Can the UK afford all the extra debt?

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

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

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

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

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

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

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

The Bank of England

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

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

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

Quantitative Easing

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

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

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

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

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

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

Actual Debt Costs

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

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

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

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

Comment

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

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

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

Podcast

 

 

The UK shopper strikes yet again!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Public Finances

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

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

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

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

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

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

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

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

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

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

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

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

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

National Debt

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

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

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

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

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

Comment

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

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

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

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

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

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

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

 

 

 

 

 

The UK house price boom is facing higher mortgage rates

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

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

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

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

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

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

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

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

Monetary Policy

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

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

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

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

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

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

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

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

Comment

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

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

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

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

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

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

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

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

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

The economy

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

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

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

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

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

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

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

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

Impact of Lockdown 2

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

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

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

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

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

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

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

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

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

Comment

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

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

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

 

 

 

Central bank Digital Coins are to enforce negative interest-rates

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

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

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

The real problem is highlighted here.

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

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

The ECB’s Problem

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

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

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

The Plan

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

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

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

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

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

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

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

The IMF lets the cat out of the bag

Back in February 2019 it told us this.

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

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

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

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

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

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

Comment

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

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

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

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

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

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

Podcast

The Bank of England has pumped up the housing market again

Overnight there has been quite a shift in economic sentiment. To some extent I am referring to the falls in equity markets although the real issue is the new lockdown in France and increased restrictions in Germany. As we have been noting they were obviously on their way and the Euro area now looks set to see its economy contract again this quarter. It will be interesting to see how and if the ECB responds to this in today’s meeting and these feeds also into the Bank of England. The UK has tightened restrictions especially in Northern Ireland and Wales as we now wonder what more the central banks can do in response to this?

Still even in this economic storm there is something to make a central banker smile.

LONDON (Reuters) – Lloyds Banking Group LLOY.L posted forecast-beating third quarter profit on Thursday, lowering its provisions for expected bad loans due to the pandemic and cashing in on a boom in demand for mortgages.

Britain’s biggest domestic lender reported pre-tax profits of 1 billion pounds for the July-September period, compared to the 588 million pounds average of analysts’ forecasts.

Few things cheer a central banker more than an improvement in prospects for The Precious! But we can see that there is also for them a cherry on top of the icing.

The bank booked new mortgage lending of 3.5 billion pounds over the quarter, after receiving the biggest surge in quarterly applications since 2008.

That links into the theme of monetary easing which of course is claimed to help businesses but if you believe the official protestations somehow inexplicably ends up in the housing market every time. So let us look at the latest monetary data which has just been released. Oh and one point before I move on, what use are analysts who keep getting things so wrong?

Mortgages

Whoever was responsible for the Bank of England morning meeting today must have run there with a smile on their face and gone through the whole release word by word.

The mortgage market strengthened a little further in September. On net, households borrowed an additional £4.8 billion secured on their homes, following borrowing of £3.0 billion in August. This pickup in borrowing follows high levels of mortgage approvals for house purchase seen over recent months. Mortgage borrowing troughed at £0.2 billion in April, but has since recovered reaching levels slightly higher than the average of £4.0 billion in the six months to February 2020. The increase on the month reflected higher gross borrowing of £20.5 billion, although this remains below the February level of £23.4 billion.

From their perspective they will see this as a direct response to the interest-rate cuts and QE they have undertaken as net mortgage borrowing has gone from £0.2 billion in April to £4.8 billion. Something they can achieve.

The outlook,from their perspective, looks bright as well.

The number of mortgage approvals for house purchase continued increasing sharply in September, to 91,500 from 85,500 in August (Chart 1). This was the highest number of approvals since September 2007, and is 24% higher than approvals in February 2020. Approvals in September were around 10 times higher than the trough of 9,300 approvals in May.

At this point we have what in central banking terms is quite an apparent triumph as they have lit the blue touch paper for the housing market. It has not only been them as there have also been Stamp Duty reductions but we see that there is an area of the economy that monetary policy can affect.

As to what people are paying? Here are the numbers.

