Central bankers are warming us up for more inflation again

A feature of the credit crunch era is the repetition of various suggestions from governments and central banks. One example of this has been the issue of Eurobonds which invariably has a lifespan until the nearest German official spots it. Another has been the concept of central banks overshooting their inflation target for a while. It is something that is usually supported by those especially keen on ( even more) interest-rate cuts and monetary easing so let us take a look.

Last Wednesday European Central Bank President Mario Draghi appeared to join the fray and the emphasis is mine.

Well, on your second question I will answer saying exactly the same thing. We don’t tolerate too low inflation; we remain fully committed to using all necessary instruments to return inflation to 2% without undue delay. Likewise, our inflation aim doesn’t imply a ceiling of 2%. Inflation can deviate from our objective in both directions, so long as the path of inflation converges towards our medium-term objective. I believe I must have said something close to this, or something to this extent a few other times in the past few years.

Nice try Mario but not all pf us had our senses completely dulled by what was otherwise a going through the motions press conference. As what he said at the press conference last September was really rather different.

In relation to that: shouldn’t the ECB be aiming for an overshoot on inflation rather than an undershoot given that it’s been below target for so long?

Second point: our objective is an inflation rate which is below, but close to 2% over the medium term; we stay with that, that’s our objective.

As you can see back then he was clearly sign posting an inflation targeting system aiming for inflation below 2%. That was in line with the valedictory speech given by his predecessor Jean-Claude Trichet which gave us a pretty exact definition by the way he was so pleased with it averaging 1.97% per annum in his term. So we have seen a shift which leads to the question, why?

The actual situation

What makes the switch look rather odd is the actual inflation situation in the Euro area. Back to Mario at the ECB press conference on Wednesday.

According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.4% in March 2019, after 1.5% in February, reflecting mainly a decline in food, services and non-energy industrial goods price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline over the coming months.

So we find that inflation is below target and expected to fall further in 2019. This was a subject which was probed by one of the questions.

 It’s quite clear that the sliding of the five-year-to-five-year inflation expectations corresponds to a deterioration of the economic outlook. It’s also quite clear that as the economic outlook, especially the economic activity slows down, also markets expect less pressure in the labour market, but we haven’t seen that yet.

The issue of markets for inflation expectations is often misunderstood as the truth is we know so little about what inflation will be then. But such as it is again  the trend may well be lower so why have we been guided towards higher inflation being permitted.

It might have been a slip of the tongue but Mario Draghi is usually quite careful with his language. This leaves us with another thought, which is that if he is warming us up for an attitude change he is doing soon behalf of his successor as he departs to his retirement villa at the end of October.

The US

Minneapolis Fed President Neel Kashkari suggested this in his #AskNeel exercise on Twitter.

Well we officially have a symmetric target and actual inflation has averaged around 1.7%, below our 2% target, for the past several years. So if we were at 2.3% for several years that shouldn’t be concerning.

Also he reminded those observing the debate on Twitter that the US inflation target is symmetric and thus unlike the ECB.

Yes, i think we should really live the symmetric target and not tap the brakes prematurely. This is why I’ve been arguing for more accommodative monetary policy. But we are undertaking a year long review of various approaches so I am keeping an open mind.

As you can see with views like that the Donald is likely to be describing Neel Kashkari as “one of the best people”.  If we move to the detail there are various issues and my initial one is that inflation tends to feed on itself and be self-fulfilling so the idea that we can be just over the target at say 2.3% is far from telling the full picture. Usually iy would then go higher. Also if your wages were not growing or only growing at 1% you would be concerned about even that seemingly low-level of inflation.

If we consider the review the US Fed is undertaken we see from last week’s speech by Vice Chair Clarida a denial that it has any plans to change its 2% per annum target and we know what to do with those! Especially as he later points out this.

In part because of that concern, some economists have advocated “makeup” strategies under which policymakers seek to undo, in part or in whole, past inflation deviations from target. Such strategies include targeting average inflation over a multiyear period and price-level targeting, in which policymakers seek to stabilize the price level around a constant growth path.

As the credit crunch era has seen inflation generally be below target this would be quite a shift as it would allow for quite a catch-up. Which of course is exactly the point!

Comment

Central bankers fear that they are approaching something of a nexus point. They have deployed monetary policy on a scale that would not have been believed before the credit crunch hit us. Yet in spite of the negative interest-rates, QE style bond purchases and in some cases equity and property buys we see that there has been an economic slow down and inflation is generally below target. Also the country that has deployed monetary policy the most in terms of scale Japan has virtually no inflation at all ( 0.2% in February).

At each point in the crisis where central bankers face such issues they have found a way to ease policy again. We have seen various attempts at this and below is an example from Charles Evans the President of the Chicago Fed from back in March 2012.

My preferred inflation threshold is a forecast of 3 percent over the medium term.

We have seen others look for 4% per annum. What we are seeing now is another way of trying to get the same effect but this time looking backwards rather than forwards.

There are plenty of problems with this. Whilst a higher inflation target might make life easier for central bankers the ordinary worker and consumer faces what economists call “sticky” wages. Or in simple terms prices go up but wages may not and if the credit crunch is any guide will not. My country the UK suffered from that in 2010/11 when the Bank of England “looked through” consumer inflation which went above 5% with the consequence of real wages taking a sharp hit from which they have still to recover.

