Why is the Bank of England preparing for a 0% interest-rate?

Sometimes events have their own motion as after enjoying watching England in the cricket yesterday which is far from something I can always I had time to note it was Mansion House speech time. My mind turned back to 2014 when Bank of England Governor Mark Carney promised an interest-rate rise.

There’s already great speculation about the exact timing of the first-rate hike and this decision is becoming
more balanced.
It could happen sooner than markets currently expect.

Of course four years later we are still waiting for the unreliable boyfriend to match his words with deeds. Indeed last night he was sailing in completely the opposite direction as shown by this.

The additional capital means the MPC could, if necessary, re-launch the TFS in future on the Bank’s balance sheet, cementing 0% as the lower bound.

We have learnt in the credit crunch era to watch such things closely as preparations for an easing on monetary policy have so regularly turned into action as opposed to tightening for which in the UK we have yet to see an outright one. All we have is a reversal of the last error ridden cut to a 0.25% Bank Rate as I note that the extra £60 billion of QE, Corporate Bond QE and Term Funding Scheme are still in existence.

There was another mention of a 0% interest-rate later in the piece.

Although the principles guiding the MPC’s choice of threshold still hold, with the lower bound on Bank Rate
now permanently close to 0%,

In the words of Talking Heads “is it?”

The Lower Bound

This has been an area which if we keep our language neutral has been problematic for Governor Carney to say the least! For example last night’s speech mentioned an area I have flagged for some time.

relative to the effective lower bound on Bank
Rate of 0.5% at that time

When the statement was originally made there were obvious issues when we had countries that had negative interest-rates well below the “lower bound”. As an example the Swiss National Bank announced this yesterday morning.

Interest on sight deposits at
the SNB remains at −0.75% and the target range for the three-month Libor is unchanged at
between −1.25% and −0.25%

As they are already equipped for a -1.25% interest-rate and have a -0.75% one it is hard not to smile at the “lower bound” of Mark Carney. The truth in my opinion is that it means something quite different and as ever the main player is the “precious” or the banks.

In August 2016, the MPC launched the Term Funding Scheme (TFS) in order to reinforce the pass-through
of the cut in Bank Rate to 0.25% to the borrowing rates faced by households and companies.

As you can see it is badged as a benefit to you and me which of course is a perfect way to slip cheap liquidity to the banks. After all competing for savings from us must be a frightful bore for them and it is much easier to get wholesale amounts and rates from the Bank of England.

Bank of England balance sheet

There are changes here as well.

With the Chancellor’s announcement tonight of a ground-breaking new financial arrangement and capital
injection for the Bank of England, we now have a balance sheet fit for purpose and the future.

What arrangement? There will be a capital injection of £1.2 billion this year raising it to £3.5 billion. That can go as high as £5.5 billion should the Bank of England make profits bur after that it has to be returned to HM Treasury.

The gearing for liquidity operations is quite something to behold.

The additional capital will significantly increase the amount of liquidity the Bank can provide through
collateralised, market-wide facilities without needing an indemnity from HM Treasury to more than half a
trillion pounds. This lending capacity would expand to over three quarters of a trillion pounds when, as
designed, additional capital above the target level is accrued through retained earnings.

On the first number the gearing would be of the order of 140 times.Care is needed with that though as the Bank of England does insist on collateral in return for the liquidity. Mind you that is not perfect as a guardian as those who recall the episode where the Special Liquidity Scheme was ended early due to “phantom securities”. If you do not know about that the phrase itself is rather eloquent as an explanation.

Reducing the National Debt

Yesterday was  good day for data on the UK public finances but that may be dwarfed by what was announced in the speech.

Today’s announcement increases the amount of risk the Bank can carry on its balance sheet. As a result,
the Bank plans to bring the £127 billion of lending extended through the TFS onto our balance sheet by the
end of 2018/19 the financial year.

That had me immediately wondering if the Office for National Statistics will now drop the requirement for this to be added to the UK National Debt. this would bring us into line with rules elsewhere as for example if you will forgive the alphabetti spaghetti the TLTROs and LTROs of the European Central Bank are not added to the respective national debts. Such a change would reduce our national debt from 85.4% of GDP to below 80%. I am sure I am not the only person thinking that would be plenty to help finance the suggested boost to the NHS should you choose.

QE

There was a change here and this reflects the 0.5% change in the “lower bound”

Although the principles guiding the MPC’s choice of threshold still hold, with the lower bound on Bank Rate
now permanently close to 0%, the MPC views that the level from which Bank Rate can be cut materially is
now around 1.5%.
Reflecting this, the MPC now intends not to reduce the stock of purchased assets until Bank Rate reaches
around 1.5%.

Let me offer you two thoughts on this. Firstly as the Bank of England has yet to raise interest-rates from the emergency 0.5% level then discussing 1.5% or 2% is a moot point. Secondly this is a way of locking in losses as you will be driving the price of the Gilts owned lower by raising Bank Rate. Even holding the Gilts to maturity has issues because you get 100 back and in the days of the panic driven Sledgehammer QE buying where market participants saw free money coming and moved prices away the Bank of England paid way over 100.

Comment

It is hard not to have a wry smile at Governor Carney planning for a 0% Bank Rate as one of his colleagues joins those voting for a rise to 0.75%. Of course Governor Carney wants a rise to 0.75% eventually, say after his term has ended for example. The irony was that the person who has put so much effort into trying to be the next Governor voted for a rise. As to how Andy Haldane’s campaign has gone let me offer you this from Duncan Weldon.

Next month: 6 votes to hold 2 votes to hike And one vote for something involving a dog and a frisbee.