The ‘effective’ interest rates – the actual interest rates paid – on newly drawn, and the outstanding stock of, mortgages were little changed in September. New mortgage rates were 1.74%, an increase of 2 basis points on the month, while the interest rate on the stock of mortgage loans fell 1 basis point to 2.13% in September.

Money Supply

Curiously the Money and Credit release does not tell us the money supply numbers these days although we do get this.

Overall, private sector companies and households increased their holdings of money in September. Sterling money (known as M4ex) increased by £10.8 billion in September; a significant rise from August which saw withdrawals of £1.0 billion (Chart 5). This is a continuation of the trend of strong deposit flows seen between March and July, albeit at a much weaker pace in comparison to the £40.5 billion monthly average seen during that period.

In essence this is part of the higher savings we have observed where people have furlough payments to keep incomes going but opportunities to spend them have been cut.

I have looked them up and annual M4 (broad money) growth was 11.6% in September. So we are seeing a push of the order of 12% which is more than in the Euro area.

Consumer Credit

Here the going has got a lot tougher and the monetary push seems to be fading already.

Household’s consumer credit weakened in September with net repayments of £0.6 billion, following some additional net borrowing in July (£1.1 billion) and August (£0.3 billion).

Actually the numbers have established something of an even declining trend since July. This means that the detail looks really rather grim.

Although the repayment in September was small in comparison to the £3.9 billion monthly average seen between March and June, this contrasts with an average of £1.1 billion of additional borrowing per month in the 18 months to February 2020. The weakness in consumer credit net flows pushed the annual growth rate down further in September to -4.6%, a new series low since it began in 1994.

In fact it is essentially repayment of credit card debt.

The net repayment of consumer credit was driven by a net repayment on credit cards of £0.6 billion

So it has an annual growth rate of -11.3% now. That is probably due to the price of it which is something of a binary situation.For those unaware there have been quite a few 0% offers in the UK for some time now but this is also true for others.

The cost of credit card borrowing was also broadly unchanged at 17.92% in September.

Although blaming the interest-rate for credit card borrowing does have the problem that overdraft interest-rates have been on quite a tear.

The effective rates – the actual interest rate paid – on interest-charging overdrafts continued to rise in September, by 3.52 percentage points to 22.52%. This is the highest since the series began in 2016, and compares to a rate of 10.32% in March 2020 before new rules on overdraft pricing came into effect.

Perhaps those that can have switched to the much cheaper personal loans.

Rates on new personal loans to individuals were little changed in September, at 4.78%, compared to an interest rate of around 7% in early 2020.

As you can see Bank of England policy has been effective in reducing the price of those.

Comment

The present situation gives us an insight into the limits of monetary policy and as to whether we are “maxxed out”. We see that the Bank of England interest-rate cuts, QE bond purchases (another £4.4 billion this week) and credit easing can influence the housing market and personal loans. However we have also noted the way that more risky borrowers are now wondering where all the interest-rate cuts went? For example a 2 year fixed rate with a 5% deposit was 2.74% in July as the Bank of England pushed rates lower but was 3.95% in September, or a fair bit higher than before the easing ( it was typically around 3%).

So we see that monetary policy is colliding with these times even before we get out into the real economy and a reason for this can be see on this morning’s release from Lloyds Bank. Some £62.7 billion of mortgages went into payment holidays of which £9.1 billion have been further extended and £2.2 billion have missed payments. No doubt the banks fear more of this and this is why they are tightening credit for riskier borrowers which operates in the opposite direction to Bank of England policy.

So the easing gets muted and we are left mostly with the easing of credit for the government as the instrument of policy right  now.

 

 

 

 

The Bank of England has become an agent of fiscal policy

It is time to take a look at the strategy of the Bank of England as there were 2 speeches by policymakers yesterday and 2 more are due today including one from the Governor. But before we get to them let us first note where we are. Bank Rate is at 0.1% which is still considered by the Bank of England to be its lower bound, however it did say that about 0.5% and look what happened next! We are at what might now be called cruising speed for QE bond purchases of just over £4.4 billion per week. Previously this would have been considered fast but compared to the initial surge in late March it is not. The Corporate Bond programme has now reached £20 billion and may now be over as the Bank has been vague about the target here. That is probably for best as whilst the Danish shipping company Maersk and Apple were no doubt grateful for the purchases there were issues especially with the latter. It is hard not to laugh at the latter where the richest company in the world apparently needed cheaper funding. Also we have around £117 billion deployed as a subsidy for banks via the Term Funding Scheme and some £16 billion of Commercial Paper has been bought under the Covid Corporate Financing Facility of CCFF.