Next comes the issue that in the modern era 2% per annum may be too high as a target anyway. In spite of all the effort it has been mostly undershot and as 2% in itself has no reason for existence why not cut it? Then we might make progress in real wage terms or more realistically reduce the falls. That is before we get to the issue of inflation measures lacking credibility in the real world as things get more expensive but inflation is officially recorded as low.

Meanwhile central bankers sing along to Marvin Gaye.

‘Cause baby there ain’t no mountain high enough

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Could the UK target house price inflation and should we?

Yesterday brought news of a policy initiative from the Labour party on a subject close to my heart and was a subject which occupied much of my afternoon and evening. It also reminded me of the way that social media can have more than a few different but similar strands ongoing at the same time. So if I missed anyone out apologies but I did my best and did better at least that the respondent who seemed to think my name was Tom.

Here from The Guardian is the basis of the proposal.

The Bank of England could be set a target for house price inflation under plans being explored by the Labour party, with tougher powers to restrict mortgage lending to close the gap between property prices and average incomes.

The shadow housing secretary, John Healey, is considering whether, under a Labour government, the Bank should be set an explicit target following a decade of runaway growth in the property market, with the aim of tackling the housing crisis.

The author of the idea is Grace Blakeley and I replied to her that there are various problems with this but let us set out her idea properly from her paper for the think tank the IPPR.

This would be equivalent to the remit the Monetary Policy
Committee has to control consumer price inflation. Under such a target the Bank of England should aim to keep nominal house price inflation at (say) zero per cent for an initial period – perhaps five years – to reset expectations,
and allow affordability to improve.

As I replied to Grace I am a fan of that in spirit but there are issues including one from the next sentence which I have just spotted.

It should then be increased to the same
rate as the consumer price inflation target of 2 per cent per year, meaning zero real-terms house price growth.

Er no that is not zero in real terms because if you are aiming for “affordability to improve” your objective must be for wage growth to exceed house price growth yet it does not apparently merit a mention there. If for example both consumer and house price inflation were on this target at 2% per annum you would be losing ground if wage growth was below that level.

How would this be enacted?

The target should be implemented using
macroprudential tools such as capital requirements, loan-to-value, and debt to-income ratios.

The first question is whether you could do this? Mostly a new policy regime could as we already have some moves in this direction from the Bank of England as pointed out in the paper.

The FPC recently implemented a
loan-to-income ratio of 4.5 per cent for 15 per cent of new mortgages,

The two catches as that this area is one where the truth can be and sometimes is hidden as those who recall the  “liar loans” era will know. Next is the concept of shadow banking or if I may be permitted a long word the concept of disintermediation where you restrict the banks so people borrow form elsewhere such as offshore or overseas.

These problems would be especially evident if you tried to implement this.

Since house price inflation is different in parts of the country, the FPC’s guidance should be regionally specific.

That recognition is welcome but the scale of the issue troubles me. Let me give you some examples from right now where house prices are rising in much of the Midlands and Yorkshire as well as Northern Ireland whilst falling in and around London. Also as @HenryPryor pointed what the situation in Northern Ireland is very different to elsewhere.

Confirmation from that despite enjoying robust inflation in recent months, house prices in Northern Ireland remain some 41% 𝐥𝐨𝐰𝐞𝐫 than they were just prior to the start of the financial crisis in 2007.

Perhaps you could define Northern Ireland but is even it homogenous? A clear danger is that you end up with a bureaucratic nightmare with loads of different definitions and all sorts of border issues as well as increasing the likelihood of another form of disintermediation.

The relationship between the Bank of England and the government

A clear issue is that whilst the Bank of England can influence house prices it does not control them and the paper sets out areas where it is not in control.

House prices are also determined by other factors, not least the supply of housing, and therefore adoption of the target would need to be accompanied by a much more active housing policy. This might include public housebuilding, changes to planning policy, and curbs on overseas purchases of UK homes (Ryan-Collins et al 2017). The FPC should be able to request that the government do more with housing policy if it judges that it will be unable to meet its target through macroprudential tools alone.

The supply of housing is something we have discussed on here pretty much since I began writing articles and the theme has been that government’s of many hues have serially disappointed. The Ebbsfleet saga has been the headline in this respect. Also I have to say that the idea of the Financial Planning Committee needing to “request” help from government policy is welcome in one way but problematic in another. First it is a confession that macroprudential policies are far from a holy grail in this area. Second I can see many scenarios of which the main one would be an upcoming election when the government would simply pay lip service or worse ignore the “request”. Thus we would likely find ourselves singing along to Taylor Swift.

I knew you were trouble when you walked in
So shame on me now
Flew me to places I’d never been
Now I’m lying on the cold hard ground
Oh, oh, trouble, trouble, trouble
Oh, oh, trouble, trouble, trouble

I do mostly agree with this part though and so does the Bank of England as otherwise it would not have introduced the Funding for Lending Scheme back in the summer of 2012.

It is also worth noting, however, that recent research has shown that the level of mortgage lending is the primary determinant of house prices (Ryan-Collins et
al 2017).

