Some in the UK have experienced higher and not lower interest-rates

Today has brought more news on a long running theme of this website. This is the way that ever easier monetary policy has made home ownership increasingly unaffordable for the young. Here is the Institute for Fiscal Studies on the subject and the emphasis is theirs.

Today’s young adults are significantly less likely to own a home at a given age than those born only five or ten years earlier. At the age of 27, those born in the late 1980s had a homeownership rate of 25%, compared with 33% for those born five years earlier (in the early 1980s) and 43% for those born ten years earlier (in the late 1970s).

So in generational terms this has gone 43%, 33% and now 25% with about as clear a trend as you could see. The driving force of this will be very familiar to regular readers but it seems that more than a few elsewhere need to be reminded of it.

The key reason for the decline is the sharp rise in house prices relative to incomes. Mean house prices were 152% higher in 2015–16 than in 1995–96 after adjusting for inflation. By contrast, the real net family incomes of those aged 25–34 grew by only 22% over the same twenty years. As a result, the average (median) ratio between the average house price in the region where a young adult lives and their annual net family income doubled from 4 to 8, with all of the increase occurring by 2007–08.

That is an odd ending to the paragraph because we know house price growth began again in the UK in 2013 and yet real wage growth has been to say the least thin on the ground. But we can at least agree with the broad sweep that compared to income the affordability of houses has halved.  It is also interesting to note that over the twenty year period looked at real family income growth was only 1% per annum. The IFS then goes on to give us more of a breakdown of its analysis.

This increase in house prices relative to family incomes fully explains the fall in homeownership for young adults. The likelihood of a young adult owning their own home given how their income compares with house prices in their region is little changed from twenty years ago. But in 2015–16 almost 90% of 25- to 34-year-olds faced average regional house prices of at least four times their income , compared with less than half twenty years earlier. At the same time, 38% faced a house-price-to-income ratio of over 10, compared with just 9% twenty years ago.

If we step back for a moment this is merely the other side of the coin from the “wealth effects”  otherwise known as higher house prices that the Bank of England has been so keen on. We have had Bank Rate cut to 0.5% and even 0.25% for a while, some £435 billion of Quantitative Easing and of course the Funding for Lending Scheme which the Bank of England felt cut mortgage rates by around 2%. So if we take away the spin the problems with house price affordability were a deliberate policy move by the Bank of England and I do sometimes wonder why millennials are not picketing Threadneedle Street.

Debt

I have some thoughts for you on the report by the Resolution Foundation on the scale of the problem here.

Standing at nearly £1.9 trillion, UK household debt remains a big issue.

We get quite a bit of analysis that tells us much of this is fine but a lot of care is needed here as you see that is a line straight out of the Bank of England which has an enormous vested interest here. This phrase gets us ready for another “surprise” at a later date.

appears to have been associated with borrowing by higher income households,

Also does anyone really believe this line?

And many of the credit market fundamentals look much improved relative to the pre-crisis period, with tighter lending criteria and closer monitoring of potentially unwelcome developments.

We are always told it is better until they can tell us that no more. But even such analysis cannot avoid this.

 Increases in the base rate will inevitably increase costs for many indebted households and have the potential to further increase the debt ‘distress’ faced by some.

We then get much more Bank of England inspired spin.

The base rate is expected to rise only gradually, and to remain well below past norms.

It has been telling us that such 2014 whereas Bank Rate is still 0.5% as they of course cut it after promising increases and then put it back. But you see the position is more complex than that as whilst some borrowing got cheaper for example the mortgage rates I was looking at above and some personal loans other bits of borrowing got more expensive. These days we have a proliferation of payday lenders and the like who are on our television screens plugging loans with annual interest rates of 50% or 60% at best and in some cases far higher. What difference would a Bank Rate of say 1.5% make here?

I noted some analysis on the United States which pointed out that for consumer debt Americans were paying higher interest-rates for a given official one which raised a wry smile as that was one of my earliest themes and may even be the first one albeit I was referring mostly to the UK. Let me explain what I mean as the UK average credit card interest rate was 15.67% on the first of January 2017 pre credit crunch ( Bank of England data). So after all the Bank Rate cuts and QE it has fallen to 17.95%. Oh! The overdraft rate has responded to all the official easing by going from 17.16% to 19.71%. Oh times two!