There was a time when people used to disagree with my views about Andy Haldane whereas now the silence is deafening in two respects. One is that I do not get challenged on social media about it anymore and the other is that if you look for the chorus line of support that used to exist it appears to have disappeared and in some cases been redacted.

Moving to more positive news there has been rather a good piece written by the England footballer Raheem Sterling and whilst no doubt there has been some ghostwriting the final message is very welcome I think.

England is still a place where a naughty boy who comes from nothing can live his dream.

 

 

 

 

 

 

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Can the Bank of England improve productivity?

This morning has brought a reminder of a challenge to the Bank of England,

Labour has said it will set the Bank of England a new 3 per cent target for productivity growth but refused to specify when this should be achieved. John McDonnell, shadow chancellor, will on Wednesday launch Labour’s final report on the UK’s financial system. ( Financial Times)

Reading this raised a wry smile as of course the reforms of Governor Carney reduced productivity by changing the output of the Monetary Policy Committee from 12 meetings a year to 8. But I think we all know they are likely to overlook that one.

Why?

The interim report was published in December and hammered out a familiar beat about UK productivity.

UK productivity has stagnated since the financial crisis of 2007/08. Real output per hour worked rose
just 1.4% between 2007 and 2016 . Within the G7, only Italy performed worse (-1.7%). Excluding the UK, the G7 countries have experienced a 7.5% productivity increase over this period, led by the US, Canada and Japan.

Also there is this.

In addition, the ‘productivity gap’ for the UK – the difference between output per hour in 2016 and
its pre-crisis trend – is minus 15.8%. The productivity gap for the G7 ex-UK countries is minus 8.8%.

I have been consistently dubious about “productivity gap” type analysis for several reasons. Firstly some economic activity and hence productivity before the credit crunch was just an illusion or a type of imagination. Otherwise we would not have had a credit crunch. Also the simple reality is that we have ups and downs not just ups.

Added to that is the problem of international comparisons. Let me illustrate that with some official data from the Office for National Statistics.

The UK’s long-running nominal productivity gap with the other six G7 economies was broadly unchanged in 2016: falling from 16.4% in 2015 to 16.3% in 2016 in output per hour worked terms.

Yet there are clearly problems with this as I note we are doing better than Japan which is a strong exporting nation.

On a current price gross domestic product (GDP) per hour worked basis, UK productivity in 2016 was: above that of Japan by 8.7%, with the gap narrowing from 10.0% in 2015

Also we have apparently done much better than Italy in the credit crunch era by getting worse relative to them!

lower than that of Italy by 10.5%, with the gap widening from 9.6% in 2015

Or if you prefer I think the comparison with France tells us the most if we recall that our economies are much more similar than we often like to admit and yet we are.

lower than that of France by 22.8%, with the gap widening from 22.2% in 2015

Thus we can only conclude that the numbers are not giving us the full picture. For example I think it is the UK’s success with employment that has to some extent worsened recorded productivity.

Also the Financial Times is in error on the data.

Productivity growth has never exceeded 3 per cent a year in Britain.

I think there is a clue in the phrase Industrial Revolution which challenges that! Or more recently there was over 6% in 1940 and 41 or 5% in 1968 in terms of total factor productivity according to FRED the database of the St.Louis Fed.

How would this happen?

A basic problem is identified which I agree with.

UK banks have helped to create a distorted economy. Lending is flowing into unproductive sectors.

This goes further.

As a central bank sitting at the heart of
the UK financial system, the Bank of England needs to be playing an active, leading role, ensuring banks
are helping UK companies to innovate. Flow of funds analysis shows that banks are diverting resources
away from industries vital to the future of this country.

Here I depart a little as I think that the Bank of England should set an environment to help banks change but it is not its role to centrally direct. I do agree with the last sentence as for example I have written many times about how the Funding for Lending Scheme pumped up UK mortgage lending rather than business lending.

One way this occurs is that banks have to put much more capital aside for business lending than they do for mortgage lending or unsecured lending. Also on the demand side for business lending there is a feature which my late father ( who was a small business owner) really,really,really,really ( h/t Carly Rae Jepson)  hated. Here is Dan Davies on Medium pointing out the reality here.

Because, historically, a very high proportion of business lending in the British market has been mortgage-lending-in-disguise. The business loan is usually secured, and usually additionally secured by a charge over the owner’s house.

He hints at some hope for the future but have I clearly pointed out yet that my father hated this feature with a passion? Changes though will need to be throughout the Bank of England infrastructure as the Bank Underground blog has in my view lost the plot as well.

Combining this with firm accounting data, we estimate that a £1 rise in the value of the homes of a firm’s directors leads the average firm in our sample to invest 3p more and increase their total wage bill by 3p.

Yes house prices raise both investment and wages. You might wonder with house prices soaring in recent years compared to almost any other metric it did not trouble anyone that investment and wages are not following it! But instead taking the numbers above with the ones below mean it is apparently a triumph.

This is because the homes of firm directors are worth £1.5 trillion………..Combined with the microeconometric evidence that firms invest 3p more for every £1 increase in the value of their director’s homes, this implies that nominal business investment would rise by around £4.5 billion (0.03*150); an increase of about 2.8%.  By a similar calculation, a 10% increase in real estate prices would increase the total nominal wages paid by firms by 0.8% due to the homes of firm directors.

Thus the answer to life the universe and everything is not 42 as one might reasonably argue especially on international towel day but it is at least according to all echelons of the Bank of England higher house prices. It is time for some PM Dawn to cool us down.