The Pound’s Exchange Rate

It has been a volatile 2020 for the UK Pound £ as the Brexit merry-go-round has been added to by the Covid-19 pandemic. The initial impact was for the currency to take a dive although fortunately one of the more reliable reverse indicators kicked in as the Financial Times suggested the only was was down at US $1.15. Yesterday saw a rather different pattern as we rallied above US $1.31. However as we widen our perspective we have been in a phase where both the Euro and the Yen have been firm,

If we switch to the trade-weighted or effective index we see that the Pound fell close to 73 in late March but has now rallied to 78. Under the old Bank of England rule of thumb that is equivalent to a 1.25% increase in Bank Rate. Right now the impact is not as strong due to trade issues but even if we say 1% that is a big move relative to interest-rates these days.

Ramsden

Deputy Governor Ransden opened the batting in his speech yesterday by claiming  that lower interest-rates were nothing at all to do with the cuts he and his colleagues have voted for at all.

Over time, these developments reduced the trend interest-rate, big R*, required to bring stocks of capital and wealth into line. And policy rates, including in the UK, followed the trend downwards.

So we no longer have to pay him a large salary and fund an index-linked pension as doe example AI could do the job quite easily? Also it is hard not to note that we would not be told this if the interest-rate cuts had worked.

As a former official at HM Treasury one might expect him to be a fan of QE as it makes the Treasury’s job far easier so this is little surprise.

QE has been an effective tool for stimulating demand through the 11 years of its use in the UK .

Really? If it has been so effective why has it been required for 11 years then? He moves onto a suggestion that there is plenty of “headroom” for more of it. This is followed by an extraordinary enthusiasm for central planning.

But again my starting point is that we have plenty of scope to affect prices. While yields on longer-dated Gilts are at historically low levels, that does not mean they could not still go lower.

There is a problem with his planning though because the QE he is such an enthusiast for has given the UK negative interest-rates via bond yields. At the time of writing maturities out to 6 years or so have negative yields of around -0.06%, Yet he is not a fan of negative interest-rates.

While there might be an appropriate time to use negative interest-rates, that time is not right now, when the economy and the financial system are grappling with the effects of an unprecedented crisis, as well as the myriad uncertainties this crisis has created.

Ah okay, so he is worried about The Precious! The Precious! Curious that because we are told they are so strong.

the banking sector as a whole starts from a position of strength.

Perhaps somebody should show Deputy Governor Dave a chart of the banks share prices. That would soon end any talk of strength. Also if you are Deputy Governor for Markets and Banking it would help if you had some idea about markets.

As a generic I would just like to point out that those who claim the Bank of England is independent need to explain how it has come to be that all the Deputy-Governors have come from HM Treasury?

The Chief Economist

The loose cannon on the decks has been on the wires this morning as he has been speaking at a virtual event. From ForexLive

  • Nothing new to say on negative rates
  • BOE is doing work on negative rates, not the same as being ready to use it
  • Monetary policy can provide more of a cushion to the crisis
  • But more of the heavy lifting has to be done by fiscal policy

Actually he then went on what is a rather odd excursion even for him.

There Is An Open Question Whether Voluntary Or Involuntary Social Distancing Is Holding Back Spending ( @LiveSquawk)

For newer readers he seems to be on something of a journey as previously one would expect him to be an advocate of negative interest-rates whereas now he is against them.

Comment

There is a sub-plot to all of this and let me ask the question is this all now about fiscal policy? The issues over monetary policy are now relatively minor as any future interest-rate cuts will be small in scale to what we have seen and QE bond buying is on the go already. The counterpoint to this is that the Bank of England has seen something of a reverse takeover by HM Treasury as its alumni fill the Deputy Governor roles. Its role is of course fiscal policy.