Comment

There is a lot to consider here and let me again say that as regular readers will be aware I think that economic policy does need to take account of asset price booms and busts. The catch is in the latter part though because the very same Bank of England that you would be asking to reduce house price growth has been explicitly ramping it since the summer of 2012 and implicitly before then with the Bank Rate cuts and QE bond purchases that preceded it. So the current poachers would have to turn into gamekeepers. Would they? I have my doubts because as we look around the world central banks seem to fold like deck chairs when asset prices fall.

Next comes the issue of could this be done? To which the answer is definitely maybe as you could start on this road and at first your theories would apply. But if we look back to the past history of macroprudential policies there was a reason why they were abandoned and it is because they themselves lead to a boom and bust cycle and bringing things up to date I have doubts on these lines as well as I tweeted to Grace.

One of the problems of central banks in the modern era is that they have often ended up operating in a pro-cyclical fashion. How can you be sure with their poor Forward Guidance record that they can be counter cyclical?

It is easy to spot cycles in hindsight but looking ahead it is far harder as otherwise the aphorism that central banks have never predicted a recession would not keep doing the rounds.

Can we fix it? Yes we can make a start as I hinted at here.

Whilst I support the spirit of this in terms of including house prices. I would point out that the UK could change things by simply going back to the Retail Prices Index as an inflation target because it includes house prices.

Personally I would update the RPI ( using the RPIX version to exclude mortgage costs) so that it explicitly has house prices rather than reply on them implicitly via depreciation and as a stop-gap we could drop out fashion clothing to trim the formula effect. So in effect we would be reversing the changes made by Gordon Brown in the early part of the 2000s. Then off we go although something else would have to be changed as well as basically a clear out of current Bank of England policy makers.

you have the issue of it these days also supporting the economy as defined by GDP

Me on The Investing Channel

In the future will everybody be paid to issue debt?

This morning has brought a couple of developments on a road I have both expected and feared for some time. This road to nowhere became a theme as I questioned how central banks would respond to the next slow down? We have two examples of that this morning as we see industrial profits in China fall 14% year on year after quality adjustment or 27% without ( h/t @Trinhnomics). Also we have some clear hints – much more useful than so-called Forward Guidance – from ECB President Mario Draghi. So let me jump to a clear consequence of this.

The stockpile of global bonds with below-zero yields just hit $10 trillion — intensifying the conundrum for investors hungry for returns while fretting the brewing economic slowdown.

A Bloomberg index tracking negative-yielding debt has reached the highest level since September 2017………

This latest move if you look at their chart has taken the amount of negative yielding debt from less than US $6 trillion last September to US $10 trillion now as we observe what a tear it has been on. So if you buy and hold to maturity of these bonds you guarantee you will make a loss. So why might you do it?

While negative yields on paper suggest that investors lose money just by holding the obligations, bond buyers could also be looking at price gains if growth stalls and inflation stays low. But along the way, risk assets may be entering the danger zone.

So one argument is the “greater fool” one. In the hope of price gains someone else may be willing to risk a negative yield and an ultimate loss should they hold the bond to maturity.

However there always ways a nuance to that which was that of a foreign investor. He or she may not be too bothered by the risk of a bond market loss if they expect to make more in the currency. This has played out in the German and Swiss bond markets and never went away in the latter and is back in the former. Also investors pile into those two markets in times of fear where a small loss seems acceptable. This has its dangers as those who invested in negative yielding bonds in Italy have discovered over the past year or two.

The more modern nuance is that you buy a bond at a negative yield expecting the central bank to buy it off you at a higher price and therefore more negative yield. Let me give you an example from my country the UK yesterday afternoon. The Bank of England paid 144 for a UK Gilt maturing in 2034 which will mature at 100. This does not in this instance create a negative yield but it does bring a much lower one as a Gilt issue with a 4.5% coupon finds its yield reduced to 1.32%. There was a time the thought that a UK Gilt would be priced at 144 would only raise loud laughs. I also recall that the Sledgehammer QE of the summer of 2016 did create negative yields in the UK albeit only briefly. Of course in real terms ( allowing for inflation) that made the yield heavily negative.

The Euro area

The activities of the European Central Bank under Mario Draghi and in particular the QE based bond buyer have added to the negative yielding bond total. This morning he is clearly pointing us to the danger of larger negative interest-rates and yields as he focuses on what to him is “the precious”.

We will continue monitoring how banks can maintain healthy earning conditions while net interest margins are compressed. And, if necessary, we need to reflect on possible measures that can preserve the favourable implications of negative rates for the economy, while mitigating the side effects, if any. That said, low bank profitability is not an inevitable consequence of negative rates.

This matters because so far banks have found it difficult to offer depositors less than 0%. There have been some examples of it but in general not so . Thus should the ECB offer a deposit rate even lower than the current -0.4% the banks would be hit and for a central banker this is very concerning. This is made worse in the Euro area by the parlous state of some of the banks. Mario is also pointing us towards the ” favourable implications of negative rates for the economy” which has led Daniel Lacalle to suggest this.

Spain: Mortgage lending rises 16% in the middle of a slowdown with 80% of leading indicators in negative territory.

There is an attempt by Mario to blame Johnny Foreigner for the Euro area slow down.