Reality used to be a friend of mine
Reality used to be a friend of mine
Maybe “Why?” is the question that’s on your mind
But reality used to be a friend of mine

Comment

There is a lot to consider here as there is a fair bit of nuance. You see there are areas which can be improved I think. Firstly there are the barriers to business lending around supply ( risk capital requirements) and demand ( having to pledge your home). Next there are changes caused ironically by the higher house prices the Bank of England is so keen on. From Dan Davies again.

we’ve got a generation of young adults coming through who neither own houses, nor have any realistic aspirations to do so. Residential housing as an asset has been more or less completely financialised, and now needs to be seen as part of the pension savings industry .

So the future for millennials is very different and as banks are unlikely to be accepting avocados on toast or otherwise as security this is on its way.

And if you have a generation of businesspeople who don’t own houses, and who therefore can’t be fit into the historic template of British small business lending, then you’ve got the impetus for a total reinvention of small business finance in the UK.

Thus the Bank of England does need to get in tune with Tracy Chapman.

Don’t you know
They’re talkin’ bout a revolution
It sounds like a whisper.

Can it under its present leadership? I very much doubt it but for all the hot air it produces there is an opportunity under the new Governor next year to really drive things forwards. After all he or she hopefully will not be connected to a policy like QE which via its support of zombie banks in particular has worsened productivity.

Meanwhile on a lighter note Financing Investment also suggests this.

Moving some Bank of England functions to Birmingham.

This would help justify HS2 to some extent. But I also recall this from Yes Prime Minister. Here is the Chief of the Defence Staff on relocation.

You can’t ask senior officers to live permanently in the North!  The wives would stand for it for one thing. Children’s schools. What about Harrods? What about Wimbledon? Ascot? Henley? The Army & Navy club? I mean civilisation generally, it is just not on…….Morale would plummet.

Mind you there was some hope

I suppose other ranks can be, junior officer perhaps

 

London House Prices are falling on one measure and also rising!

This morning has seen Rightmove update us on the UK property market and in response we have learnt where Bloomberg journalists live.

London house prices fell the most since the beginning of the year in June as the capital’s property market continued to lag behind the rest of the country.

The price of property coming to market in London dropped by 0.9 percent, bringing the average price to 631,737 pounds ($838,000), property-website operator Rightmove said in a report Monday. Values fell 1 percent from a year earlier, marking the 10th negative month in a row.

The rest of the country only gets a brief look in.

Nationally, prices grew 0.4 percent on the month and 1.7 percent on an annual basis.

Then it is time to get back to the heart of the matter.

In London, “new-to-the-market sellers recognize that the traditionally busier spring selling season is drawing to a close,” said Rightmove Director Miles Shipside.

Oh and as it is Bloomberg there is a consistent scapegoat for pretty much all seasons.

London’s property market has been hit particularly badly by uncertainty surrounding Britain’s impeding exit from the European Union.

Actually we get a reminder of what Rightmove really say from property industry eye.

New asking prices have bounced up to another record, averaging £309,439.

This morning Rightmove said asking prices for properties new to the market are 0.4% up on last month, and 1.7% up on June last year.

The Rightmove data is not for the price at which property is sold it is what sellers are asking for the property or trying to get. In terms of a rising price by this measure then it is a northern thing as the stock available has declined.

From the west midlands northwards, stock has fallen away since a year ago, by between 2.2% and 10.4% in Scotland.

Stock has also dwindled in Wales, by 10.3%.

Whereas prices are under pressure from something of a wave of more housing stock coming onto the market in the south.

By contrast, the amount of available stock has shot up almost 25% on a year ago in the east of England; by 20% in the south-east; by 16.4% in London; 8.2% in the south-west; and by 4% in the east midlands.

Land of Confusion

I am using the Genesis lyric because if we move to LSL/Acadata we get told something very different about London house prices.

Despite the lack of movement in prices, there is one big change in the market this month: London and the South East are no longer a brake on the market. Taking into account these two regions, there was a 2.2% annual price growth – taking them out of the equation, the growth rate is lower – at 2.1 %. It reverses the trend of most of last year.

Although we have learnt from past experience to feel something of a chill when we read something like this.

This is partly due to a change in methodology, which better captures sales of new build properties. These tend to cost more than existing homes and have a particularly strong impact on the average price in London.

In fact the major impact from this is on flats in London.

This was particularly pronounced for flats, where new build flats sold at an average premium of almost
a third (32.3%). They also made up a substantial proportion of sales of all flats, accounting for more than a quarter (26.4%), whereas new builds accounted for just 2.4% of sales of detached properties.

Once you have done that you get this.

The revised figures in London, taking into account new build properties, show annual growth of 2.9%, the lowest since March 2012. Prices also fell on a monthly basis, down 0.3%, taking the average house price in the capital to £636,947.

In case you are no aware the issue of how to treat new builds is a difficult one and is one where the official Office for National Statistics series has had trouble too. Obviously a brand new property cannot have a price rise per se but you can calculate an index based on say quantity like size or number of bedrooms. Much more difficult and perhaps impossible is to allow for the quality of the property.

Also treating London as one market gets a bit of a critique from reality below.

A number of London boroughs are recording big falls over the 12 months to April 2018. They include the City of London (down 24.9%, albeit on a small number of sales), Southwark, down 19.1% (largely as a result of high value properties sold the year before); and Wandsworth, down 13.1%. Growth has been more modest, with only Kensington and Chelsea, the most expensive borough, recording double-digit growth, up 10.4% to £2.17 million. The next highest increase over the year was Lambeth, where prices increased 5.8%.

The issue at this level is that you are down to a small number of sales in some cases leading to large swings. For obvious reasons people like to view the data for Kensington and Chelsea but if it is based on only a handful of sales it is to say the least problematic. Although sometimes just one sale can be crystal clear at least for it.