The speech by Deputy Governor Ramsden can be translated as we will keep fiscal policy cheap for you as he exhibits his enthusiasm for making the job of his former colleagues easier. That allows the Chancellor to make announcements like this.

Chancellor Rishi Sunak is to unveil new support for workers and firms hit by restrictions imposed as coronavirus cases rise across the UK.
He is due to update the Job Support Scheme, which replaces furlough in November, in the Commons on Thursday. ( BBC )

So we have been on quite a journey where we were assured that monetary policy would work but instead had a troubled decade. Whilst the Covid-19 pandemic episode is a type of Black Swan event there is the issue that something would be along sooner or later that we would be vulnerable to. Now central banks are basically faciliatators for fiscal policy. This brings me to my next point, why are we not asking why we always need more stimuli? Surely that means there is an unaddressed problem.

UK sees a worrying rise in inflation and record borrowing

Today has brought quite a panoply of UK economic data some of it which is hardly a surprise, but there is a section which is rather eye-catching and provides food for thought. It will only be revealed at the Bank of England morning meeting if someone has the career equivalent of a death wish.

The annual rate for CPI excluding indirect taxes, CPIY, is 2.2%, up from 1.8% last month……The annual rate for CPI at constant tax rates, CPI-CT, is 2.2%, up from 1.8% last month.

The pattern for these numbers has been for a rise as CPI-CT initially dipped in response to the Covid-19 pandemic and fell to 0.4% in May. But since then has gone 0.5%,1%,1.8% and now 2.2%.

The sector driving the change has been the services sector which has seen quite a lift-off. If we look back we see that it has been regularly above 2% per annum but after a brief dip to 1.7% in June it has gone 2.1%, 4.1% and now 5%. Something that the Bank of England should be investigating as these seems to be quite an inflationary surge going on here. It is so strong that it has overpowered the good section ( -0.4% and the energy one ( -8.5%) both of which are seeing disinflation.

Nothing to see here, move along now please

Of course the official Bank of England view will be based on this number.

The Consumer Prices Index (CPI) 12-month rate was 0.5% in September 2020, up from 0.2% in August.

On that road they can vote for more QE bond buying next month ( another £100 billion seems likely) and if one policymaker is any guide they are looking ever more at further interest-rate cuts.

There is some debate about the scale of the stimulus that negative rates have imparted on these economies, but the growing empirical literature finds that the effect has
generally been positive, i.e. negative rates have not been counterproductive to the aims of monetary policy.

That is hardly a ringing endorsement but there is more.

My own view is that the risk that negative rates end up being counterproductive to the aims of monetary
policy is low. Since it has not been tried in the UK, there is uncertainty about this judgement, and the MPC is
not at a point yet when it can reach a conclusion on this issue. But given how low short term and long term
interest rates already are, headroom for monetary policy is limited, and we must consider ways to extend that
headroom.

So should there be a vote on this subject he will vote yes to negative interest-rates.

Returning to inflation measurement there has been something of a misfire. In fact in terms of the establishment’s objective it has been a disaster.

The Consumer Prices Index including owner occupiers’ housing costs (CPIH) 12-month inflation rate was 0.7% in September 2020, up from 0.5% in August 2020.

The issue here is that the measure which was designed to give a lower inflation reading is giving a higher one than its predecessor CPI. Even worse the factor that was introduced to further weaken the measure is the one to blame.

The OOH component annual rate is 1.2%, up from 1.1% last month.

OOH is Owner Occupied Housing and is mostly composed of rents which are never paid as it assumes that if you own your own home you pay yourself a rent. That is a complete fantasy as the two major payments are in fact the sale price and for many the mortgage costs and rent is not paid. This is quite different to those who do rent and for them it is included. But there is another swerve here which is that the inflation report today is for September but the rent figures are not. They are “smoothed” in technical terms which means they are a composition of rents over the past 16 months or so, or if you prefer they represent the picture around the turn of the year. Yes we have pre pandemic numbers for rent rises ( there were some then) covering a period where there seem to be quite a lot of rent falls.

Returning to the inflation numbers the much maligned Retail Prices Index or RPI continues to put in a better performance than its replacements.

The all items RPI annual rate is 1.1%, up from 0.5% last month.The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs), is 1.4%, up from 0.8% last month.

