The Bank of England and Mark Carney are in denial mode

One of the features of the Brexit debate has been the role of the Bank of England in it. One thing that a supposedly independent central bank should do is avoid being accused of being on one side or the other of political debates. Also it has presented a view which is supposedly supported by the whole institution when with such a split nation that seems incredibly implausible. Thus the alternative view of independence and the reason for having external members, which is to provide different perspectives and emphasis, looks troubled at best.

On this road we see an organisation where all the Deputy-Governors are alumni of Her Majesty’s Treasury, which raises the issue of establishment capture. Also this from the Bank of England website suggests the use of another form of motivation to capture individuals.

Dr Ben Broadbent became Deputy Governor on 1 July 2014. Prior to that, he was an external member of the Monetary Policy Committee from 1 June 2011.

I am far from alone in thinking that this sets up all the wrong motivations and strengthens the power of the Governor via patronage. As to appointment of the absent-minded professor maybe one day he will demonstrate why unless of course we already know.

For the decade prior to his appointment to the MPC, Dr Broadbent was Senior European Economist at Goldman Sachs,

Mervyn King

There is something of an irony in the way that any sort of flicker of Bank of England comes from the former Governor the now Baron King of Lothbury although Bloomberg describe him without his new title.

Mervyn King, a professor at the New York University Stern School of Business,

If we move to his critique here are the details.

It saddens me to see the Bank of England unnecessarily drawn into this project. The Bank’s latest worst-case scenario shows the cost of leaving without a deal exceeding 10 percent of GDP.

Why is this wrong?

Two factors are responsible for the size of this effect: first, the assertion that productivity will fall because of lower trade; second, the assumption that disruption at borders — queues of lorries and interminable customs checks — will continue year after year. Neither is plausible. On this I concur with Paul Krugman. He’s no friend of Brexit and believes that Britain would be better off inside the EU — but on the claim of lower productivity, he describes the Bank’s estimates as “black box numbers” that are “dubious” and “questionable.” And on the claim of semi-permanent dislocation, he just says, “Really?” I agree: The British civil service may not be perfect, but it surely isn’t as bad as that.

The productivity issue is one that has been addressed at the Treasury Select Committee ( TSC) this morning. As I listened I heard Deputy Governor Broadbent tell us that productivity has been falling which is true but when it came to a rationale for further Brexit driven effects we got only waffle. Actually the Chair of the TSC Nicky Morgan was much more impressive by discussing the oil price shock of the 1970s as opposed to Ben Broadbent’s New Zealand based example from the same decade. Later questions on this subject had both the Governor and Ben Broadbent in retreat on the issue of how useful an example New Zealand will be especially as it coincided with a large oil price shock.

There are different arguments as to how long any Brexit effect would last. However one would expect at least some of the issues to decline and go away.

Bank of England evidence

If we move to this morning;s questions posed to the Bank of England there has been a clear attempt by Governor Carney to cover off the fire he is under with two methodologies.

  1. To say the Treasury Select Committee asked for the production of scenarios.
  2. To present it as a technocratic and scientific process where we were told 160 people were involved and 600, measurements were taken. We were guided towards some elasticities where the range was presented between 0.75 and 0.16 and told that 0.25 had been chosen.

He has a point with the first issue because they did do that when it would have been better to have asked the Office for Budget Responsibility. After all as it has been drawn from the same establishment base it would have been likely to have given similar answers if that was the purpose and kept the Bank of England out of it. The second argument is very weak as anyone familiar with the methodology knows that economic models depend more on the assumptions used than anything else. You do not need to know much about them to realise that they are an art form much more than they are a science. Usually of course a bad art form.

Next up was Deputy Governor Jon Cunliffe who has spent a career at HM Treasury as well as this described from the Bank of England website.

Before joining the Bank, Jon was the UK Permanent Representative to the European Union, effective from 9 January 2012.

When quizzed on this he told us this was in the past but a mere ten minutes later he was boasting about his experience. Sadly the inconsistency remained unchallenged as did his assertion that the higher cost of doing financial services business in Frankfurt as opposed to London was not going to be a major factor.

The issue of making this accessible came up with an MP just asking “I am looking for human speak” which added to a previous request for Governor Carney to talk like a human being rather than like an economist. This did not go especially well and to my mind left the interventions of the absent-minded professor as mostly waffle.

Sadly this from the Governor was not challenged though.

We are delivering price stability

Since inflation has been above its 2% per annum target for 18 months that is open to quite a bit of debate! That is before we get to the deeper issue of a 2% inflation target not being the price stability but is spun as. Also if we reflect that reality then one may be troubled by the next bit.

We will deliver financial stability.

Comment

There is a fair bit to consider here and as ever I do my best to avoid the politics and cover what has been said as accurately as I can as there is no official transcript yet. But let me return to an issue I raised last Thursday about the scenario where the Bank of England raises Bank Rate to 5.5% and other interest-rates go even higher.

BOE informing the masses. Carney tells that its controversial projection of Bank Rate going up to 5.5% on disorderly Brexit is mechanistic – a calculation from “a sum of squared deviations of inflation from target and output from potential.” Capiche? ( @DavidRobinson2k )

Nobody seems to have told the “squared deviations” that we are dealing with people who have consistently ignored deviations in inflation above target. Apparently though this is a complete success.

Carney adds that there was “a simpler, less-successful time”, when the Bank only focused on inflation…and we know how that turned out [it led to the financial crisis!].

That’s why we now have a financial policy committee to guard the economy, and that’s why the banks are ready for Brexit, the governor explains: ( The Guardian )

 

 

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What is going on at the Bank of England these days?