For those wondering if the previous owners had overpaid back in 2013 I did ask.

Number Crunching

Moving on here is some Monday morning humour from the British Chambers of Commerce.

The British Chambers of Commerce (BCC) has today (Monday) slightly downgraded its growth expectations for the UK economy, forecasting GDP growth for 2018 at 1.3% (from 1.4%) which, if realised, will be the weakest calendar year growth since 2009, when the economy was in the throes of the global financial crisis. The BCC has also downgraded its GDP growth forecast for 2019 from 1.5% to 1.4%.

Yes they think they can forecast GDP growth to 0.1%!

Next come courtesy of those suffering from a type of amnesia.

Households could be left up to £1,000 a year worse off because of Brexit trade barriers, a report will suggest.

Global consultancy firm Oliver Wyman will say that under the most negative scenario of high import tariffs and high regulatory barriers the cost to the economy could total £27bn.

The problem here is the authors so with the help of FT Alphaville let me show you how their crystal ball has worked out in the past.

It has long been known that consulting firm Oliver Wyman crowned Anglo Irish the world’s best bank in 2006 — just when Anglo was actually… well, you know the story.

Sadly, the report that bestowed this fateful distinction has (quite unaccountably!) vanished from the Oliver Wyman corporate site.

Or this.

North American Investment Bank – Bear Stearns (SPI 230) is the best-performing company in this year’s most improved sector, investment banking.

Comment

After a barrage of contradictory numbers let us step back and take stock. We see that the background for UK house prices is not what it was. For example the Term Funding Scheme of the Bank of England ended in February and whilst it still represents some £126.6 billion of cheap liquidity for the banks it is now gently declining. Other factors such as a 0.5% Bank Rate and £435 billion of QE have been at play in raising prices but that has worn off now. Perhaps we are still seeing the influence of the Help To Buy scheme in the North but unless prices fall more in London many are still above its cap of £600,000.

A welcome development is that house price growth seems to have fallen back in line with wage growth although of course the official numbers still disagree (3.9%). Even that development has the issue of course that it does not help with prices being much too high in many parts of the country. As to detail all we can honestly say is that house price inflation has fallen and some parts of London especially in the centre are seeing falls.

Moving onto my new measure which refers to a block of around 80 flats near the US Embassy in Nine Elms there was an improvement this week, There were signs of life (open windows etc) in 12 as opposed to 8.

 

 

The Bank of England has a credit card problem

This morning has brought a development in two areas which are of high interest to us. So let us crack on with this from the Financial Times.

The Bank of England has issued a warning about the sort of risky lending practices particularly important to Virgin Money, at a critical time in the bank’s negotiations over a £1.6bn takeover by rival CYBG.

When one reads about risky lending it is hard not to think about the surge in unsecured consumer lending in the UK over the past couple of years or so.

The 12-month growth rate of consumer credit was 8.8% in April, compared to 8.6% in March ( Bank of England)

That rate of growth was described a couple of months ago as “weak” by Sir Dave Ramsden. Apparently such analysis qualifies you to be a Deputy Governor these days and even gets you a Knighthood. Also if 8% is weak I wonder what he thinks of inflation at 2/3%?

However the thought that the Bank of England is worried about the consumer fades somewhat as we note that yet again the “precious” seems to be the priority.

In a letter sent to bank chiefs last week seen by the FT, the Prudential Regulation Authority, BoE’s supervisor of the largest banks and insurers, said “a small number of firms” were vulnerable to sudden losses if customers on zero per cent interest credit card offers then leave earlier or borrow less than expected.

How might losses happen?

Melanie Beaman, PRA director for UK deposit takers, wrote that banks with high reliance on so-called “effective interest rate” accounting should consider holding additional capital to mitigate the risks.

The word effective makes me nervous so what does it mean?

EIR allows lenders that offer products with temporary interest-free periods to book in advance some of the revenues they expect to receive once the introductory period ends.

That sounds rather like Enron doesn’t it? I also recall a computer leasing firm in the UK that went bust after operating a scheme where future revenues were booked as present ones and costs were like that poor battered can. Anyway there is a rather good reply to this on the FT website.

I am expecting to win the lottery. Can l  bank the anticipated income now please?  ( TRIMONTIUM)

There is more.

Optimistic assumptions about factors such as customer retention rates and future borrowing levels allow banks to report higher incomes, but increase the risk of valuation errors that could lead to a reversal and weaken their balance sheets, according to the PRA.

Are these the same balance sheets that they keep telling us are not only “resilient” but increasingly so? We seem to be entering into a phase where updating my financial lexicon for these times will be a busy task again. Perhaps “Optimistic” will go in there too?

Moving on one bank in particular seems to have been singed out.

Almost 20 per cent of Virgin Money’s annual net interest income in 2017 came from the EIR method. Industry executives said any perceived threat to capital levels could strengthen CYBG’s (Clydesdale &Yorkshire) hand in negotiations. Virgin Money declined to comment on the PRA’s letter or the merger discussions. CYBG and the PRA also declined to comment.

This is a little awkward as intervening during a takeover/merger raises the spectre of “dirty tricks” and to coin a phrase it would have been “Fa-fa-fa-fa-fa-fa-fa-fa-fa-far better” if they have been more speedy.

FPC

We do not mention this often but let me note this from a speech from Anil Kashyap, Member of the Financial Policy Committee. Do not be embarrassed if you thought “who?” as so did I.