They still have mortgage payments reducing inflation which if the latest rises for low deposit mortgages are any guide will be reversing soon.

As to this month’s inflation rise then a major factor was the end of the Eat Out To Help Out Scheme.

Transport costs, and restaurant and café prices, following the end of the Eat Out to Help Out scheme, made the largest upward contributions (of 0.23 and 0.21 percentage points, respectively) to the change in the CPIH 12-month inflation rate between August and September 2020.

Borrowing Has Surged

The theme here will not surprise regular readers although the exact amount was uncertain.

Borrowing (PSNB ex) in the first six months of this financial year (April to September 2020) is estimated to have been £208.5 billion, £174.5 billion more than in the same period last year and the highest borrowing in any April to September period since records began in 1993; each of the six months from April to September 2020 were also records.

We looked a few days ago at a suggestion by the Institute for Fiscal Studies what we might borrow £350 billion or so this fiscal year and we are on that sort of road. As to the state of play we can compare this to what the Bank of England has bought via its QE operations. Sadly our official statisticians have used the wrong number.

At the end of September 2020, the gilt holdings of the APF were £569.2 billion (at nominal value), an increase of £12.2 billion compared with a month earlier. Over the same period, the net gilt issuance by the DMO was £22.7 billion, which implies that gilt holdings by bodies other than the APF have grown by £10.5 billion since July 2020.

That will be especially out for longer-dated Gilts which are being purchased for more than twice their nominal value on occassion. The value of the APF at the end of September was £674 billion. Looking at the calendar the Bank of England bought around £21 billion of UK Gilts or bonds in September meaning it bought nearly all those offered in net terms ( it does not buy new Gilts but by buying older ones pushes others into buying newer ones).

National Debt

The total here is misleading ironically because if the numbers above. Let me explain why.

At the end of September 2020, the amount of money owed by the public sector to the private sector was approximately £2.1 trillion (or £2,059.7 billion), which equates to 103.5% of gross domestic product (GDP).

That seems simple but a reasonable chunk of that is not debt at all and it relates to the Bank of England.

The estimated impact of the APF’s gilt holdings on PSND ex currently stands at £105.6 billion, the difference between the nominal value of its gilt holdings and the market value it paid at the time of purchase. The final debt impact of the APF depends on the disposal of these financial instruments at the end of the scheme.

Further, the APF holds £19.7 billion in corporate bonds, adding an equivalent amount to the level of public sector net debt.

If we just consider the latter point no allowance at all is made for the value of the corporate bonds. In fact we can also throw in the Term Funding Scheme for good luck and end up with a total of £225 billion. Thus allowing for all that this is where we are.

public sector net debt excluding public sector banks (PSND ex) at the end of September 2020 would reduce by £225.6 billion (or 11.4 percentage points of GDP) to £1,834.1 billion (or 92.1% of GDP).

Comment

Some of the numbers come under the category described by the apocryphal civil servant Sir Humphrey Appleby as a clarification. By that he does not mean something that is clearer he means you issue it to obscure the truth. We have seen this consistently in the area of inflation measurement where the last decade has seen a litany of increasingly desperate official attempts to miss measure it. It is also hard not to have a wry smile at one inflation measure rising about the target as the Bank of England is often keen on emphasising such breakdowns. But a suspect a rise will get ignored on the grounds it is inconvenient.

Switching to the UK public finances we see that there is a lot of uncertainty as many tax receipt numbers are estimated. In normal times that is a relatively minor matter but at a time like this will be much more material. Also government expenditure is more uncertain that you might think or frankly in an IT era it should be. The national debt is also much more debatable that you might think especially with the Bank of England chomping on it like this.

Come back stronger than a powered-up Pacman ( Kaiser Chiefs )
Oh well.

 

 

 

Is this the end of yield?

A feature of my career has been both lower interest-rates and bond yields. There have been many occasions when it did not feel like that! For example I remember asking Legal and General why they were buying the UK Long bond ( Gilt) at a yield of 15%. Apologies if I have shocked millennial and Generation Z readers there. There was also the day in 1992 when the UK fell out of the Exchange Rate Mechanism and interest-rates were not only raised to 12% but another rise to 15% was also announced. The latter by the way was scrapped as that example of Forward Guidance did not even survive into the next day.