The last year has seen a loss of growth momentum in the euro area, which has extended into 2019. This has been predominantly driven by pervasive uncertainty in the global economy that has spilled over into the external sector. So far, the domestic economy has remained relatively resilient and the drivers of the current expansion remain in place. However, the risks to the outlook remain tilted to the downside.

Those involved in the domestic economy might be worried by the use of the word “resilient” as that is usually reserved for banks in danger of collapse and we know what invariably happens next. But no doubt you have noted that in spite of the rhetoric we are pointed towards the economy heading south.

Then we get the central banking mic-drop as we wonder if this is the new “Whatever it takes ( to save the Euro)”.

We are not short of instruments to deliver on our mandate.

That also qualifies as an official denial especially as the actual detail shows that things from Mario’s point of view are not going well.

The weakening growth picture has naturally affected the inflation outlook as well. Our projections for headline inflation this year have been revised downwards and we now see inflation at 1.6% in 2021. Slower growth will also lead to a more muted recovery in underlying inflation than we had previously expected.

Comment

We have seen today that not only are there more people finding that debt pays in a literal sense but we have arrived in a zone where more of this is in prospect. I have explained above how this morning has brought a suggestion that there will be more of it in the Euro area and by implication around Europe as it again acts as a supermassive black hole. But let me now introduce the possibility of a new front.

Back in the 1980s the superb BBC television series Yes Prime Minister had an episode where Sir Humphrey Appleby suggests to Prime Minister Jim Hacker.

Why don’t you announce a cut in interest-rates?

Hacker responds by saying the Bank of England will not do it to which Sir Humphrey replies by suggesting a Governor who would ( and then does…). Now in a modern era of independent central banks that cannot possibly happen can it?

 He said the Fed should immediately reverse course and cut rates by half a percentage point.

Those are the words of the likely US Federal Reserve nominee Stephen Moore as spoken to the New York Times. Just in case you think that this is why he is on his way to being appointed I would for reasons of balance like to put the official denial on record.

And he promised he would demonstrate independence from Mr. Trump, whose agenda Mr. Moore has helped shape and frequently praised.

Returning directly to my theme of the day this in itself would not take US yields negative but a drop in the official interest-rate from 2.5% to 2% would bring many other ones towards it. For a start it would make us wonder how many interest-rate cuts might follow? Some of these thoughts are already in play as the US Treasury Note ten-year yield which I pointed out was 2.5% on Friday is 2.39% as I type this, In the UK the ten-year Gilt yield has fallen below 1% following the £2.3 billion of Operation Twist style QE as it refills its coffers on its way back to £435 billion.

 

UK house prices rose by 5.9% in February according to the Halifax

This morning has brought news that is like a ray of sunshine to Bank of England Governor Mark Carney. Indeed I am told he keeps checking if the sun has gone over the yardarm. From Reuters.

British house prices jumped in February, rising by 5.9 percent from January, mortgage lender Nationwide said on Thursday.

In annual terms, prices were up by 2.8 percent in the three months to February, the lender said.

A Reuters poll of economists had pointed to a 0.1 percent increase on the month and a 1.0 percent annual rise in prices.

Halifax’s index has tended to be more volatile than other measures of house prices of late.

Actually if you crunch the numbers UK house prices were 5.3% higher in February than in February 2018. So any junior at the Bank of England spotting this and telling the Governor will go straight on the fact-track promotion scheme. In case you are wondering why there is a difference between that and the number reported it is because the Halifax uses quarterly and not monthly numbers for annual growth.

In the latest quarter (December – February) house prices were 1.8% higher than in the preceding three months (September – November).

As we break the numbers down we see that there is a clear issue with monthly volatility with the last four months showing growth of -1.2%,2.5%,-3% and now 5.9%.So the series has increasingly placed itself in question.

Maybe they have been looking at Fulham which for some reason has seen quite a pick up in activity recently although care is needed as it saw drops this time last year.I also note that some of you have been pointing out a bit of a boom in the Midlands. Perhaps the Halifax only went to these two areas in February but however you try to spin it this months number reduces the credibility of the series.

Actually it also has rather caught out Silvana Tenreyro of the Bank of England who has not been keeping up with current events.

And official UK house price growth has also fallen, from an annual rate of 8% in mid-2016 to below
3% in the latest data. The growth rate of the Nationwide house price index, a timelier indicator, has fallen
further still.

Tenreyro

She sort of backs the Bank of England party line as she says “I agree with Mark” with little apparent enthusiasm.

So while I still envisage that in the event of a smooth Brexit we will need a small amount of tightening over
the next three years, before voting for any rate rises I would want to be confident that demand was growing
faster than supply.

She also repeats the Bank of England standard that whilst they are giving us Forward Guidance of higher interest-rates in fact interest-rates may go up or down.

As the MPC has long emphasised, the monetary policy response to such a scenario will depend on the
balance of these effects on supply, demand and the exchange rate. In my judgement, a situation where the
negative demand effects outweigh those other effects is more likely, which would necessitate a loosening in
policy. But it is easy to envisage other plausible scenarios requiring the opposite response.

Although as no doubt many of you have already spotted she seems to have “a loosening in policy” in mind. Also she does seem rather obsessed with one subject.