Yesterday saw the publication of Brexit forecasts from HM Treasury and the Bank of England. The former was always going to be politically driven but the Bank of England is supposed to be independent, although these days we have to ask independent of what? There is little sign of that to be seen. Let us take a look at the Bank of England scenarios.

The estimated paths for GDP, CPI inflation and unemployment in the Economic Partnership scenarios are
shown in Charts A, B and C. The range reflects the sensitivity to the key assumptions about the extent to
which trade barriers rise, and how rapidly uncertainty declines. GDP is between 1¼% and 3¾% lower than
the May 2016 trend by end-2023. Relative to the November 2018 Inflation Report projection, by end-2023 it is 1¾% higher in the Close scenario, and ¾% lower in the Less Close scenario.

After singing its own fingers last time around it is calling these scenarios rather than forecasts but pretty much everyone is ignoring that. The problem with this sort of thing is that you end up doing things the other way around. Frankly the answers are decided and then the assumptions are picked to get you there. We do know some things.

Productivity growth has slowed, sterling has depreciated and the increase in inflation has squeezed real incomes.

However really the most certainty we have is about the middle part of a lower UK Pound £ and even there the Bank of England seems to omit its own part ( Bank Rate cut and Sledgehammer QE ) in the fall. That caused the fall in real incomes as we see how policy affected the results.

If we move wider the Bank of England attracted fire from both sides as for example this is from the former Monetary Policy Committee member Andrew Sentance who is a remain supporter.

The reputation of economic forecasts has taken a bad blow today with both UK government and appearing to use forecasts to support political objectives. Let’s debate – which I strongly oppose – rationally without recourse to bogus forecasts.

Why would he think that?

Well take a look at this.

The estimated paths for GDP, CPI inflation and unemployment in the disruptive and disorderly scenarios
are shown in Charts A, B and C. GDP is between 7¾% and 10½% lower than the May 2016 trend by end 2023.
Relative to the November 2018 Inflation Report projection, GDP is between 4¾% and 7¾% lower by
end-2023. This is accompanied by a rise in unemployment to between 5¾% and 7½%. Inflation in these
scenarios then rises to between 4¼% and 6½%.

It is the latter point about inflation and a claimed implication of it I wish to subject to both analysis and number-crunching.

How would the Bank of England respond to higher inflation?

Here is the claimed response.

Monetary policy responds mechanically to balance deviations of inflation from target and output
relative to potential. Bank Rate rises to 5.5%.

Let us see how monetary policy last responded to an expected deviation of inflation above target to back this up.

This package comprises:  a 25 basis point cut in Bank Rate to 0.25%; a new Term Funding Scheme to reinforce the pass-through of the cut in Bank Rate; the purchase of up to £10 billion of UK corporate bonds; and an expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion.

As you can see the mechanical response seems to be missing! Unless of course you count the mechanical response of the mind of Mark Carney as he panicked thinking the UK was going into recession. The other 8 either panicked too or meekly fell in line. The point is further highlighted if we look at the scenario assumed for the exchange-rate of the UK Pound £.

And as the sterling risk premium increases, sterling falls by 25%, in addition to the 9% it has already fallen
since the May 2016 Inflation Report.

Let us examine the reaction function. Let us say that the £ had fallen by 10% when the Bank of England took action then if it ” responds mechanically” we would expect this time around to see a 0.625% reduction in Bank Rate and some £150 billion of extra QE as well as another Term Funding Scheme bank subsidy of over £300 billion.

Instead we are expected to believe that the Bank of England would raise and not cut interest-rates and would do so by 4.75%! There is also an issue with the timing as the forward guidance of the Bank of England has been for Bank Rate rises for over 4 years now and we have had precisely 0.25% in net terms. So at the current rate of progress the interest-rate increases would be complete somewhere around the turn of the century.

Actually there is more because other interest-rates would go even higher it would appear.

Uncertainty about institutional credibility leads to a pronounced increase in risk premia on sterling
assets, including a 100bps increase in the term premium on gilts.

So an extra 1% on Gilt yields although this is only related to a particular piece of theory as we skip what they would be apart from an implication of maybe 6.5%. A particular catch in that is the current ten-year yield is a mere 1.33% and over the past 24 hours it has been falling adding to the previous falls I have been reporting for a while now. Markets do of course move in the wrong direction at times but Gilt investors seem to be placing their bets on the Gilt market and ignoring the Bank of England scenario.

But wait there is more.

Overall, interest rates on loans to households and businesses rise by 250bps more than Bank Rate.

Can this sort of thing happen? Yes as we saw it in the build up to the credit crunch as UK interest-rates disconnected from Bank Rate by around 2%. Also yesterday we were noting such a thing via the fact that Unicredit of Italy has found itself paying 7.83% on a bond which was yielding only 1% as recently as yesterday. But there are two main problems of which the first occurred on Mark Carney’s watch as we note that they way he “responds mechanically” to such developments is to sing along with MARRS.

Pump up the volume
Pump up the volume
Pump up the volume
Get down

Actually such a response by the Bank of England was typical before the advent of Governor Carney. Recall this?

For instance, during the financial crisis the exchange rate
depreciated around 30% initially but settled to be around 25% below its pre-crisis peak in the following
couple of years.

So in a broad sweep in line with the new worst case scenario especially as we recall that inflation went above 5% on both main measures. So Bank Rate went to 5.5%? Er now it was slashed by over 4% to 0.5% and we saw the advent of QE that eventually rose in that phase to £375 billion.