Putting it another way for the around 4% cut in official interest-rates up is yet again the new down as the borrowers above see a rise of around 2% in what they are paying. Is this yet another bank subsidy?

Also the Bank Rate cut and £60 billion QE about which Governor Carney frequently likes to boast reduced the credit card interest-rate by 0.03% briefly and raised the overdraft rate by 0.03%. I doubt anyone noticed.

Comment

One of the features of the credit crunch era is the way that we have been broken down into different groups. For example those with a mortgage have in general seen lower interest-rates as have personal loans but those with overdrafts or ongoing credit card debt have not and even worse have seen rises. Of course some with credit card debt have been able to take advantage of 0% deals but I notice that these seem to come with fees these days. So lots of different impacts on different groups which brings me to the impact of Bank of England policy. This is yet another example of where it has benefited some groups at the expense of others as some gain but others lose. There is also a more general point that is true everywhere I look is that “the precious” otherwise know as the banks have been able to raise their margins whilst the authorities look away.

If we shift to the asset side of the equation the Bank of England has benefitted those with them by the way it has boosted house prices. But the other side of the coin is seen by the falling levels of home ownership amongst the young as they ( and others) face inflation as they see higher house prices. Next in the equation comes that some will be helped by the “bank of mum and dad” be that by cash or inheritance. How much more of a mixed soup could this be? Yet the central planners continue to meddle and these days are so confused themselves that they come out with rubbish like there will be more interest rate rises than the ones we have promised but not delivered for the last four years.

 

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If UK growth has a “speed limit” of 1.5% how is manufacturing growing at 3.4%?

Yesterday saw the Quarterly Inflation Report of the Bank of England where its takes the opportunity to explain its views on the UK economy. There was a subject which Governor Mark Carney returned to several times and it was also in the opening statement.

It is useful to step back to assess how the economy has performed relative to the MPC’s expectations in order to understand the forces at work on it.

You are always in trouble when you have to keep telling your audience you got things right. I don’t see Pep Guardiola having to explain things like that or Eddie Jones and that is because things have gone well for them. Increasingly the Governor is finding himself having to field questions essentially based upon my theme that the Bank of England has a poor forecasting record. Actually tucked away in his statement was yet another confession.

GDP growth is expected to average around 1¾%
over the forecast period, a little stronger than projected in November.

I would like to present his main point in another way as we were told that policy is “transparent” and being done “transparently”. Okay so apply that test to this?

The MPC judges that, were the economy to evolve broadly in line with its February Inflation Report projections, monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent over the forecast period than it anticipated at the time of the
November Report, in order to return inflation sustainably to the target.

So if they get things right which they usually do not then interest-rates will rise by more than the previous unspecified hint? That is opaque rather than transparent especially when you have a habit of saying things like this.

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. (Mansion House June 2014).

What actually happened? The next move was a Bank Rate cut! Also I noted this in the Financial Times from back then.

This speech marks an important change of tone from the governor……..with rates rising earlier, further and faster than markets currently price in.

I noted this because it was from Michael Saunders who was of course giving bad advice to Citibank customers as we wonder if his enthusiasm for the Governor’s thoughts and words got him appointed to the Monetary Policy Committee?

Also I note that the 0.25% Bank Rate cut and Sledgehammer QE is claimed to have had an enormous impact.

this strategy has worked with
employment rising and slack steadily being absorbed

Yet this morning Ben Broadbent has contradicted this on BBC 5 Live’s Wake Up To Money.

dep gov Ben Broadbent said that was “true to some extent”, adding he didn’t think a couple of 25 basis point [0.25%] rises in a year would be a great shock

So if two rises are no big deal how was one cut a big deal? I guess if you send out your absent-minded professor out at the crack of dawn he is more likely to go off-piste.

Our intrepid Governor was also keen to expound on the Bank of England’s improvement in the area of diversity which he did as part of a panel composed of four middle-aged white men. As to policy independence regular readers will be well aware of my theme that the establishment took the Bank back under its control some time ago.

Today’s data

This was always going to be affected by the shutdown of the oil and gas pipeline for the Forties area in the North Sea as we already knew it has reduced GDP by around 0.05%.