These days the numbers for interest-rates and yields have become much lower, For example it seemed something of a threshold when the benchmark UK bond or Gilt yield crossed 2%. That was mostly driven by the concept of it being at least in theory ( we have an inflation target of 2% per annum) the threshold between having a real yield and not having one. The threshold however was soon bypassed as the Gilt market continued to surge in price terms. So much in fact that we moved a decimal point as 2.0% became 0.2%. In fact it is very close to the latter ( 0.22%) as I type this.

What happened to the Bond Vigilantes?

We get something of an insight into this by looking at the case of Italy. In the Euro area crisis we saw its benchmark bond yield rise above 7% and if we compare then to now everything is worse.

In the second quarter of 2020 the Gross Domestic Product (GDP) was revised downwards by 13% to the previous
quarter (from 12.8%)………In Q2, Gross disposable income of consumer households decreased in nominal terms by 5.8% with respect to the previous quarter, while final consumption expenditure decreased by 11.5% in nominal terms. Thus, the saving rate increased to 18.6%, 5.3 percentage points higher than in the previous quarter.

That is from the Italian Statistics Office last week. It has been followed this week by this from the IMF.

The International Monetary Fund on Tuesday raised its Italy GDP forecast for 2020 to -10.6%, from June’s -12.8%.
That is an improvement of 2.2 percentage points.
But the IMF cut its Italian growth forecast for next year.
GDP is now expected to rise 5.2% in 2021, 1.1 percentage points lower than the 6.3% forecast in June. ( ANSA)

So the IMF have made this year look better but taken half of that away next year. Actually it makes a mockery of the forecasting process because if you do better then surely that should continue? But, for our purposes today, the issue is of a large fall in economic output in double-digits. This especially matters for Italy because we know from our long-running “Girlfriend in a Coma” theme that it struggles to grow in the better times. So if it loses ground we have to question not only when it will regain it but also if it will?

Switching to debt dynamics ANSA also reported this.

The IMF also said Italy’s public debt will rise to 161.8% of GDP this year, from 134.8% last year, and will then fall to 158.3% in 2021 and 152.6% in 2025.

Those numbers raise a wry smile as we were told back in the day by the Euro area that 120% on this measure was significant. That was quite an own goal at the time but now it has been left well behind. As to the projected declines I would ignore them as they are a given in official forecasts but the reality is that the numbers keep singing along with Jackie Wilson.

You know your love (your love keeps lifting me)
Keep on lifting (love keeps lifting me)
Higher (lifting me)
Higher and higher (higher)

Actually Italy has over time been relatively successful in terms of its annual deficit but not now.

The IMF sees a budget deficit of 13% this year and 6.2% next, falling to 2.5% by 2025.

In a Bond  Vigilante world we would see a soaring bond yields as we note all metrics being worse. Whereas last week I noted this.

Italian 10-Year Government #Bond #Yield Falls To Lowest In More Than A Year At 0.765% – RTRS

This represents quite a move in the opposite direction from when the infamous “‘We are not here to close spreads. This is not the function or the mission of the ECB.’” quote from ECB President Christine Lagarde saw the yield head for 3%. That was as recent as March.

Monday brought more of the same.

Italy‘s 10-year and 30-year sovereign bond yields have dropped to all time-lows of 0.72% and 1.59%, respectively. ( @fwred)

Actually the bond market rally has continued meaning that at 0.64% the Italian benchmark yield is below the US one at 0.72%. This has led some to conclude that Italy is more creditworthy than the US, but perhaps they just have a sense of humour. John Authers of Bloomberg puts it like this.

Forza Italia! The Italian spread over German bunds is the lowest in three years, while the yield on Italian bonds is the lowest since at least 1320: (h/t Jim Reid, @DeutscheBank

)

Take care with the last bit because if I recall my history correctly Italy began around 1870.

But the fundamental point that Italy illustrates is that the Bond Vigilante theme relating to economic problems is presently defunct. In fact we see the opposite of it in markets as you make the most money from markets which start with the worst prospects as there is more to gain.