The statute setting up the FPC also makes the committee responsible for taking steps (here I am
paraphrasing) to reduce the risks associated with unsustainable build-ups of debt for households and
businesses. This means that the FPC is obliged to monitor credit developments and if necessary be
prepared to advocate for policies that may lead some borrowers and lenders to change the terms of a deal
that they were otherwise willing to consummate.

Worthy stuff except of course if we move to the MPC and go back to the summer of 2016. This was Chief Economist Andy Haldane in both June and July as he gave essentially the same speech twice.

Put differently, I would rather run the risk of taking a sledgehammer to crack a nut than taking a miniature
rock hammer to tunnel my way out of prison – like another Andy, the one in the Shawshank Redemption.

Seeing as monetary policy easings in the UK had invariably led to rises in unsecured borrowing you might think the FPC would have been on the case. However Andy was something of a zealot.

In my personal view, this means a material easing of monetary policy is likely to be needed, as one part of a
collective policy response aimed at helping protect the economy and jobs from a downturn. Given the scale
of insurance required, a package of mutually-complementary monetary policy easing measures is likely to be necessary. And this monetary response, if it is to buttress expectations and confidence, needs I think to be
delivered promptly as well as muscularly.

Not only had Andy completely misread the economic situation the credit taps were turned open. He and the Bank of England would prefer us to forget that they planned even more for November 2016 ( Bank Rate to 0.1% for example) which even they ended up dropping like it was a hot potato.

My point though is that the cause of this below was the Bank of England itself. So if the FPC wanted to stop it then it merely needed to walk to the next committee room.

Consumer credit had been growing particularly rapidly. It had reached an annual growth
rate of 10.9% in November 2016 – the fastest rate of expansion since 2005 – before easing back
somewhat in subsequent months. ( FPC Minutes March 2017)

As some like Governor Carney are on both committees they could have warned themselves about their own behaviour. Instead they act like Alan Pardew when he was manager of Newcastle United.

“I actually thought we contained him (Gareth Bale) quite well.”

He only scored twice…..

Credit Card Interest-Rates

Whilst the Bank of England is concerned about 0% credit card rates albeit for the banks not us. There is also the fact that despite all its interest-rate cuts,QE and credit easing the interest-rate charged on them has risen in the credit crunch era.

Effective rates on the stock of interest-charging credit cards decreased 22bps to 18.26% in April 2018.

I remember when I first looked back in the credit crunch day and it was ~17%.

Comment

You may be wondering after reading the sentence above whether policy has in fact been eased? I say yes on two counts. Firstly it seems to be an area where there is as far as we can tell pretty much inexhaustible demand so the quantity easing of the Bank of England has been a big factor eventually driving volumes back up. Next is a twofold factor on interest-rates which as many of you have commented over the years a lot of credit card borrowing is at 0%. It may well be a loss leader to suck borrowers in but it is the state of play. Next we can only assume that credit card interest-rates would be even higher otherwise although of course we do not know that.

What we do know is that unsecured lending of which credit card lending is a major factor has surged in th last couple of years or so. Accordingly it was a mistake to give the Bank of England control over both the accelerator and the brake.

Me on Core Finance TV

 

Rising inflation trends are putting a squeeze on central banks

Sometimes events have their own natural flow and after noting yesterday that the winds of change in UK inflation are reversing we have been reminded twice already today that the heat is on. First from a land down under where inflation expectations have done this according to Trading Economics.

Inflation Expectations in Australia increased to 4.20 percent in June from 3.70 percent in May of 2018.

This is significant in several respects. Firstly the message is expect higher inflation and if we look at the Reserve Bank of Australia this is the highest number in the series ( since March 2013). Next  if we stay with the RBA it poses clear questions as inflation at 1.9% is below target ( 2.5%) but f these expectations are any guide then an interest-rate of 1.5% seems well behind the curve.

Indeed the RBA is between a rock and a hard place as we observe this from Reuters.

Australia’s central bank governor said on Wednesday the current slowdown in the housing market isn’t a cause for concern but flagged the need for policy to remain at record lows for the foreseeable future with wage growth and inflation still weak.

Home prices across Australia’s major cities have fallen for successive months since late last year as tighter lending standards at banks cooled demand in Sydney and Melbourne – the two biggest markets.

You know something is bad when we are told it is not a concern!

If we move to much cooler Sweden I note this from its statistics authority.

The inflation rate according to the CPI with a fixed interest rate (CPIF) was 2.1 percent in May 2018, up from 1.9 percent in April 2018. The CPIF increased by 0.3 percent from April to May.

So Mission Accomplished!

The Riksbank’s target is to hold inflation in terms of the CPIF around 2 per cent a year.

Yet we find that having hit it and via higher oil prices the pressure being upwards it is doing this.

The Executive Board has therefore decided to hold the repo rate unchanged at −0.50 per cent and assesses that the rate will begin to be raised towards the end of the year, which is somewhat later than previously forecast.

Care is needed here as you see the Riksbank has been forecasting an interest-rate rise for some years now but like the Unreliable Boyfriend somehow it keeps forgetting to actually do it.

I keep forgettin’ things will never be the same again
I keep forgettin’ how you made that so clear
I keep forgettin’ ( Michael McDonald )

Anyway it is a case of watch this space as even they have real food for thought right now as they face the situation below with negative interest-rates.

Economic activity in Sweden is still strong and inflation has been close to the target for the past year.

US Inflation

The situation here is part of an increasingly familiar trend.

The all items index rose 2.8 percent for the 12 months ending May, continuing its upward trend since the beginning of the year. The index for all items less food and
energy rose 2.2 percent for the 12 months ending May. The food index increased 1.2 percent, and the energy index rose 11.7 percent.

This was repeated at an earlier stage in the inflation cycle as we found out yesterday.