And however Brexit affects the economy, my monetary
policy decisions will continue to be framed by the MPC’s remit.

As to the more technical details after more than a few assumptions she thinks she has detected a rise in productivity growth.

More sophisticated statistical filtering
methods tell a similar story to these simple averages, with the trend of four-quarter productivity growth
picking up gradually from 0.1% in 2012 to 0.7% in 2018 when using the backcast data.

I would just warn that the accuracy of the numbers here may not be enough to support such filtering. Also her view that these numbers tend to be revised higher is not having a good morning as Eurostat has just revised Euro area GDP growth for the autumn of this year down from 0.2% to 0.1%

Saunders

Michael has discovered something which I first reported on here nearly ten-years ago.

Since late 2017, the MPC has increased the policy rate by 50bp, in two 25bp steps. Consistent with MPC
guidance, the rise in the policy rate has been gradual and limited……………However, pass-through to retail interest rates – both deposit rates and lending rates – has been unusually small. Many household interest rates have barely changed.

Actually it is the reason why QE was introduced because policymakers thought that the large cuts in Bank Rate would do the trick but found that some interest-rates did move but others did not. Actually some rose as I recall credit card interest-rates rising from circa 17% to more like 19%. So it is nice to see Michael catching up with reality. Some of you may already be experiencing a version of this which is far from unexpected here.

It is a similar story for rates on new household time deposits: a rise of 15bp so far (roughly 30% of
the rise in Bank Rate), versus average pass-through of just above 100% in prior MPC hiking cycles.

It seems that those looking for deposits and savings have little or no faith in the Forward Guidance of the Bank of England. Also it pumped them full of liquidity with the latest version of that being the Term Funding Scheme and if we add up such schemes they are still providing some £137 billion of liquidity. Or to put it another way that means that banks and building societies have much less need to compete for deposits. It also directly leads into this.

The average rate on new mortgages (covering both fixed and variable rate loans) is up by only 10-15bp, roughly 30% of the rise in the appropriate mix of Bank Rate and swap rates.

Brighter members at the Bank of England will consider that to be quite a triumph.

Frankly the section on higher interest-rates just seems like hot air.

In that scenario, further UK monetary tightening – limited and gradual – probably will be needed over time.

Okay but not now ( unlike when they wanted to cut which was immediate)

However, the possibility that monetary tightening might be needed in the future does not necessarily mean
we need to tighten now

You may have noted how quickly the rises went from probable to possible and we quickly see they may vanish in a puff of smoke.

And as we have said before, the monetary
policy response to Brexit, whatever form it takes, will not be automatic and could be in either direction.

Comment

The farce that is Forward Guidance is a saga that no-one seems able to stop. Supposedly individuals and businesses are being helped in their planning by being informed of what the Bank of England intends to do with interest-rates. The most obvious problem is that when there was a response from the ordinary person via a higher uptake in fixed-rate mortgages the Bank of England then cut interest-rates in a sharp about turn. I never really imagined many would follow this outside of financial markets but that must have cut the number even further.

As to house prices we are reminded of the flawed nature of many of the indices which measure them by today’s extraordinary number from the Halifax.

The Investing Channel

 

 

 

Is it to be higher interest-rates from Mark Carney and the Bank of England?

Yesterday saw a swathe of news from the Bank of England and in particular its Governor Mark Carney who gave evidence to the Economic Affairs Committee of the House of Lords. That is the same body I gave evidence too over the Retail Prices Index and inflation measurement more generally. In some ways he was true to form but in more recent terms opened up a new front with this.

*CARNEY: MARKET PATH OF BOE RATES MAY NOT BE HIGH ENOUGH ( @SmithEconomics )

Although @fxmacro struggled to keep the online equivalent of a straight face.

CARNEY: MARKET PATH OF BOE RATES MAY NOT BE HIGH ENOUGH algos buying on this gibberish

If we start with the algorithm buying meme that is because some automated trades operate off headlines. Things have become much more advanced than in the days of what we used to call “Metal Mickey” ( after a children’s TV programme) trading on the LIFFE floor but the essence is the same. In this instance it and other buying saw the UK Pound £ rise by around half a cent.

Actually the UK Pound £ has been rising in 2019 as the effective exchange rate index has risen from 76.25 on January 3rd to more like 80 now meaning using the old Bank of England rule of thumb that monetary conditions have tightened by a bit more than a 0.5% Bank Rate rise. So it is initially curious to say the least to be hinting at interest-rate rises especially if we see the economic news.

Markit business survey

Governor Carney was speaking not long after the Markit Purchasing Manager’s Index or PMI survey for services had been released. This completed the set which told us this.

At 51.4 in February, up from 50.3 in January, the seasonally adjusted All Sector Output Index signalled a marginal expansion of UK private sector output.

So some growth but not much as they indicated here.

“The latest PMI surveys indicate that the UK economy
remained close to stagnation in February, despite a flurry
of activity in many sectors ahead of the UK’s scheduled
departure from the EU. The data suggest the economy is on
course to grow by just 0.1% in the first quarter.”

Putting it another way.

UK PMI charted against Bank of England policy decisions. PMI still deep in dovish territory.