What about exchange-rate problems Shaun?

This is a subtext which does still continue. Only on Monday we noted that Turkey had to pay 6.5% for a US Dollar bond. Some of the exchange-rate risk is removed by issuing in US Dollars but not all because at some point Turkish Lira need to be used to repay it. But 6.5% looks stellar right now. There is also Argentina where yields are between 40% and 50%.

These are special cases where the yields mostly reflect an expected fall in the currency.

Comment

I have looked at Italy in detail because it illustrates so many of the points at hand. It should be seeing bond yield rises if we apply past thinking styles but we are seeing its doppelganger. The situation is very similar in Greece where the benchmark bond yield is 0.78%. If we look wider around the world we see this.From Bloomberg.

JPMorgan Chase & Co. says the stockpile of developed sovereign debt with a negative yields adjusted for inflation has doubled over the past two years to $31 trillion.

As the Federal Reserve prepares to let prices run hotter to fix the pandemic-hit labor market, the Wall Street bank has a message for investors: Get used to it.“Despite how logic defying the phenomenon is, negative real yields will likely stay with us for a long period to come,” wrote strategists including Boyang Liu and Eddie Yoon.

Adding in inflation means that the situation gets worse for bond owners. There is a familiar theme here because those who own bonds have had quite a party. But the hangover is on its way for future owners who see a market where the profits have already been taken, so what is left for them?

I have left out until now the major cause of the moves in recent times which has been all the QE bond buying by central banks. An example of this will take place this afternoon in my home country when the Bank of England buys another £1.473 billion. The market price for bonds these days is what the central bank is willing to pay. If you can call it a market price. Next comes the issue that countries are relying on this and here is the Governor of the Bank of Italy in Corriere della Sera

Then there is the average cost of debt. Right now it’s 2.4%. It is a high value.

2.4% high? So we arrive at my point which is that the central bankers will drive yields ever lower and as to any turn it will require quite a change as they sing along with McFadden & Whitehead.

Ain’t No Stoppin Us Now!
We’re on the move!
Ain’t No Stoppin Us Now!
We’ve got the groove!

The UK will continue to see quite a surge in the national debt

Today I thought it was time to take stock of the UK economic situation. This is because we find ourselves experiencing a sort of second wave of the Covid-19 pandemic.

Official figures show the UK has recorded a further 22,961 cases of COVID-19 after Public Health England announced it has identified 15,841 cases that were not included in previous cases between 25 September and 2 October due to a technical issue. ( Sky News )

Those numbers are something of a shambles and as a TalkTalk customer it does seem to have similarities to when Baroness Harding was in charge of it. Fortunately we are not experiencing a similar rise in deaths ( 33) as we try to allow for the lags in this process. But however you look at the numbers economic restrictions look set to remain and maybe increased as we note what is about to take place in Paris.

Paris and neighbouring suburbs have been placed on maximum coronavirus alert on Monday, the prime minister’s office announced on Sunday, with the city’s iconic bars closing, as alarming Covid-19 infection numbers appeared to leave the French government little choice. Mayor Anne Hidalgo is to outline further specific measures Monday morning. ( France24)

We have already seen more restrictions for Madrid. So the overall picture is not a good one for those who have asserted the likelihood of a V-Shaped economic recovery.Some area yes but others not and on a purely personal level passing bars and pubs in South-West London trade looks thin. All of this is also before we see the end of the furlough scheme at the end of the month.

Car Registrations

This morning’s update showed an area which is still in trouble.

The UK new car market declined -4.4% in September, according to figures published today by the Society of Motor Manufacturers and Traders (SMMT). The sector recorded 328,041 new registrations in the month – the weakest September since the introduction of the dual number plate system in 1999 and some -15.8% lower than the 10-year average of around 390,000 units for the month.

There are quite a few factors at play here. The car industry had its issues pre the pandemic. But added to it was the lockdown earlier this year followed by several U-Turns. People were encouraged to drive to work as the previous official view of encouraging public transport changed. But in London this was accompanied by the sprouting of cycle lanes in many places that looked rather bizarre to even a Boris Biker like me. This was not helped by problems with a couple of bridges and now official policy is for people to work from home again.