Comment

The first comment was provided by financial markets as we have already noted the Gilt market rally which was accompanied by the UK Pound £ rallying above US $1.28. The UK FTSE 100 did fall but only by 13 points. If there is anything a Bank of England Governor would hate it is being ignored.

Actually the timing was bad too. For some reason the report was delayed from 7:30 am to 4:30 pm but due to yet another problem it was another ten minutes late. This means that very quickly eyes turned to this by Federal Reserve Chair Jerome Powell.

Stocks ripped higher on Wednesday after Federal Reserve Chairman Jerome Powell said interest rates are close to neutral, a change in tone from remarks the central bank chief made nearly two months ago. ( CNBC )

Roughly that seems to take 0.5% off the expected path of US interest-rates and has led to the US ten-year Treasury Note yield falling back to 3%. Also trying to convince people about higher inflation is not so easy when the oil price ( WTI) falls below US $50.

Me on Core Finance TV

 

 

 

 

 

What can we expect next from UK house prices?

A feature of the credit crunch era has been the way that central banks have concentrated so much firepower on the housing market so that they can get house prices rising again. Of course they mostly hide under the euphemism of asset prices on this particular road. For them it is a win-win as it provides wealth effects and supports the banking sector via raising the value of its mortgage book. The increasingly poor first time buyer finds him or herself facing inflation via higher prices rather than wealth effects as we note the consumer inflation indices are constructed to avoid the whole issue.

This moves onto the issue of Forward Guidance which exists mostly in a fantasy world too. Let me give you an example from the Bank (of England) Underground Blog.

 It is reasonable to suppose that the more someone knows about a central bank and how it conducts policy, the more confidence they will have that the central bank will act to bring inflation back to target.

Really? To do so you have to ignore the two main periods in the credit crunch era when the Bank of England “looked through” inflation above target as real wages were hit hard. Yet they continue to churn out this sort of thing.

 And Haldane and McMahon, using the institutional knowledge score discussed above, show that for the UK, higher knowledge corresponds to greater satisfaction with the Bank, and inflation expectations closer to 2% at all horizons.

So according to the Bank of England you are none to bright if you disagree with them! I think it would have been better if Andy Haldane stuck to being a nosy parker about others Spotify play lists.

The area where the general public has I think grasped the nettle as regards central banking forward guidance is in the area of house prices. The Bank of England loudspeakers have been blaring out Yazz’s one hit.

The only way is up, baby
For you and me now
The only way is up, baby
For you and me now

Indeed even if things go wrong then we can apparently party on.

But if we should be evicted
Huh, from our homes
We’ll just move somewhere else
And still carry on

Where are we now?

If we switch to the current state of play we are in a situation where the new supply of moves to boost house prices have dried up. For example the Term Funding Scheme ended in February and after over four years of dithering the Bank of England raised Bank Rate to 0.75% in August. Combining this with the fall in real wages after the EU leave vote led to me expecting house prices to begin to fall but so far only in London has this happened. One factor in this has led to a blog from the National Institute of Economic and Social Research or NIESR last week.

The key point is that although the political turmoil was of great concern, the impact on bond prices followed a pattern we have seen before in which risk rises but expectations of a policy response militate against the risk.

The politics may be of great concern to the NIESR but the UK Gilt market has been driven by the intervention of the Bank of England. Not only has it already bought some £435 billion of it but its behaviour with the Sledgehammer QE of August 2016 has led to expectations of more of it in any setback. The irony is that good news may make the Gilt market fall because it makes extra QE less likely. The impact of this has been heightened by the way the Bank of England was apparently willing to pay pretty much any price for Gilts in the late summer of 2016. For the first time ever one section of the market saw negative yields as the market picked off the Bank of England’s buyers.

Mortgage Rates

This is where the Gilt yield meets an economic impact. If we think about mortgage rates then they are most driven by the five-year yield. On the day of the August Bank Rate it was 1.1% and of course according to the Bank of England the intelligent observer would be expecting further “limited and gradual rises” along the lines of its forward guidance. Yet it is 0.96% as I type this and the latest mortgage news seems to be following this. From Mortgage Strategy.

TSB has reduced interest rates by up to 0.35 per cent on mortgages for residential, home purchase and remortgage borrowers.

Changes applied include reductions of up to 0.35 per cent on five-year fixed deals up to 95 per cent LTV in its house purchase range; reductions of up to 0.25 per cent on two-year fixes up to 90 per cent LTV; and up to 0.30 per cent on five-year fixes up to 90 per cent LTV for remortgage borrowers.

That was from Friday and this was from Thursday.

Investec Private Bank has announced cuts to a series of its fixed and tracker mortgages.

Reductions total up to 0.50 per cent, and all within the 80 per cent – 85 per cent owner-occupier category.

Specifically, the variable rate mortgage has been cut by 0.50 per cent, the three-year fixed rate product by 0.10 per cent, the four-year by 0.15 per cent, and the five-year fixed rate by 0.20 per cent.

So the mortgage rates which had overall risen are in some cases on the way back down again. We will have to see how this plays out as Moneyfacts are still recording higher 2 year mortgage rates ( 2.51% now versus the low of 2.33% in January). I am placing an emphasis on fixed-rate mortgages because of the recent state of play.

The vast majority of new mortgage loans – 96% – are on fixed interest rates, typically for two or five years.

Currently half of all outstanding loans are on fixed rates, equating to about 4.7 million households.  ( BBC in August).