In December 2017, total production was estimated to have decreased by 1.3% compared with November 2017; mining and quarrying provided the only downward contribution, falling by 19.1% as a result of the shut-down of the Forties oil pipeline for a large part of December.

Ouch indeed! However if we look deeper we see that production has been on an upwards sweep.

Total production output increased by 2.3% for the three months to December 2017 compared with the same three months to December 2016……….For the calendar year 2017, total production output increased by 2.1% compared with 2016,

Now that the Forties pipeline is back to normal there will be an additional push to the numbers.

Manufacturing

This sector has been on a good run which has been welcome to see after years and indeed decades of relative decline.

In the three months to December 2017……..due to a rise of 1.3% in manufacturing;

As to the driving force well we have heavy metal football at Liverpool courtesy of Jurgen Klopp and maybe we have some heavy metal economics too.

Within manufacturing, 9 of the 13 manufacturing sub-sectors experienced growth; the largest contribution to quarterly growth came from basic metals and metal products, which increased by 5.7%.

If we look deeper we see this which compares the latest quarter with a year ago..

The largest upward contribution came from manufacturing, which increased by 3.4%, due to broad-based strength, with 9 of the 13 sub-sectors increasing. Transport equipment provided the largest upward contribution, increasing by 6.6%, with three of its four industries increasing. The largest upward contribution came from the manufacture of aircraft, spacecraft and related machinery, while motor vehicles, trailers and semi-trailers fell by 0.3%.

There is something of an irony for those who found it amusing to jest that the UK would have to export to space in future as we indeed seem to be doing so. Of course space has been in the news this week with the successful, launch of the Falcon Heavy rocket with the successful landing of two of the three boosters which according to the Meatloaf critique “aint bad” and was also awe-inspiring. As you can imagine I heartily approve of it playing Space Oddity on repeat and the way Don’t Panic flashes on the car dashboard in big friendly letters.

Returning to manufacturing we have nearly made our way back to the place we were once before as the Eagles might put it.

 both production and manufacturing output have risen but remain below their level reached in the pre-downturn gross domestic product (GDP) peak in Quarter 1 (Jan to Mar) 2008, by 5.2% and 0.5% respectively in the three months to December 2017.

Trade

The familiar theme is as ever of yet another deficit but the December numbers were even more difficult to interpret than usual due to the impact of the Forties pipeline closure. This was its impact on the latest quarter.

The 21.6% decrease in export volumes of fuels (mainly oil) had a large impact on the fall in export volumes. When excluding oil export volumes increased by 1.3%……The value increase in fuels imports was due largely to price movements, as fuels import prices increased by 14.2% while fuels import volumes increased by 0.3%.

If we look back 2017 was a better year for UK trade.

UK export volumes up 7.4% between 2016 & 2017, import volumes were up 4.1%

This meant that the trade deficit fell by £7 billion ( not by £70 billion as was initially reported) so the cautionary note is that we still have a long way to go.

Comment

Today’s numbers provide their own critique to the rhetoric of Mark Carney and the Bank of England. Let me show you the two. Firstly the data.

The largest upward contribution came from manufacturing, which increased by 3.4%

Yet according to the Bank of England this is the “speed limit”.

the MPC judges that very little spare capacity remains and that supply capacity will grow only modestly over the
forecast, averaging around 1½% a year.

If you think it through logically it is an area where you would expect physical constraints and yet it does not seem to be bothered. Indeed the other area where there are physical constraints has done even better on an annual comparison.

 construction output in Great Britain grew by 5.1% in 2017

So as ever the Bank of England prefers its models to reality and if you listened carefully to the press conference Ben Broadbent confirmed this. What he did not say was that he is persisting with this in spite of a shocking track record.

Just for clarity the construction numbers are correct but had really strong growth followed by the more recent weakness. However as I have pointed out many times care is needed as we regularly get significant revisions..

 

 

 

 

What is happening in the UK housing market?

This morning has brought news to bring the current winter chill into today’s policy meeting for the Bank of England. This is that there are more signs of declines in London house prices as the Financial Times reports.

High-end homes in central London are selling at the biggest discounts in more than a decade as sellers continue to set ambitious prices even as the market declines.

Let us look further as of course for most of the period even the concept of a discount was a mirage.