There is the ongoing background as to what cars we should buy? The internal combustion engine is out of favour but there are plenty of issues with batteries made out of toxic elements. The net effect of all the factors is this.

 With little realistic prospect of recovering the 615,000 registrations lost so far in 2020, the sector now expects an overall -30.6% market decline by the end of the year, equivalent to some £21.2 billion2 in lost sales.

Business Surveys

This was more optimistic this morning as Markit released the main PMI data.

The UK service sector showed encouraging resilience in
September, with business activity continuing to grow solidly despite the government’s Eat Out to Help Out scheme being withdrawn……….However, growth across the services sector was uneven with gains principally focussed on areas such as business-to-business services. Those sub-sectors more exposed to social contact such as Hotels, Restaurants & Catering reported a downturn in business during the month,

The better news for the large services sector fed straight into the wider measure.

The UK Composite Output Index….. recorded 56.5 to
signal a third month of growth.

This continues a welcome trend and was much better than the Euro area which recorded 50.4. However there are contexts to this which include the fact that the UK economy contracted more in the second quarter so we would expect a stronger bounce back. Also these numbers have proved unreliable so we should take them as a broad brush.

Also even with the furlough scheme the jobs situation looks weak.

Less positive, however, was on the jobs front, with private
sector employment continuing to fall at a steep rate.
September marked a seventh successive month of job
losses, with the greater decline again seen in services.
Cost considerations amid an uncertain near-term outlook
continued to weigh on the labour market.

National Debt

This has been an extraordinary year for UK debt markets which began like this.

The Net Financing Requirement (NFR) for the DMO in 2020-21 is forecast to be £156.1 billion; this will be financed exclusively by gilt sales.

Looking back to March we see that some £97.6 billion was due to redemptions of existing bonds. So we were planning to raise £58.5 billion of new debt. Also you might like to note that back then National Savings and Investments were expected to raise £6 billion this financial year.

If we press the fast forward button we now see this.

The UK Debt Management Office (DMO) is today publishing a further revision to its 2020-21 financing remit covering the period to end-November 2020. In line with the
update on the government’s financing needs announced by HM Treasury today, the DMO is planning to raise a minimum of £385 billion during the period April to November 2020 (inclusive) through the issuance of conventional and index-linked gilts.

So an just under an extra £229 billion and that is only until the end of next month. As of the beginning of this month we have issued in total some £330.5 billion or more than double what we planned for the whole financial year.

Bank of England

I am including it because the numbers above have been reduced in net terms by its purchases. So far it has bought an extra £241 billion. That number does not strictly match the numbers above as it began in late March but it does give an idea of the flows involved here.

That will continue this week with the Bank of England buying another £4.4 billion of UK bonds or Gilts and the Debt Management Office issuing another £8.5 billion.

Comment

We see a situation where we have seen a welcome bounce in UK economic activity but it still has quite a distance to travel. Sadly some areas look likely to be hit again. There must be a subliminal influence on going out and more restrictions seem probable. Thus the rate of recovery will slow and moving onto my next theme the size of the national debt and the fiscal deficit will grow. As to its size there are different ways of measuring it but here is the Office for National Statistics version.

At the end of August 2020, there was £1,718.0 billion of central government gilts in circulation (including those held by the Bank of England (BoE) Asset Purchase Facility Fund).

That will continue to grow pretty rapidly but there are a couple of reasons why we should not be immediately concerned. The average yield at the end of June was 0.29% so it is not costing much and the average maturity if we include index-linked Gilts was a bit over 18 years.

One way of measuring the surge in bond prices is to note that the market value then was some £2,659 billion so some have made large profits. This does not get much publicity. One area which has been affected is index-linked Gilts which if you allow for inflation were worth some £441.5 billion but had a market value of £805.2 billion. Why? Well they do offer a yield that is much higher than elsewhere as we see another casualty of all the QE bond purchases as they are at the wrong price and could manage to fall in price if inflation rises. Or their “yield” is -2.5%.

Imagine being a pension fund manager and having to match an inflation liability with that! It is a much larger issue than the debates over the Retail Price Index but strangely barely gets a flicker of a mention.

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