Lending

According to UK Finance which was the British Bankers Association in the same way that the leaky Windscale nuclear reprocessing plant became the leak-free Sellafield this is the state of play.

Gross mortgage lending across the residential market in October was £25.5bn, some 5.6 per cent higher than last October. The number of mortgages approved by the main high street banks in October was 4.1 per cent lower than last October; although approvals for house purchase were 3.6 per cent higher, remortgage approvals were 13.5 per cent lower and approvals for other secured borrowing were 1.3 per cent lower.

If they are right this seems to be a case of steady as she goes.

Comment

The situation so far is one of partial success for my view if the monthly update from Acadata is any guide.

House prices rebounded in October, up 0.4% – the first increase since February. The annual rate of price increases
continued to slow, however, dropping to just 1.0%.
Despite this, most regions continue to show growth, the exceptions being both the South East and North East, which show modest falls on an annual basis. The average price of a home in England and Wales is now £304,433, up from £301,367 last October.

So no national fall as hoped ( lower house prices would help first time buyers) but at east a slowing of the rise to below the rate of growth of both inflation and wages. There is also plenty of noise around as one official measure is still showing over 3% growth whilst the Rightmove asking prices survey shows falls. As ever the numbers are not easy to wade through as for example I have my doubts about this.

In London annual price growth has slowed substantially in the last month, falling to just 1.8%, yet there has still been an increase of £10,889 in the last twelve months with the average price in London now standing at £620,571.

The noose around house prices is complex as for example we have seen today in the trajectory of mortgage rates and reporting requires number-crunching as this from Politics Live in the Guardian shows.

GDP per head would fall by 3% a year, amounting to an average cost per person a year of £1,090 at today’s prices.

I would like to see an explanation of why it would fall 3% a year wouldn’t you? Much more likely the NIESR suggests a 3% fall in total and just for clarity it is against a rising trend. Of course if we saw falls as reported in the Guardian we would see the 18% drop in house prices suggested by some before the EU referendum whereas so far we have seen a slowing of the rises. But the outlook still looks cloudy for house prices and I still hope that first time buyers get some hope in terms of lower prices rather than help to borrow more.

Podcast

Central banking forward guidance ignores the rules of probability

Today we can continue our journey into the world of central bankers which is a cosy international club. It was hard as the New York Federal Reserve Bank reported in glowing terms the visit of its President John Williams to the Bronx not to recall a previous effort from his predecessor William Dudley. From Reuters in 2011.

He then stretched for a real world example. The only problem was he chose the Apple’s latest tablet computer that hit stores on Friday, which may be more popular at the New York Fed’s headquarters near Wall Street than it is on the gritty streets of Queens.

“Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful,” he said.”You have to look at the prices of all things.”

This prompted guffaws and widespread murmuring from the audience, with one audience member calling the comment “tone deaf.”

“I can’t eat an iPad,” another said.

That of course echoed around the world. This event by the Tweet storm looks more controlled in terms of audience so he may have avoided questions like this.

“When was the last time, sir, that you went grocery shopping?” one audience member asked.

Equilibrium Unemployment

Last night Michael Saunders of the Bank of England gave a speech to the CBI and as early as the fourth sentence he was pontificating about the theory that just will not die and about a number he cannot possibly know.

In the last 10-15 years, these effects from population ageing have been fairly benign, reducing the equilibrium jobless rate and neutral interest rate.

Let me now take you back just over five years when David “I can see for” Miles was giving us forward guidance on the equilibrium unemployment rate.

we will not tighten monetary policy until a recovery is strong enough and sustained enough that it has made a meaningful dent in unemployment so that it at least falls to 7 per cent…….. that linking the horizon over which an exceptionally expansionary monetary policy continues to support demand to the rate of unemployment has merit.

It is easy to forget now that we were being steered away from using GDP for monetary policy and towards the unemployment rate along these lines. Poor old David must wish he had never uttered the words below.

I suspect this is largely because the weight of money is behind a view that the significant positive news on the economic outlook means that the 7% unemployment level might be reached within around eighteen months………

Actually the unemployment rate plunged such that by the New Year these words were even more embarrassing.

If that is so unemployment is likely to fall rather more
slowly than would be usual.

Putting it another way the equilibrium unemployment rate is now 4.25% according to the Bank of England via 4.5%,5%, 5.5% and 6,5%. They may have guided to 6% as well but I do not recall it and these things tend to get redacted. Imagine you went to an engineer who guided you towards 7000 revs in your car then a few years later decided it was 4250! This sort of thing can only happen because central banking is a closed shop where the establishment appoint the same old “independent” crew.

Returning to Michael Saunders and yesterday he loses the plot more here.

Over the last 25 years, the share of the 25-64 age population with tertiary level (ie university or
similar) education has risen from 19% to 43%, a bigger rise than in most advanced economies (see figure
4).ix The tertiary education share among people aged 25-40 years is now around 50%, and the rise in this
measure has slowed in recent years.

A triumph according to Michael except he ignores the fact that this accompanies a really poor period for real wages. Indeed if the workforce is indeed more qualified, then real wages are even lower on a like for like basis. Are qualifications now required for lower skilled jobs and frankly what value are they? These are the real questions central bankers ignore as they pose the question how did we get here? That of course has been driven by their policies.

The attempt to use demographics as a smokescreen clears quickly as we compare the number below with the 2.75% error.

 This shift in workforce composition away from age groups that tend to have high jobless rates has cut the equilibrium jobless rate by about 0.3 percentage point since 2007.

 

Neutral Interest-Rate

We now move on to one of the central banking obsessions of our times. The so-called neutral interest-rate is examined below.

