need to know by the way he was at Symonds College on Monday. His idea of a Grand Tour around the country to a chorus of acclaim has morphed into giving talks to sixth-form colleges and please do not misunderstand me I mean no offence to the students of Winchester. However I do suggest they ignore the failed output gap theory that he keeps trotting out.

QE

Earlier this week Gertjan Vlieghe was more revealing than I think he intended about QE and its effects. Let me illustrate with his view on how it works.  First he tells us that unwinding QE is no big deal.

This view of how QE works implies that unwinding QE need not have a material impact on the shape of the yield curve, or indeed on the economy, if properly communicated and done gradually.

There is an obvious problem here which is that if taking it away does not have a material effect on the economy then how did applying it have a positive effect? Also if it is so easy to do there is the issue of why the Bank of England has not done any? Let us see how he thinks it works.

I argue against the view that QE works primarily by pushing down long-term interest-rates directly, through compressing the term premium  ( the portfolio balance channel)……..my view that QE works primarily via expectations, with powerful additional liquidity effects which are temporary and mainly relevant during periods of market stress.

We note immediate;y that he downplays the most obvious effect it has had with is the lowering of many bond yields around the world to what have been unprecedented levels. Odd when that was so clearly in play when Gertjan applied QE in August 2016 and the UK ten-year Gilt yield plunged to an extraordinary 0.5% and some yields in the short to medium range went negative for a while. No doubt economic historians will call that “Haldane’s heights” or the “Carney peak” for Gilt prices because unless the Bank of England has another go at impersonating a headless chicken such levels are extremely unlikely to be seen again.

Rather than the route above where bond yields fall and have an impact via lower fixed rate mortgage and company borrowing costs he seems to prefer the expectations fairy. Here individuals and companies are supposed to respond positively to something the vast majority do not understand and more than a few either have not heard of or do not care. This sort of thinking has been notable in the rise of Forward Guidance where central bankers seem to believe or at least be willing to claim and imply that the population hangs on their every word.

The view on liquidity is interesting as it is another clear area where there is an impact as money is indeed created in electronic form and the money supply raised. This particularly affects narrow measures of the money supply as for example in Japan an initial target was to double the amount of base money.  The problem comes when we try to follow the trail of where the liquidity created went? In the early days of Bank of England QE much of it seemed to get deposited straight back to the Bank itself. But over time we can spot clear signs of its impact on the financial system in two ways. The first is the impact on asset prices and especially house prices with London in the van. But even that is complicated as credit easing most recently in the form of the £126 billion or so of the Term Funding Scheme was also required. Next is the way that the Bank of England so often denies any such impact these days which relies on us forgetting the research produced by it around 2012.

Also you note that Gertjan seems to have forgotten the meaning of the word temporary as in “liquidity effects” as not one penny of the £435 billion of Bank of England QE has ever been withdrawn. So on the state of play so far it has been permanent and furthermore there is no apparent plan to change that.

Comment

As we note yet more attempts from the Bank of England to tell us that up is the new down another issue has popped up this morning that they will have hoped we have forgotten. Here is Ben Broadbent on the first quarter of 2018 from the May Inflation Report press conference.

they’re nonetheless consistent with growth much stronger than 0.1%………do not point to anything like as weak as 0.1%

Next here is the announcement this morning from the Office for National Statistics.

This follows a soft patch earlier in the year, where the UK economy grew by a revised 0.1% in Quarter 1 (Jan to Mar) 2018.

So we have seen a downwards revision to 0.1% meaning that the antennae of Ben Broadbent now have a 100% failure rate. So it is way past time for him to stop relying on surveys which keep misleading him. Actually if we look at the source of the change we see that the ONS is also finding itself in quicksand.

Construction output fell by a revised 1.6% in Quarter 1 2018, marking its weakest quarterly growth since mid- 2012. It was previously highlighted that the adverse weather conditions earlier in the year had some impact on the construction industry.

I guess they are hoping we have forgotten that they told us the weather was not much of a factor! More serious is the fact that for the past 4/5 years their measurement of construction output has been a complete mess. The have told us it was in recession ( now revised) and then that it was doing much better ( which also seems to have now been revised). Along the way we have had a large company switched from services to construction and modifications to the deflation measure of inflation. I can tell you that my Nine Elms crane index is still at its peak of 40.