So if we look at the evidence such as we have it the UK economy contracted in December by 0.2% and seems to be now growing at a quarterly rate of 0.1%. Whilst I have my doubts about PMIs ( think July 2016 if nothing else) the Bank of England relies on them. So it is hinting at interest-rate rises when two main signals are much more in line with interest-rate cuts. Of course this was familiar territory in 2016 when the promise of interest-rate rises faster than markets expect ( deja vu alert ) somehow morphed into not only an interest-rate cut but promises of another smaller one ( 0.1% or 0.15%). The former happened but the latter was dropped as it turned out that the Bank of England was reading the wrong set of tea leaves.

Has something changed?

Well definitely maybe as I note this from The Times.

A disorderly no-deal Brexit would be only half as damaging as the Bank of England warned three months ago, Mark Carney has said.

So what is the detail here?

In November the Bank said that after three years the economy would be between 4.75 per cent and 7.75 per cent smaller than under the prime minister’s plan if there was a hard Brexit.

Mr Carney, the Bank’s governor, told peers yesterday that contingency plans put in place would reduce the damage by 2 percentage points in the “disruptive” model or 3.5 percentage points in the worse “disorderly” one. Both scenarios assumed that there would be significant border frictions, a market crash and a sterling collapse on March 29.

So what has changed since November?

Britain has put in place temporary simplified procedures to reduce border checks and the government has secured six EU free-trade agreements worth about 4 per cent of UK trade. “That’s something, it’s not everything,” Mr Carney said. The Bank has also struck financial services deals with the EU. Brussels, too, has taken measures to reduce friction at the borders.

This is a really awkward subject for the Bank of England which keeps finding itself having to upgrade its forecasts for the post-EU leave vote world and now for versions of the world post Brexit. In the latter example I do have some sympathy as its work was more scenario than forecast but it is also true that it could have produced examples of how things might change if deals were struck. Also the way that Governor Carney has presented things has been in line with his own opinion and has led to accusations of being one-sided.

So maybe there is an influence here on his seeming enthusiasm for interest-rate rises although we do of course have the issue that in spite of claiming large amounts of enthusiasm over the past five years or so he has in net terms delivered the grand sum of one 0.25%.

Be Prepared

Much more satisfactory and an example of the Bank of England doing the right thing came from what may seem an arcane announcement.

The transactions will be facilitated by the activation of the standing swap line between the Bank of England and the European Central Bank as part of the existing international network of standing swap lines which provide an important tool for central banks in pursuit of their financial stability objectives.

The first weekly operation will be on 13 March and operations will run until further notice.

Actually the ECB makes it clearer as to what might happen.

Bank of England to obtain euro from the ECB in exchange for pound sterling.

Also as some may miss this then this is also true.

As part of the same agreement, the Eurosystem would stand ready to lend pound sterling to euro area banks, if the need arises.

So these arrangements provide a backstop for “the precious” otherwise known as the banking system. In terms of use it has mostly been European banks activating such lines usually to get US Dollars but there was a phase of requiring Swiss Francs. Also Japanese banks have needed US Dollars from time to time. There is an irony if we look at the present role of Ireland that the particular swap lines we are looking at today were brought in to help the Central Bank of Ireland if it needed UK Pounds.

Putting the wolf in charge of the chicken house

As the Bank of England is potentially the body that is most keen on eliminating cash so it can more easily introduce negative interest-rates today’s news which the media has latched onto is an example of gallows humour.

Sarah John, Chief Cashier, said: “We are committed to cash. Although its use is declining, many people, including vulnerable groups, still prefer to use cash. It is important that everybody has a choice about how they make payments.  The action we are announcing today will help to support cash as a viable means of payment for those who want to use it.”

The Bank is today announcing that it will convene relevant stakeholders to develop a new system for wholesale cash distribution that will support the UK in an environment of declining cash volumes.

Comment

There is a fair bit of uncertainty to say the least about what will happen in the UK as we move into April. Will we Brexit or not and if so in what form? The problem with the forecasts produced by the Bank of England are that many of the variables were unknown and some still are. We are left with the view that under Governor Carney it has been more than happy to push the establishment line which would chop another leg off the independence chair if you can find one. It is simply not its place to be cheered by one side of the debate and attacked by the other.

Moving to more technical issues I welcome the way that the FX swap lines are being made ready. Some of that is just for show as they could have been used anyway but it does no harm to show that you are prepared. As ever it is about the banks but for once the rest of us benefit too.

Lastly let me move onto a subject I spend much time on so will be brief. From the Financial Times.

UK must tackle RPI inflation reform, Mark Carney says

So he has been cracking on with it since 2013 then? Er no. I have been as regular readers will be aware but both the Financial Times and the Bank of England have stood in the way. Added to this is his suggestion that we only need one measure of consumer inflation when the ones for macroeconomics and the cost of living are really rather different due to the way the housing sector can disappear in the former like they are a Klingon battle cruiser in Star Trek.

The Bank of England reads the Guardian as it looks for economic clues

Yesterday brought something of a confession about the forecasting problems of the Bank of England.

As the American playwright Arthur Miller wrote, “A good newspaper, I suppose, is a nation talking to itself.” Using text analysis and machine learning, we decided to put this to test – to find out whether newspaper copy could tell us about the national economy, and in particular, whether it can help us predict GDP growth. ( Bank Underground).