However, the MPC judges that, in practice, population ageing currently is lifting the stock of household assets, both in the UK and globally – and hence is pushing the equilibrium level of global real interest rates lower, and will continue to do so for some time.

Interesting ( sorry). If we look at the UK real interest-rate are low because the Bank of England put them there! It then thought bond yields were too high so QE was used to help lower them. Even this was not enough so it used credit easing to reduce mortgage rates. On the other side of the coin it has had two main phases of what it calls “looking through” rises in inflation. The first in 2010/11 when both main consumer inflation measures peaked above 5% per annum and then more recently after the EU leave vote.

The fundamental issue here is something that I learnt during my days as an option trader. On the quiet days we spent many hours discussing how to measure low probability events or what we would call  far out of the money options. One company called CRT built quite a empire based on the view that low probability events were undervalued and therefore bought them and counted the profits. Those of you who have followed the collapse of the company called OptionsSellers last weekend might note that it appears ( it has been vague on the details) to have done the reverse and accordingly according to the CRT theory has lost money. In this instance all of it.

Bringing this back to central bankers lets us note that Bank Rate is presently 0.75% and the estimate of the neutral rate is say in the range 2.5% to 3%. Because that is far away and also because interest-rate changes have been so rare that is an extraordinarily low probability event. An intelligent man or woman would therefore conclude that they are likely to know little or nothing about it until there is more evidence ( like some actual interest-rate rises). By contrast central bankers regularly opine about it and attempt to present it as a fact when in fact the rest of us are singing along to Ivan Van Dahl.

Oh tell me why
Do we build castles in the sky?
Oh tell me why
Are the castles way up high?

Comment

I would like to look at something I think we can all agree with.

For most of the last 10 years, the economy has generally had significant amounts of spare capacity.

But look where it then goes.

Now, with the economy having grown above its modest potential pace for six or seven years that spare
capacity has been used up, with supply and demand in the economy broadly in balance.

Really? A more intelligent statement would be to say that the quantity measure (employment) has been strong but wage growth has been disappointingly weak. The failures around the “output gap” have led to claims wage growth is on the turn for many years from this crew. The reality is that the two main real wage falls have come when they have “looked through” inflation.

Anyway he saved the best to nearly last. If so how come we are where we are then?

BoE research suggests that this is not the case for the UK so far, and that the total impact of interest rate changes on growth and inflation is similar to the pre-crisis period.xlv The easing in mid-2016 seemed to provide the expected boost to the economy.

There are a couple of escape clauses in the second sentence such as “seemed to” and “expected” ( by who?) but we seem to be in “the operation was a success but the patient died” territory to me.

 

 

 

 

 

Was October a sign of the end of austerity for the UK Public Finances?

A feature of the past few months or so is that much of the economic data for the UK has been good, at least for these times. This was repeated by the CBI Industrial Trends Survey yesterday.

Manufacturing output growth picked up in the quarter to November, and firms saw overall order books rebound from a fall in October, according to the latest monthly CBI Industrial Trends Survey.

If we look into the detail we see this.

35% of businesses said the volume of output over the past three months was up, and 17% said it was down, giving a balance of +18%. This was above the historic average (+4%) and a slight pick-up from October (+13%).

So in spite of the ongoing problems for the car sector the manufacturing sector has been growing and above trend. Of course the trend for growth has not been much meaning that over the past few decades it has shrunk as a percentage of our economy but at least it is in a better phase and orders look solid too.

29% of manufacturers reported total order books to be above normal, and 19% said they were below normal, giving a balance of +10%. This was above the long-run average (-13%) and followed a weakening in October (-6%).17% of firms said their export order books were above normal, and 17% said they were below normal, giving a normal balance (0) – above the long-run average of -17%, and marginally higher than October (-4%).

I am not quite sure how to treat the export order books as that implies they were always shrinking, but anyway in relative terms we are doing better than usual. Speaking of exports overall take a look at this I spotted the other day.

Will I have to change the theme of trade deficits that I have run with for over twenty years now? It is way to early to say anything like that because any good month seems quite often to be followed by a reversal. But overall there has been an improving trend in there.

Bank of England

Yesterday several policymakers including Governor Carney were called to give evidence to the Treasury Select Committee. I would like to use the written evidence of Michael Saunders to illustrate their thinking, as it should in my view be questioned much more than it is.

With economic growth having been above potential for six or seven years, the spare capacity created by the recession has now probably been used up.

Hands up anybody who thinks that the past six or seven years have been “above potential”? Also if it has been this is quite a downgrade on the past as whilst I am far from a fan of extrapolating the previous boom we are way below its trends and need to understand why. Whereas the policies that have got us here from the Bank of England have apparently been a triumph. This swerve from central bankers from we saved you to the future is grim does not get challenged anything like enough. I would argue that the many of the problems have been created by their policies.

He is at it again here.

In turn, underlying pay growth (measured by private sector average weekly earnings excluding
bonuses) has picked up from 2-2½% a year ago to about 3% in June-August. This is close to a target consistent
pace, given the subdued trend in productivity growth.

As ever we see a central banker cherry-picking the data to get the answer he wants but let;s be fair. After all with their performances they are unlikely to be keen on bonuses! But there is a suggestion here that 3% wages growth is as good as it gets. Yet the same models which via their output gap theories suggest we can’t grow very fast are the same ones which previously told us that wage growth would be 5% plus if we had an employment situation like we do now.

Also the two statements below need challenging.

Under-employment has fallen markedly over recent years, with the net balance of desired extra working hours now around zero.