On an unadjusted basis, the final demand index moved up
3.1 percent for the 12 months ended in May, the largest 12-month increase since climbing 3.1 percent in January 2012.

In May, 60 percent of the rise in the index for final demand is attributable to a 1.0-percent advance in prices for final demand goods.

A little care is needed as the US Federal Reserve targets inflation based on PCE or Personal Consumption Expenditures which you may not be surprised to read is usually lower ( circa 0.4%) than CPI. We do not know what it was for May yet but using my rule of thumb it will be on its way from the 2% in April to maybe 2.4%.

What does the Federal Reserve make of this?

Well this best from yesterday evening is clear.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-3/4 to 2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

If we start with that let me give you a different definition of accommodative which is an interest-rate below the expected inflation rate. Of course that is off the scale in Sweden and perhaps Australia. Next we see a reference to “strong labo(u)r market conditions” which only adds to this. Putting it another way “strong” replaced “moderate” as its view on economic activity.

This is how the New York Times viewed matters.

The Federal Reserve raised interest rates on Wednesday and signaled that two additional increases were on the way this year, as officials expressed confidence that the United States economy was strong enough for borrowing costs to rise without choking off economic growth.

Care is needed about borrowing costs as bond yields ignored the move but of course some may pay more. Also we have seen a sort of lost decade in interest-rate terms.

The last time the rate topped 2 percent was in late summer 2008, when the economy was contracting and the Fed was cutting rates toward zero, where they would remain for years after the financial crisis.

Yet there is a clear gap between rhetoric and reality on one area at least as here is the Fed Chair.

The decision you see today is another sign that the U.S. economy is in great shape,” Mr. Powell said after the Fed’s two-day policy meeting. “Most people who want to find jobs are finding them.”

Yet I note this too.

At a comparable time of low unemployment, in 2000, “wages were growing at near 4 percent year over year and the Fed’s preferred measure of inflation was 2.5 percent,” both above today’s levels, Tara Sinclair, a senior fellow at the Indeed Hiring Lab, said in a research note.

So inflation is either there or near but can anyone realistically say that about wages?

Mr. Powell played down concerns about slow wage growth, acknowledging it is “a bit of a puzzle” but suggesting that it would normalize as the economy continued to strengthen.

What is normal now please Mr.Powell?

Comment

One of my earliest themes was that central banks would struggle when it comes to reducing all the stimulus because they would be terrified if it caused a slow down. A bit like the ECB moved around 2011 then did a U-Turn. What I did not know then was that the scale of their operations would increase dramatically exacerbating the problem. To be fair to the US Federal Reserve it is attempting the move albeit it would be better to take larger earlier steps in my opinion as opposed to this drip-feed of minor ones.

In some ways the US Federal Reserve is the worlds central bank ( via the role of the US Dollar as the reserve currency) and takes the world with it. But there have been changes here as for example the Bank of England used to move in concert with it in terms of trends if not exact amounts. But these days the Unreliable Boyfriend who is Governor of the Bank of England thinks he knows better than that and continues to dangle future rises like a carrot in front of the reality of a 0.5% Bank Rate.

This afternoon will maybe tell us a little more about Euro area monetary policy. Mario Draghi and the ECB have given Forward Guidance about the end of monthly QE via various hints. But that now faces the reality of a Euro area fading of economic growth. So Mario may be yet another central bank Governor who cannot wait for his term of office to end.

 

 

Putting rents which do not exist in a consumer inflation measure is a disgrace

Yesterday the Economic Affairs Committee took a look at the Retail Price Index measure of consumer inflation in the UK. An excellent idea except as I have contacted them to point out.

Accordingly I am making contact for two reasons. Attending the event would give your members exposure to a much wider range of expertise on the subject of the RPI than the limited group you have today. Also it will help you with the subject of balance as the four speakers you will be listening too today are all against the RPI with some being very strongly so. This gives a very unbalanced view of the ongoing debate on the subject.

The event I refer too is this evening at the Royal Statistical Society at which I will be one of those who reply to the National Statistician John Pullinger.

I intend to point out that the RPI does indeed have strengths and it relates to my letter to Bank of England Governor Mark Carney from February.

“. I am not sure what is a step up from known error but I can say that ignoring something as important to the UK as that sector when UK  house prices have risen by over 29% in your term as Governor when the targeted CPI has only risen by more like 7% is exactly that.”

This is because it makes an effort to reflect this.

This is because the RPI does include owner occupied housing and does so using house prices and mortgage interest-rates. If we look at house prices we see that admittedly on a convoluted route via the depreciation section they make up some 8.3% of the index.

This compares for example with the Consumer Price Index which completely ignores the whole subject singing “la,la,la” when it comes up. There has been a newer attempt to reflect this issue which I look at below.

Also it means that the influence is much stronger that on the only other inflation measure we have which includes house prices which is CPI (NA). In it they only have a weighting of 6.8%. So the RPI is already ahead in my view and that is before you allow for the 2.4% weighting of mortgage interest-rates.

As you can see the new effort at least acknowledges the issue but comes up with a lower weighting. This is because they decided that they only wanted to measure the rise in house prices and not the land. This is what they mean by Net Acquisitions or NA.

Now with 8.3% ( 10.7%) and 6,8% in your mind look what happens with the new preferred measure CPIH.

Now let me bring in the alternative about which the National Statistician John Pullinger and the ONS are so keen. This is where rather than using house prices and mortgages of which there are many measures we see regularly in the media and elsewhere, they use fantasy rents which are never actually paid. Even worse there are all sorts of problems measuring actual rents which may mean that this is a fantasy squared if that was possible.