As you can see there is a clearly implied view that they new help in predicting GDP growth. Curious though that they go to newspapers which are not only in decline in circulation terms but are under the “Fake News” cloud. Mind you they may well be more reliable than the Spotify playlists so beloved of Chief Economist Andy Haldane.

It is hard not to have a wry smile at the newspaper of choice here.

To find out, we used text from the daily newspaper The Guardian.

At this point the Financial Times otherwise known as the Bank of England’s house journal is likely to be somewhat miffed, although its brighter journalists will no doubt be aware of its own very poor forecasting record. Anyway Bank Underground found a nice reason to exclude it.

We chose this paper on account of it being free and easy to download;

Does the Bank of England have a poor internet connection? As to whether all of this works well they think it does.

First, their importance in forecasting current economic activity is comparable to a range of high-profile indicators, including the Index of Services, retail sales, equity prices and other confidence indicators, which are typically regarded as leading the economic cycle.

The catch is that they are comparing to this.

 the relevance of NI2 is over half the size of the IHS Markit/CIPS PMI indicator, which has come to be considered the single best survey_based predictor of current economic activity followed by many central banks and market participants.

For all their hype we know that the PMIs are not as reliable as we once thought or hoped as we mull whether the Bank of England has “amnesia” over the August 2016 PMI surveys which led to its Sledgehammer QE and Bank Rate cut as well as panicky promises of more of the same. Only for it to have a red face as it discovered it’s compass was upside down.

Upside down
Boy, you turn me
Inside out
And round and round
Upside down
Boy, you turn me
Inside out
And round and round ( Diana Ross)

Of course they could look at the money supply data which we are about to do. It has worked pretty well and it cannot be hard for them to do as they produce it themselves. It is really rather odd that they do not.

UK Money Supply

If we stay with forecasting as a theme it is really rather odd that the Bank of England abandoned the M0 money supply measure back in 2006. If it had kept it then its Chief Economist Andy Haldane may not have needed to be such a nosey parker about what everyone else is listening too on Spotify. Also for such a Europhile organisation it is rather extraordinary that today’s Money and Credit report does not include an M1 measure. After all that has proved to be an excellent economic leading indicator for the Euro area as we looked at only on Wednesday.

What we are left with is the broad money series or M4 which is very erratic on a monthly basis.

The total amount of money held by UK households, private non-financial corporations (PNFCs) and non-intermediary other financial corporations (NIOFCs) (broad money or M4ex) fell £3.6 billion in January.

Not good but that follows a £12,5 billion expansion in December which was out of line the other way. If we move to the rolling three-month average it at 2.4% is better than it was at the end of last year but continues to only suggest weak economic growth.

If we switch to lending that looks stronger and January was a good month for business lending.

The increase is bank lending to businesses was driven by lending to large businesses. This increased £4.3 billion in January, significantly above the recent levels, driven by M&A activity. Bank lending to small and medium-sized enterprises (SMEs) increased by £0.2 billion in January.

It is nice for once to see SME lending rising and if we switch to the detail around a third was for manufacturing. If we look for some perspective then the annual rate of growth for total business lending has risen to 4.2% which may be hopeful although I consider lending to be more of a lagging than a leading indicator.

Unsecured Credit

This has been on something of a tear such that the Bank of England has been able to call circa 7% annual growth rates an improvement. However there was something of a turn the other way in January.

The extra amount borrowed by consumers to buy goods and services increased to £1.1 billion in January , slightly above the £0.9 billion monthly average since July 2018, but below the £1.5 billion average between January 2016 and June 2018. Within this, credit card lending picked up after a weak December and other loans and advances increased slightly on the month.

So the Bank of England is still able to report an improvement as we note the monthly rise.

Annual consumer credit growth continued to slow, reaching 6.5% in January. The monthly flow of consumer credit was marginally higher in January than the recent average.

But even at 6.5% it is far higher than anything else in the UK economy at around double the increase in wages and quadruple the rate of economic growth.

Manufacturing PMI

There is a link between the data above and this as we see this in the report.

Efforts to stockpile inputs were aided by a solid expansion of purchasing activity at UK manufacturers. This was also felt at suppliers, where the increased demand for raw materials led to a further marked lengthening in average lead times (albeit the least marked since January 2017).

So we see that manufacturers have borrowed to build up stocks which seems sensible to me. This meant that overall we did well.

The headline seasonally adjusted IHS Markit/CIPS
Purchasing Managers’ Index® (PMI®) fell to a four-month low of 52.0 in February,

The reason why I think that is good is because if we look at the Euro area for example it had a minor contraction at 49.3 with Germany at 47.6 pulling it lower. Anyway for a different perspective here is how fastFT has covered this.

UK manufacturing outlook dimmest on record, key survey shows

I fear for what they must make of Germany don’t you?

Comment

There is a lot to consider here but let us start with the economic outlook which looks steady as she goes from the monetary data set. Not much growth but some as we bumble along. On a conceptual level this poses a deep question for the Bank of England which has interfered in so many markets yet claims that economic growth now has a “speed limit” of 1.5% conveniently ignoring its own role in this. Also why did it end the narrow money supply data which works well as a leading indicator?