So there have been much better days for both the ONS and the Bank of England. Returning to the issue of QE I would like to remind you of Wednesday’s article on the drawbacks from it which look rather more concrete than the claimed gains. As for Governor Carney he has been too busy this week flying to North America and back so he can lecture people on the dangers of climate change.

 

 

The UK Public Finances have an August stumble

Yesterday we looked at the plans of Lord Skidelsky for fiscal expansionism. Let me add to that the implication of his lines of thought is that he would boost government spending now. Whilst we are not in a 2008 style slump he was clear that he thinks we have not recovered from it and some metrics confirm that. For example if you look at Gross Domestic Product and employment we have, but the case is much weaker with GDP per head and invisible with real wages.

This brings us to a familiar issue which is whether we have had austerity or fiscal stimulus in the credit crunch era? The problem with the assertions of outright austerity is that we have run a fiscal deficit throughout the period. Language shifts over time and I can recall when that would have been called a fiscal stimulus. This does matter as I can easily name two countries who are running what might be called outright austerity in the sense of both having and planning for a fiscal surplus and they are Germany and Sweden. In the UK sense it has meant reducing the fiscal deficit and in overall terms there have been two phases as there was a change made around 2012 that softened the effort. In practice we have also seen something of a lagged response to the effort. What I mean by that is that the deficit numbers took a while to respond to the economic recovery but more recently have picked up the pace.

Putting the issue into two numbers you could say that the amount we are borrowing now offers some support for Lord Skidelsky as it was £39.4 billion in the last financial year. But the amount we have borrowed heads us in the other direction because if you take the collapse of Northern Rock as the start of the credit crunch we have added some £1.23 trillion to the UK National Debt since. For those of you wondering how we have possibly afforded this let me point you in the direction of Threadneedle Street as it is the £435 billion  QE Gilt purchases of the Bank of England which have allowed it via their impact on Gilt yields. In spite of the recent trend towards higher borrowing costs exemplified by the US ten-year Treasury Note yielding 3.09% the equivalent Gilt yields a mere 1.6%.

Borrowing Costs

Let me hand myself a slice of humble pie to eat. The reason for that is if you had asked me where Gilt yields would be a decade or so later when the credit crunch began the chances of me being right would have been slim to none ( and in line with the joke slim was out of town). In an area I was right ( long time readers will recall I was long of some UK index-linked Gilts anticipating correctly a rise in inflation), I did not envisage that one day conventional Gilt yields would be so low that the price of linkers would be driven higher because they offered some sort of coupon.Madness! Or rather the consequences of the Sledgehammer QE of August 2016 about which history will not be kind.

Today’s Data

National Debt

We can continue the Bank of England theme as it has had an impact here too and one can only imagine the panic back in July and August of 2016 when they managed to devise schemes to do this.

Since August 2017, the net debt associated with the Bank of England (BoE) increased by £44.6 billion to £193.2 billion. Nearly all of this growth was due to the activities of the Asset Purchase Facility Fund, of which the TFS is a part.

The TFS closed for drawdowns of further loans on 28 February 2018 with a loan liability of £127.0 billion. The TFS loan liability at the end of August 2018 was £126.5 billion.

Yet again we find ourselves at least in terms of the official statistics indebted to provide yet another subsidy to the banking sector. This is a shame as our performance on this metric has been improving.

Debt (Public sector net debt excluding public sector banks (PSND ex)) at the end of August 2018 was £1,781.9 billion (or 84.3% of gross domestic product (GDP)); an increase of £15.9 billion (or a decrease of 1.8 percentage points) on August 2017.

The debt has continued to increase but has done so more slowly than economic output or GDP so in relative terms it has declined.

The Fiscal Deficit

We have got used to a sequence of good numbers so I guess we were due something like this.

Borrowing (Public sector net borrowing excluding public sector banks (PSNB ex)) in August 2018 was £6.8 billion, £2.4 billion more than in August 2017; this was the largest August borrowing for two years (since 2016).

It is hard not to have a wry smile as we investigate the reason for this because you may recall last month the UK had really crunched down on spending.

While current receipts in August have increased by 1.6%, to £55.6 billion compared with August 2017, total expenditure increased by 6.9% to £60.4 billion.

We are told that this was influenced by the “triple-lock” effect on the basic state pension (3%) but that seems weak to me as that has been in play since April. In fact every spending category was higher and after the excitement in Salzburg yesterday there is food for thought in this.