But this fantasy finds itself with a weight of 16.8% or at least it was last time I checked as it is very unstable. Has our owner-occupied housing sector just doubled in size?

As you can see whilst you cannot count the (usually fast rising ) value of land it would appear that you can count the ( usually much slower rising) rent on it. That is the road that leads to where we are today where the officially approved CPIH gives a lower measure than the alternatives. Just think for a moment, if there is a sector in the UK with fast rising inflation over time it has been housing. So when you put it in the measure you can tell people it is there but it gives a lower number. Genius! Well if you do not have a conscience it is.

Yet the ordinary man or woman is not fooled and Bank of England Governor Mark Carney must have scowled when he got the results of his latest inflation survey on Friday.

After all when asked ( by the Bank of England) they come up with at 3.1% a number for inflation that is closer to the RPI then the alternatives.

Just because people think a thing does not make it right but it does mean you need a very strong case to change it . Fantasy rents are not that and even worse they come from a weak base as illustrated below.

The whole situation gets even odder when you note that from 2017 to this year the weighting for actual rents went from 5.6% to 6.9%.

Who knew that over the past year there was a tsunami of new renters? More probably but nothing like a 23% rise. This brings me back to the evidence I gave to the UK Statistics Regulator which was about Imputed Rents which relies on essentially the same set of numbers. I explained the basis for this was unstable due to the large revisions in this area which in my opinion left them singing along to Fleetwood Mac.

I’m over my head (over my head)
Oh, but it sure feels nice

Today’s data

Let me start with the number which was much the closest to what people think inflation is according to the Bank of England.

The all items RPI annual rate is 3.3%, down from 3.4% last month. The all items RPI is 280.7, up from 279.7 in April.

So reasonably close to the 3.1% people think it is as opposed to.

The all items CPI annual rate is 2.4%, unchanged from last month. The all items CPI is 105.8, up from 105.4 in April

When we ask why? We see that a major factor is the one I have been addressing above.

Average house prices in the UK have increased by 3.9% in the year to April 2018 (down from 4.2% in March 2018). This is its lowest annual rate since March 2017 when it was 3.7%.

In spite of the slow down in house price inflation it remains an upward pull on inflation measures. You will not be surprised to see what is slowing it up.

The lowest annual growth was in London, where prices increased by 1.0% over the year.

Now let me switch to what our official statisticians,regulators and the economics editor of the Financial Times keep telling us is an “improvement” in measuring the above.

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

Which is essentially driven by this.

Private rental prices paid by tenants in Great Britain rose by 1.0% in the 12 months to May 2018; unchanged from April 2018.

So they take rents ( which they have had all sorts of trouble measuring and maybe underestimating by 1% per annum) and imagine that those who do not pay rent actually do and hey presto!

The all items CPIH annual rate is 2.3%, up from 2.2% in April.

I often criticise the media but in this instance they deserve praise as in general they ignore this woeful effort.

Comment

Today has been a case of me putting forwards my views on the subject of inflation measurement which I hold very strongly. This has been an ongoing issue since 2012 and regular readers will recall my successful battle to save the RPI back then. I take comfort in that because over time I have seen my arguments succeed and more and more join my cause. This is because my arguments have fitted the events. To give a clear example I warned back in 2012 that the measure of rents used was a disaster waiting to happen whereas the official view was that it was fine. Two or three years later it was scrapped and of course we saw that the Imputed Rent numbers had a “discontinuity”. The saddest part of the ongoing shambles is even worse than the same sorry crew being treated as authorities about a subject they are consistently wrong about it is that we could have spent the last 6 years improving the measure as whilst it has strengths it is by no means perfect.

Let me give credit to the Royal Statistical Society as it has allowed alternative views an airing (me) and maybe there is a glimmer from the House of Lords who have speedily replied to me.

Staff to the Committee will be in attendance this evening, and we have emailed the details to the members: the unfortunate short notice and the busy parliamentary schedule currently means it may be unlikely for them to attend. We will report back to them on the event nevertheless.

I hope the event goes well for you.

Returning to today’s we now face the risk that this is a bottom for UK inflation as signalled by the producer price numbers.

The headline rate of inflation for goods leaving the factory gate (output prices) was 2.9% on the year to May 2018, up from 2.5% in April 2018.Prices for materials and fuels (input prices) rose 9.2% on the year to May 2018, up from 5.6% in April 2018.

This has been driven by the rise in the price of oil where Brent Crude Oil is up 56% on a year ago as I type this and the recent decline in the UK Pound £. This will put dark clouds over the Bank of England as the wages numbers were a long way from what it thought and now it may have talked the Pound £ down into an inflation rise. Yet its Chief Economist concentrates on matters like this.

Multiversities ‘hold key to next leap forward’ says ⁦⁩ Chief Economist Andy Haldane ( @jkaonline)

Isn’t that something from one of the Vin Diesel Riddick films?

 

 

 

 

 

The Bank of England seems determined to ignore the higher oil price

This morning has brought the policies of the Bank of England into focus as this from the BBC demonstrates.

Petrol prices rose by 6p a litre in May – the biggest monthly increase since the RAC began tracking prices 18 years ago.

Average petrol prices hit 129.4p a litre, while average diesel prices also rose by 6p to 132.3p a litre.

The RAC said a “punitive combination” of higher crude oil prices and a weaker pound was to blame for the increases.

It pointed out that oil prices broke through the $80-a-barrel mark twice in May – a three-and-a-half year high.

As well as the higher global market price of crude, the pound’s current weakness against the US dollar also makes petrol more expensive as oil is traded in dollars.