Much may happen at the end of this month as we wait to see what and indeed if any form of Brexit starts at the end of it. But we continue to borrow heavily on an unsecured basis and even with the better number in January be far less enthusiastic about small business borrowing. Just as a reminder the Funding for Lending Scheme of the Bank of England was supposed to provide exactly the opposite result.

 

The perils of Persimmon and how easy monetary policy helped create excess profits

One of the main themes of my work is that  the monetary easing by central banks has boosted asset prices, but the catch is that for example rises in house prices are inflation for the first-time buyer as well as those trading up. So the theme that it is all wealth effects is untrue. But we find that the effort to pump up house prices has also involved governments and in the UK much of this has been focused on the Help To Buy scheme. There are two main problems with this of which the opening one is simply that if you give people “help” in this form it is only brief because house prices rise to the new amount that can be afforded rather quickly. This creates windfall gains for existing home owners and the companies that build the houses. It is the latter we will focus on as there is a candidate in number one position for earning what in my days as a student were called “excess profits”. So one bit of economics 101 exists even if it is only good news for the shareholders and managers of in this instance Persimmon Homes.

Persimmon

From Reuters earlier.

Britain’s Persimmon Plc, which is under scrutiny from the government for its practices under the “Help to Buy” scheme, on Tuesday named interim Chief Executive Officer Dave Jenkinson to the role on a permanent basis.

The company, whose former CEO Jeff Fairburn stepped down last year amid backlash surrounding his bonus package, reported a 13 percent rise in full-year pretax profit to 1.09 billion pounds ($1.43 billion)

So profits are now over a billion pounds and we can remind ourselves that at Persimmon profits were at an excess level on an individual basis as we go back to the 22nd of October last year.

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.

In this instance we can spell excess profits with one word, greed. Returning to the company itself I explained back then how the excess profits were built up.

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.

This morning we have been provided with some numbers to that effect. From the BBC.

Almost half the homes it built (7,970 out of 16,449) sold through the Help-to-Buy scheme Average selling price of all its homes: £215,563…….Mike Amey, managing director of global investment management firm Pimco, told the BBC that profit per household at Persimmon had trebled since Help To Buy was introduced.

I think he means per house built but we get the idea. So we see that Help To Buy has allowed Persimmon to build more houses at treble the previous profit. This has led to this.

The Persimmon money machine rolls on, profits past the £1bn mark and £2.2bn returned to shareholders in the past seven years, with the promise of more – much more – to come. ( BBC)

When Help To Buy started back in April 2013 the share price was around £9 as opposed to the current £24 and of course as noted above money has also been returned to shareholders. I guess that avoids the rise in the share price becoming even higher. As the current market capitalisation is £7.6 billion according to Investing.com the extra dividends have been both significant and material.

Shoddy Work

This is a section my late father would be more than happy for me to emphasise. His work as a plastering subcontractor saw him work on one estate which was built so badly it was easier in the end to knock it all down. Another was where the architect was proud of his inward sloping balconies and ignored warnings of the dangers, well until it rained anyway. So let me note that the excess profits have not been accompanied by high quality work.

Persimmon has been dogged by complaints about poor build quality among Help to Buy customers – with satisfaction rates remaining below its 4-star target of 80%. ( SkyNews )

Reuters have suggested the housing minister James Brokenshire is now on the case.

However the company – along with some others in the sector – has attracted criticism for practices such as selling houses with rising leasehold charges which make them hard or impossible to sell on, and for poor quality workmanship.

“Leasehold, build quality, their leadership seemingly not getting they’re accountable to their customers, are all points that have been raised by (the minister) privately,” the source said, echoing a report in The Times newspaper.

The issue with leasehold charges is a national disgrace. The issues concerning leasehold and freehold ownership were supposed to have been settled years and indeed decades ago. Yet the scandal goes on and nothing has been done about it.

Comment

The environment remains extremely favourable for the likes of Persimmon and it continues to receive a bit more than a helping hand from the Help To Buy scheme. This is because whilst we have seen some house price falls these are mostly around central London where prices are too high for Help To Buy anyway. We are left to observe a scheme that has enriched one group of people the shareholders and massively enriched the managers and directors. It is not as if the quality of the work has been high and in fact the reverse seems to be the case.

There is a clear issue in the way that these things have been allowed to persist as we all make mistakes but even if we give the government a free pass on the first year or two we cannot give it a free pass on the way it has allowed this to persist. I do hope that government ministers will not in the future be joining housebuilders boards of directors.

If we move to monetary policy there may be further relief for house builders if the evidence of Sir David Ramsden to Parliament earlier is any guide.

I agree with the MPC’s collective view
that the monetary policy response to Brexit, whatever form it takes, will not be automatic and could
be in either direction.

Also Governor Mark Carney points out this.

Although the principles guiding the MPC’s choice of threshold still hold, the creation of the
Term Funding Scheme had reduced the effective lower bound on Bank Rate from ½% to 0%.

Also the Governor has got himself into something of a mess with this statement.

The MPC now views that the level from which Bank Rate can be cut materially is now
around 1½%.

So the cut from 0.5% to 0.25% was not “material”? Odd because I recall him claiming that it has saved around 250,000 jobs……