The UK contributions to the EU in August 2008 were £1.0 billion; a £0.6 billion increase on August 2017, seeing a return to a similar level as 2016 after a low 2017 due to an EU Budget surplus distributed to member states.

If we return to the underlying trend we see that in spite of this month we remain overall in a better phase for the deficit.

Borrowing (PSNB ex) in the current financial year-to-date (YTD) was £17.8 billion: £7.8 billion less than in the same period in 2017; the lowest year-to-date for 16 years (since 2002).

This is because the rate of growth of revenues at ~4% is higher than the rate of growth of spending at ~2%. The latest strong set of retail sales figures are backed up by the VAT data and income tax is doing pretty well too. Also the overall trend to lower inflation has reduced debt costs by £2.3 billion via the RPI.

One area which is of note is a confirmation of a slowing of the housing market as Stamp Duty revenues have dipped by £400 million to £5.5 billion.

Comment

The UK has made considerable progress in reducing its fiscal deficit and as ever a time like this brings us to something of a crossroads. Some will want to press on with this and others will be sympathetic to a Lord Skidelsky expansion. The latter are supported by the reality that austerity such as it is has in some cases hit the weaker members of our society. The former may note that whilst the cost of our debt remains low a continuation of the recent rise in Gilt yields will begin to get expensive. The simple truth is that we have so much more of it these days as if we return to the Northern Rock collapse we owed £0.54 trillion as opposed to the £1.77 trillion now (year to July). Putting it another way that is why some of you have replied on here saying we cannot afford interest-rates and yields of more than 3%.

In terms of the underlying economy our present trajectory continues to be one of bumbling along so it should support the fiscal position and mean that the Office for Budget Responsibility is wrong again.The OBR’s only hope is that the weak monetary data acts as a stronger drag on the economy which is an irony as I don’t think it has a monetarist on it. Meanwhile the boost provided by the booming housing market is fading away.

As some Friday humour I present this to you from the Washington Post.

I wanted to understand Europe’s populism. So I talked to Bono.

Me on Core Finance

 

 

Will UK house prices fall by 35% and is that a good thing?

Yesterday the Governor of the Bank of England attended the UK Cabinet meeting to update them on what the Bank thinks about the potential post Brexit economic situation. Typically the main area focused on has been house prices which of course is revealing in itself. Let us take a look at how this has been reflected in the Bank’s house journal otherwise known as the Financial Times.

Mark Carney, Bank of England governor, has delivered a “chilling” warning to Theresa May’s cabinet that a no-deal Brexit could lead to economic chaos, including a property crash that could see house prices fall by a third.

I pointed out on social media that whilst the journalists at the FT might find such a fall in house prices “chilling” first-time buyers would welcome it. Maybe they might start to find a few places to be affordable. So they might well welcome the fact that the FT then remembered that 35% is more than a third!

Among Mr Carney’s most stunning warnings was that house prices would be 35 per cent lower than would otherwise be the case three years after a disruptive no-deal Brexit — which would assume a breakdown in trading relations with the EU.

If you are wondering what would cause this then it was Governor Carney’s version of the four horsemen of the apocalypse.

The property crash would be driven by rising unemployment, depressed economic growth, higher inflation and higher interest rates, Mr Carney warned.

This is where the water gets very choppy for Governor Carney. This is because he has played that card before, and two of his horsemen went missing. Let me explain by jumping back to May 2016. From the Guardian.

The Bank warned a vote to leave the EU could:

  • Push the pound lower, “perhaps sharply”.
  • Prompt households and businesses to delay spending.
  • Increase unemployment.
  • Hit economic growth.
  • Stoke inflation.

Missing from that list is the higher mortgage rates that he had suggested earlier in 2016. Three of the points came true to some extent as the Pound £ fell and due to it inflation by my calculations rose by 1.25% to 1.5%. This reduced real wages and hit UK economic growth. But unemployment continued to fall and employment rise. Also the delays in spending did not turn up. Or to be more specific whilst there may have been some investment delays, the UK consumer definitely did go on quite a splurge as retail sales boomed.