There is little or nothing that could have been done about the rising price of crude oil but there is something that could have been done about the “pound’s current weakness against the US dollar”. In fact it is worse than that if we look back to April 20th.

The governor of the Bank of England has said that an interest rate rise is “likely” this year, but any increases will be gradual.

This was quite an unreliable boyfriend style reversal on the previous forward guidance towards a Bank Rate rise in May that the Financial Times thought was something of a triumph. But the crucial point here is that the UK Pound £ was US $1.42 the day before Mark Carney spoke as opposed to US $1.33. Some of that is the result of what we call the King Dollar but Governor Carney gave things a shove. After all we used to move with the US Dollar much more than we have partly because our monetary policy was more aligned with its. Or to be precise only cuts in interest-rates seem likely to be aligned with the US under the stewardship of Governor Carney.

Just as a reminder UK inflation remains above target where it has been for a while.

The Consumer Prices Index (CPI) 12-month rate was 2.4% in April 2018, down from 2.5% in March 2018.

The welcome fall in inflation due to the rally in the UK Pound £ has been torpedoed by the unreliable boyfriend and a specific example of this is shown below.

Let us give the BBC some credit for releasing those although the analysis by its economics editor Kamal Ahmed ignores the role of the Bank of England.

Silvana Tenreyro

Silvana in case you are unaware is a member of the Monetary Policy Committee who gave a speech at the University of Surrey yesterday evening. As you can imagine at a time of rising inflation concerns she got straight to what she considers to be important.

Many critics have laid the blame on the tools that economists use – our models.So, in my speech today, I
will attempt to shed some light on how and why economists use models. Specifically, I will focus on how they
are useful to me as a practitioner on the MPC

Things do not start well because in my life whilst there has been a change from paper based maps to the era of Google Maps they have proved both useful and reliable unlike economic models.

An oft-used analogy is to think of models as maps

Perhaps Silvana gets regularly lost. She certainly seems lost at sea here.

Similarly, economic models have improved with greater
computing power, econometric techniques and data availability, but there is still significant uncertainty that
cannot be eliminated.

Let me add to this with an issue we have regularly looked at on here which is the Phillips Curve and associated “output gap” style analysis.

Many commentators have recently argued that the Phillips curve is no longer apparent in the data – the
observed correlation between inflation and slack is much weaker than it has been in the past. If the Phillips
curve truly has flattened or disappeared, then the current strength of the UK labour market may be less likely
to translate into a pick-up in domestic inflationary pressures. Given that the Phillips curve is one of the
building blocks of standard macroeconomic models, including those used by the MPC, a breakdown in the
relationship would also call for a reassessment.

Er no I have been arguing this since about 2010/11 as the evidence began that it was not working in the real world. However Silvana prefers the safe cosy world of her Ivory Tower.

My view is that these fears are largely misplaced. I expect that the narrowing in labour market slack we have
seen over the past year will lead to greater inflationary pressures, as in our standard models.

The fundamental problem is that the Bank of England has told us this for year after year now. One year they may even be right and no doubt there will be an attempt to redact the many years of errors and being wrong but we are now at a stage where the whole theory is flawed even if it now gets a year correct. As we stand with four months in a row of falling total pay in the UK the outlook for the Phillips Curve is yet again poor. Here is how Silvana tells us about this.

Although average weekly earnings (AWE) growth has now been strengthening since the middle of 2017,

Inflation

Fortunately on her way to the apparently important work of explaining to us of how up is the new down regarding economic models Silvana does refer to her views on inflation.

such as energy costs. And indeed, Chart 2 shows that the contribution of the purple bars to inflation
is correlated with the peaks and troughs of oil-price inflation over the past decade or so

It is probably because her mind is on other matters that she has given us a presumably unintentional rather devastating critique of the central bankers obsession with core inflation which of course ignores exactly that ( and food). Mind you it does not take her long to forget this.

Since the effects of oil-price swings are transitory, there is a good case for ‘looking through’ their impact on inflation.

Oh and those who recall my critique of the Bank of England models on the subject of the impact of the post EU leave vote will permit me a smile as I note this.

But in the past few quarters, we have seen some
building evidence that import prices have been rising slightly less than we had expected (only by around half
of the increase in foreign export prices – Chart 3). For me, this may be one reason why CPI inflation has
recently fallen back faster than we had expected.

I have no idea why they thought this and argued against it correctly as even they now admit. This is of course especially awkward in the middle of a speech designed to boost the economic models that have just been wrong yet again!

Comment

If we move to the policy prescription the outlook is not good for someone who has just dismissed the recent rise in the oil price as only likely to have a “transitory” effect. In fact as we move forwards we get the same vacuous waffle.

While I anticipate that a few rate rises will be needed, the timing of those rate rises is an open question

Okay but when?

With falling imported inflation offset by a gradual pick-up in domestic costs, I judge that conditional on the
outlook I have just described, a gradual tightening in monetary policy will be necessary over the next three
years to return inflation to target and keep demand growing broadly in line with supply.

So not anytime soon!

The flexibility is limited, however – waiting a few more
quarters increases the likelihood that inflation overshoots the target. In May, I felt that as in these scenarios, the costs of waiting a short period of time for more information were
small.

So more of the same although let me give Silvana a little credit as she was willing to point out that Forward Guidance is a farce.

Taken literally, the models suggest implausibly large economic effects from promises about interest rates many years in the future. There is ample empirical evidence that these strong assumptions do not hold in real-world data.

Also she does seem willing to accept that the world is a disaggregated place full of different impacts on different individuals.

Another unrealistic assumption in many macroeconomic models is that everyone is the same. Or more
accurately, that everyone can be characterised by a single, representative household or firm.