Okay so traditional output gap and full employment theory. But how does it go with this?

Overall, a U6-type  underemployment measure (which combines unemployment, IVPTs and the marginally attached) has fallen to 11.8% of the workforce in June-August from 12.6% a year ago.

It seems that there is quite a gap here as we recall that the level we have been guided to for the unemployment rate has dropped from 7% to 4.25% over the past five years, again with much less challenge than should have happened.

Oh and if you are struggling with currency trends Governor Carney provided his thoughts on the matter. From Bloomberg.

“There will be events that move sterling up and events that move sterling down,” he said. “That will likely continue for the next little while.”

The Public Finances

The picture here has been set fair and to some extent that continued today in the official figures.

Borrowing in the current financial year-to-date (YTD) was £26.7 billion: £11.2 billion less than in the same period in 2017; the lowest year-to-date for 13 years (since 2005).

As you can see this picked up the pace on the previous year, and FYE stands for Financial Year Ending.

Borrowing in the FYE March 2018 was £40.1 billion: £5.5 billion less than in FYE March 2017; the lowest financial year for 11 years (since FYE 2007).

So we need to borrow less than we did which means that in relative terms the debt issue is fading as the economy has been growing.

Debt at the end of October 2018 excluding Bank of England (mainly quantitative easing) was £1,598.5 billion (or 75.0% of GDP); a decrease of £33.6 billion (or a decrease of 4.0 percentage points) on October 2017.

Oh and as a technical point it is not mainly QE it is mainly the Term Funding Scheme and if we put the Bank of England back in the ratio is falling more slowly and is 84% of GDP.

The end of austerity?

October itself had an interesting kicker which will be immediately apparent below.

Central government receipts in October 2018 increased by 1.2% compared with October 2017, to £59.9 billion; while total expenditure increased by 7.7% to £65.4 billion.

I have looked into the numbers and if we look just at taxes growth seems to have remained at around 4%. The extremely complicated business as to how we account for interest on the Bank of England’s QE holdings seems to have subtracted about £1 billion which makes up the difference.

Moving to expenditure the explanation is about as clear as mud.

This month, much of the increase in spending was in the current account, with notable growth in both the expenditure on goods and services as well as net social benefits. Over the same period, interest payments on the government’s outstanding debt have increased; due largely to movements in the Retail Prices Index to which index-linked bonds are pegged.

So we spent more because we spent more. As to the index-linked debt we will have to monitor that as overall the numbers are down this financial year and with the oil price now at US $64 that will help.

As ever it is complicated as you see last October we thought we borrowed £8 billion but the figures ( as happens often) have improved.

Borrowing (Public sector net borrowing excluding public sector banks) in October 2018 was £8.8 billion, £1.6 billion more than in October 2017;

Comment

So the overall good economic news has led to a number higher than before for the UK fiscal deficit! It is a reminder that these numbers are erratic as back in July we were noting harsh austerity and now October says “spend,spend,spend.” Whilst there may be some flickers of change in for example the £700 million extra for the troubled local authority sector we need to see more before there is a clear change of direction.

One thing we can be sure of however is the first rule of OBR Club, where OBR stands for the Office of Budget Responsibility. When I checked last October’s it had around half the year’s data but apparently had learnt nothing.

The Office for Budget Responsibility (OBR) forecast that public sector net borrowing (excluding public sector banks) will be £58.3 billion during the financial year ending March 2018, an increase of £12.5 billion on the outturn net borrowing in the financial year ending March 2017.

Up is always the new down for them. Well we should have realised October might be a dodgy month when the OBR released this on the 29th.

On 29 October 2018, the Office for Budget Responsibility (OBR) revised their official forecast of borrowing for the financial year ending (FYE) March 2019 down by £11.6 billion to £25.5 billion.

 

What are the economic implications of Brexit?

Today there can only be one subject although as ever I will avoid the politics as much as is possible. Anyway at the current rate of progress anything on that subject would be out of date before I finished typing! At least in a world where the Brexit Secretary resigns over the Brexit deal. What exactly has he been doing these last few months? Let us move onto what is the debate over the economics and look at the outlook published by the International Monetary Fund or IMF yesterday.

IMF

The background is something that we are hearing from many establishments and central banks these days.

Moderate growth of just above 1½ percent is projected for the coming years, conditional on reaching a broad free trade agreement (FTA) with the EU and a smooth Brexit process.

Obviously the second part of the sentence is specific to the UK but both the Bank of England with its “speed limit” and the European Central Bank or ECB have been hammering out this bear. As ever the problem is how we got here? After all both central banks have indulged in monetary easing on a grand scale involving large interest-rate cuts, QE and credit easing. Yet the future is apparently not as bright as they promised. In essence we in Europe have a future that is a bit better than the past trajectory of Italy as we note that such views only cover what Chic called “Good Times” and mostly ignores recessions and setbacks.

The view from Tokyo is even worse where expanding the balance sheet of the Bank of Japan to more than 100% of GDP has led to the speed limit being between 0.5% and 1%. Is that the next step? Because if so a lot harder questions need to be asked about the way that central banks have been allowed to operate as borrowing from Peter to pay Paul has not gone anything like as well as they have claimed.

IMF View

Here is their base view on a no-deal Brexit.

On the downside, reverting to WTO trade rules, even in an orderly manner, would lead to long-run output losses for the UK of around 5 to 8 percent of GDP compared to a no-Brexit scenario. This is because of higher tariff and non-tariff trade barriers, lower migration, and reduced foreign direct investment.