Where the Governor also hit trouble was on the recession issue. This was partly due to his habit of playing politics where he associated himself with forecasts suggesting there would be one. The actual Bank of England view was careful to use the word “could” but the HM Treasury one was not.

a vote to leave would represent an immediate and profound shock to our economy. That shock would push our economy into a recession and lead to an increase in unemployment of around 500,000, GDP would be 3.6% smaller, average real wages would be lower, inflation higher, sterling weaker, house prices would be hit and public borrowing would rise
compared with a vote to remain.

Partly due to his own obvious personal views Governor Carney got sucked into this. It did not help that the HM Treasury report was signed off by the former Deputy Governor Sir Charlie Bean which gave it a sort of Bank of England gloss and sheen. The May 2016 Inflation Report press conference had question after question on the recession issue which illustrates the perception at the time. Then this was added to in July and August 2016 when the Bank of England and in particular its Chief Economist Andy Haldane again raised the recession issue by telling us the Bank needed a “Sledgehammer” response and then delivering it. Or half delivering it because by the time we got to the second part being due ( November 2016) it was clear that the chief economist had got it wrong. But that phase seemed to be driven by a Bank of England in panic mode looking at a later section of the HM Treasury report.

In this severe scenario, GDP would be 6% smaller, there would be a deeper recession, and the number of people
made unemployed would rise by around 800,000 compared with a vote to remain. The hit to wages, inflation, house prices and borrowing would be larger. There is a credible risk that this more acute scenario could materialise.

Did the Bank of England Sledgehammer stop a recession?

Over the past 2 years this has come up a lot with journalists and ex Bank of England staff suggesting that it did. If so it would have been the fastest real economy response to monetary action in history. That would be odd at a time the ECB was telling us it thought the reaction function had slowed, But anyway rather than me making the case let me hand you over to Mark Carney himself and ony the emphasis is mine.

Monetary policy operates with a lag – long and
variable lag, as you know – and if there is a sharp adjustment in demand, in activity, from whatever event, it will take some time for stimulus, if it’s provided – if it’s appropriate to be provided – for it to course through the economy and offset, to cushion that fall in demand. ( May 2016 Inflation Report press conference)

Although he did later claim to have “saved” 250,000 jobs showing yet again the appropriateness of the word unreliable in his case.

Interest-Rates

This is another awkward area for the Governor as he is back to predicting higher interest-rates. The last time he did that he cut them! Still maybe he has learnt something as his critique of a future cut is a description of what happened after the August 2016  one.

“If you cut rates you would end up with higher inflation.”

Public Finances

Moving away from the Governor to the Chancellor he appears to be unaware that the deficit figures have improved considerably.

Mr Hammond said the Treasury would be constrained in its ability to tackle the crisis by boosting spending, noting the country was still recovering from the aftermath of the 2008 crash and questioning the effectiveness of a fiscal stimulus in one country.

Comment

There is a fair bit to consider here. Let us start with house prices which have proved to be rather resilient in 2017/18, and I mean the dictionary definition of resilient not the way central bankers apply it to banks and growth. I thought we would see the beginnings of some falls but whilst there have been some in London the national picture has instead been one of slowing growth. The ideal scenario in my opinion would be for some gentle falls to deflate the bubble.Some argue that it could be done by them being flat for a while but with wage growth seemingly stuck in the 2% to 3% range that would take too long in my opinion.

But house prices are too high and the Bank of England and the government have conspired and operated to put them there. The use of the word “help” in some of the policies has been especially Orwellian as the result of it is invariably to push house prices even higher and thus even more out of reach. So to them a 35% fall seems dreadful and I can imagine the gloom around the cabinet table as it was announced. The Governor would have been gloomy too as the fall would be slightly larger than the rises his policies have helped to engineer as we mull whether that is why 35% in particular was chosen?

So overall a 35% fall in house prices would bring benefits but it would not be a perfect policy. I have had various replies on social media from people who have recently bought and I have friends in that position. I wish them no ill which is why my preference is for the scenario I have outlined. But the housing market cannot be a one way bet forever .

Also let us take some perspective. You see there is little new in the forecast we have discussed today as it has been the Bank of England no-deal Brexit forecast for some time now. So let me finish on a more optimistic note tucked away in the FT article.

However, he boosted Mrs May’s position when he said that if she struck a Brexit deal based on her much-criticised Chequers exit plan presented to Brussels in July, the economy would outperform current forecasts because it would be better than the bank’s assumed outcome.

A reward for his extra seven months? At that point the Prime Minister might have mused how much nicer he might have been if she had given him an extra year.