The issue with that style of analysis is that in the long-run many things will change and we simply do not know what they will be. For example the UK would likely end up with higher trade tariffs with the European Union but might cut them elsewhere. Initially one would expect foreign investment to be lower due to the uncertainty but as time passes the UK may make moves – for example a mooted reduction in Corporation Tax – to offset that. Lower migration is the most likely to continue although as we have until now had little control over our borders it seems set to be driven by demand with fewer people wanting to come.

The IMF has a worse scenario for a disorderly situation.

A worst-case scenario would be a disorderly exit from the EU without an implementation period. In such a scenario, a sudden shift in investors’ preference for UK assets could lead to a sharp fall in asset prices and a hit to consumer and business confidence, which in turn would have adverse
impact on the balance sheets of households, firms and financial intermediaries. Sterling would depreciate further, raising domestic prices and affecting households’ real income and consumption. A disorderly exit is likely to lead to widespread disruptions in production and
services.

If we pick our way through this we open with what is mostly a euphemism for house prices which are of course supposed to be already falling. In fact I though and indeed hoped we would see a fall as they are too high but if we take yesterday’s official data we see that they were rising at an annual rate of 3.5% in September. One asset price that is surging today is the UK Gilt market where the long gilt future has risen over one point and the ten-year yield has fallen from 1.5% to 1.38%. As we have political turmoil right now and a disorderly departure is thus more likely this is awkward for the IMF. Of course the driving force in my opinion is investors seeing through the rather transparent “Forward Guidance” of Bank of England Governor Mark Carney and expectations of him pressing on his control P button. Last time around his “Sledgehammer QE” drove the ten-year Gilt yield as low as 0.5% so you can see what punters, excuse me investors may be thinking of.

If we move onto business investment then the IMF finds much firmer ground under its feet basically because of this. From last Friday’s GDP release by the Office for National Statistics.

being partially offset by a fall of 1.2% in early estimates of business investment.

The issue around consumer confidence is more complicated as some issues remain here as the IMF hints at.

At 8.1 percent yoy in August, consumer credit growth remains high relative to income growth.

What would happen to sterling? Well this morning;s circa two cent fall versus the US Dollar gives backing to the IMF view but of course we are already considerably lower than we were. So I do not expect a similar move unless there is a complete calamity. That brings in the trade issue where a calamity would mean trade at the ports and airports grinding to a halt. In the political shambles we are living through that is of course possible but you would think both sides would move heaven and earth to avoid it.

Comment

As you can see there is some solid backing for the IMF view but also more than a few areas which are debatable. To be fair it does hint at one of these itself.

New trade arrangements with countries outside the EU could offset some of losses on trade with the EU over the long run.

The exact balance is simply unknowable. For example in the short-term one would expect trade in goods and services to be affected but over time new products and methods will apply. Philosophically this type of steady-state analysis will always look bad because any change on this scale will have dislocations but any possible benefits are for the future and are therefore unpredictable. Indeed there is always a lot of doubt about such matters. Let me illustrate this with something from the IMF as recently as July 4th on the subject of Germany.

In the first quarter of 2018, growth slowed to 0.3 percent (qoq), reflecting a normal correction following unusually strong growth in late 2017 and temporary factors (strikes, a particularly nasty flu outbreak, and early Easter holidays).

Is the flu outbreak ongoing as we mull this from the German statistics office yesterday?

The Federal Statistical Office (Destatis) reports that, in the third quarter of 2018, the gross domestic product (GDP) shrank by 0.2% on the second quarter of 2018 after adjustment for price, seasonal and calendar variations. This was the first decline recorded in a quarter-on-quarter comparison since the first quarter of 2015.

That reduced the annual rate of GDP growth to 1.1% or half of what the IMF forecast for this year (2.2%) and pretty much half of what was forecast for next year (2.1%).

Next let me move to the UK consumer which I have dodged so far and maybe the most unpredictable of all. The reason for this is it is entwined with Bank of England policy and the IMF did its best to rewrite history tucked away in its report.

Mortgage rates are at record low levels in part due to intense bank competition.

After all the Bank of England moves to reduce mortgage rates ( remember its own research suggested a nearly 2% fall in them due to the Funding for Lending Scheme on its own) that is breathtaking! Any “intense bank competition” has been driven by the policy of “the spice must flow” to the banks.

Which brings me to my next suggestion which is the surge in the UK Gilt market is in my opinion due to it rejecting the Forward Guidance of “limited but gradual interest-rate rises” of Mark Carney and the Bank of England. Instead expectations of Sledgehammer QE 2.0 which if you recall in its madness drove the ten-year Gilt yield to 0.5% seem to be at play. Perhaps a Bank Rate cut to what after all is the “emergency” rate of 0.5% too.

So how do you think the UK consumer would respond now?

Number Crunching 

Is everything 1.5% these days? From the IMF about UK Bank Rate.

The nominal policy rate is still below the Fund staff’s estimated neutral rate of about 1½ percent

 

 

Decision day and the Inflation Report arrive at the Bank of England

Today brings us to what is called Super Thursday as not only does the Bank of England announce its policy decision but we get the latest Inflation Report. Actually the Bank of England has already voted in a change decided upon by Mark Carney so that the official Minutes can be released with the decision. The problem with that comes from the issue that there is plenty of time for any decision to leak. That is on my mind this morning because markets have seen moves and activity.

Sterling extended its gains on Thursday……….

The pound jumped 0.9 percent to as high as $1.2881  sending the currency to a five-day high.

Against the euro, it rose to 88.155 pence per euro  before settling up half a percent at 88.21 pence. The gains follow a rise for sterling on Wednesday.

Now let me switch to interest-rate markets.

Short Sterling being hit in monster clips this morning 20k plus sells. ( @stewhampton)

For those unaware Short Sterling is the future contract for UK interest-rates and is somewhere where I worked back in the day in its options market. The confusing name comes I guess because they were trying to describe short-term interest-rates for sterling and it all got shortened. Anyway @stewhampton has continued.

Continuation of yesterday’s price action, all sells. Smacks of a surprise BOE vote on the hawkish side to me.

Looking at the actual movements we see that the contract for September 2019 was some 0.05 lower at the worst. For comparison an actual Bank of England move is usually 0.25%.

The Shadow MPC

The Times newspaper runs a Shadow Monetary Policy Committee so let us take a look at what it decided.

Sir John Gieve, Charles Goodhart and Andrew Sentance, all former Bank ratesetters, called on the monetary policy committee to increase rates after the £103 billion of fiscal loosening over six years unveiled in Monday’s budget.

Sir Steve Robson, a former Treasury mandarin, Geoff Dicks, a former member of the Office for Budget Responsibility, and Bronwyn Curtis, a non-executive member of the OBR, agreed. All six also cited the tight labour market, with unemployment at a 43-year low of 4 per cent, and rising wages.

On a personal note it is nice to see that Charles Goodhart is still active as he wrote a fair few of the books I read on UK monetary policy as an undergraduate. Also not many people call for a rise in interest-rates at their own semi-retirement party as Andrew Sentance did on Tuesday!

Before I move on I would also like to note that some seem to be catching up with a suggestion I first made in City-AM a bit over five years ago.

Of those who voted to hold rates, Rupert Pennant-Rea, a former deputy governor at the Bank, said that the MPC should start unwinding the £435 billion quantitative easing programme — signalling a bias on The Times panel for tighter policy.Ms Curtis and Sir Steve also called for QE to be wound down.

Decision Day

These are always rather fraught when there is the remote possibility that something may happen. Back in the day that usually meant an interest-rate change and moves were regularly larger which we returned to for a while with the cuts post credit crunch. These days it can also reflect a change in the rhetoric of the Bank of England as well as its Forward Guidance. That is of course if anyone takes much notice of the Forward Guidance which has been wrong more often than it has been right.

But you can have some humour as this from @RANSquawk shows.

Lloyds on – Prices have reversed from the 1.2660 range lows, back through 1.2850 resistance – This, along with momentum back in bull mode, supports our view for a move back towards the top of the 1.2660-1.3320 range

Yes now it has gone up the only way is up and you can guess which song has been linked to on social media.

Doubts

If we now look at the other side of the coin there have been other factors at play over the past 24 hours. First there was the announcement by Brexit Secretary Dominic Raab of progress followed this morning by this.

The UK has struck a deal with the EU on post-Brexit financial services, according to unconfirmed reports.

The Times newspaper said London had agreed in talks with Brussels to give UK financial services firms continued access to the bloc. ( BBC)

On this road we see reasons to be cheerful for the UK Pound £ and also a possible explanation for the lower short sterling. After all a Brexit deal and a likely stronger Pound £ might mean the Bank of England might raise interest-rates again at some future date. Of course we are building up something of a Fleetwood Mac style chain here as we are relying on the words of journalists about the acts of politicians influencing an unreliable boyfriend. Oh well.

House Prices

Having gone to so much effort to raise house prices for which during the tenure of Governor Carney the only way has indeed been up this will worry the Bank of England.

October saw a slowdown in annual house price growth to
1.6% from 2.0% in September. As a result, annual house
price growth moved below the narrow range of c2-3%
prevailing over the previous 12 months. Prices flat month-on-month after accounting for seasonal effects. ( Nationwide)

Reuters have implictly confirmed my point about Mark Carney’s tenure.

That was the weakest increase since May 2013, before Britain’s housing market started to throw off the after-effects of the global financial crisis.

Manufacturing

There was also a downbeat survey from Markit released at 9:30 am.

The seasonally adjusted IHS Markit/CIPS Purchasing
Managers’ Index® (PMI®) fell to a 27-month low of 51.1,
down from September’s revised reading of 53.6 (originally
published as 53.8).

Of course that 27-month low was when they got things really rather wrong after the EU Leave vote and perhaps most significantly helped trigger a Bank of England rate cut. As to factors here I think it is being driven by the automotive sector and the worries about trade generally. In some ways this measure has in fact been a sort of optimism/pessimism reading on views about Brexit.

One slightly odd feature of the report was this as we recall that a number above 50 is supposed to be an expansion and  after all they do measure down to 0.1.

At current levels, the survey indicates that factory output could contract in the fourth quarter, dropping by 0.2%

 

Comment

As you can see there is much for the Bank of England to consider this morning as they advance from a full English ( Scottish & Welsh versions are available) breakfast to morning coffee and biscuits. After all having voted last night there is not much to do until the press conference at 12:30 and less than half of them have to attend that. But as to a rate rise today I think it is time for some Oasis.

Definitely Maybe

Whilst some might say it is on the cards I think that if we add in the weak monetary data we have been watching in 2018 it would be an odd decision. After all it is promising to raise interest-rates like this.

As little by little we gave you everything you ever dreamed of
Little by little the wheels of your life have slowly fallen off
Little by little you have to give it all in all your life
And all the time I just ask myself why you’re really here?

But of course they have made odd decisions before………

Me on Core Finance TV