In 2017 homes in the most exclusive postcodes were sold at an average discount of 10 per cent or more on their initial asking price, according to figures from LonRes, a research company. The gap between what buyers will pay and what sellers ask for their homes in this segment of the market is now greater than it was in either 2008 or 2009, following the financial crisis.

The areas most affected are shown below.

LonRes’s data cover London’s most exclusive districts, including Kensington and Chelsea, as well as prime parts of the capital extending from Canary Wharf in the east to Richmond in the west and Hampstead in north London.

Actually though if we look further we see that the position seems rather similar now across London.

Outside the most expensive “prime central” areas, discounts to initial asking price stood at just over 9 per cent — the highest level since 2009.

As ever we see that estate agents have their own language as we note “prime central” is a further refinement to “prime”. Also whilst the situation is now similar so far the more exclusive areas have been hit harder.

Prices per square foot in prime London have fallen 5 per cent since their 2014 peak while in the most expensive “prime central” areas they are down 11 per cent.

Also there are fewer transactions taking place.

Transaction volumes fell across central London in 2017, with the number of properties sold down 3.6 per cent over the year as fewer homes were put to the market.

Although care is needed as how many homes are sold in central London as a 3.6% fall may not be that many. It would appear that there is one remaining source of demand.

Foreign buyers, who are attracted by favourable exchange rates between sterling and most currencies, were an exception.

So presumably not Americans then if we look at the exchange-rate.

Ghost towns?

This issue reminds me of this from the Guardian at the end of January.

More than half of the 1,900 ultra-luxury apartments built in London last year failed to sell, raising fears that the capital will be left with dozens of “posh ghost towers”………The total number of unsold luxury new-build homes, which are rarely advertised at less than £1m, has now hit a record high of 3,000 units.

If you are wondering what ultra-luxury means?

The swanky flats, complete with private gyms, swimming pools and cinema rooms.

Cinema rooms are a new one on me. But as to the problem I don’t know about you but the £3 million price tag gives quite a clue.

Builders started work last year on 1,900 apartments priced at more than £1,500 per sq ft, but only 900 have sold, according to property data experts Molior London. A typical high-end three-bedroom apartment consists of around 2,000 sq ft, which works out at a sale price of £3m.

I guess such numbers distort your view of reality as I note the definition of affordable being used here from Steven Herd.

“We need ‘affordable’ one- or two-bedroom apartments priced at £500,000.

What we are getting seems instead to be more of the same old song.

Molior says it would take at least three years to sell the glut of ultra-luxury flats if sales continue at their current rate and if no further new-builds are started.

However, ambitious property developers have a further 420 residential towers (each at least 20 storeys high) in the pipeline, says New London Architecture and GL Hearn.

My personal interest in Nine Elms as it is close to me – 25 cranes now between Battersea Dogs Home and Vauxhall visible to someone on a Boris Bike – makes me read the bit below and wonder how such a good development can be made of the wrong properties?

Herd says the Nine Elms development, near the new US embassy in south London, was one of the best redevelopment schemes in Europe but consisted of “the wrong properties that Londoners don’t need”

As ever boom seems to be turning into dust as we look back to the lyrics of The Specials from three decades ago.

Do you remember the good old days
Before the ghost town?
We danced and sang,
And the music played inna de boomtown

Halifax

The downbeat view of the UK housing market started today from the view that London is a leading indicator or if you prefer the canary in the coalmine. It was added to by the latest data from Halifax Bank of Scotland.

On a monthly basis, prices fell for the second consecutive month in January (by 0.6% following a 0.8% decrease in December)……….House prices remained unchanged in the recent quarter (November-January) from the
previous quarter (August-October).

Thus we see that anything like the same trend will mean that we will see a quarterly decline when we get the February data. Also the year on year growth is fading away.

Prices in the last three months to January were 2.2% higher than in the same three months a year earlier, although the annual change in January was lower than in December (2.7%).

Finally it is down to a similar level to wage growth although of course we need it to be below it for quite a sustained period to see any real improvement in affordabilty as for now thinks have simply stopped getting worse.

Looking ahead there was a worrying sign for estate agents and the housing industry at the end of 2017.

Mortgage approvals for house purchases ended the year with a sharp fall. The number of
mortgage approvals – a leading indicator of completed house sales – fell by 5.7% month on
month in December to 61,039, the lowest level since January 2015. Over the year to December
2017 total mortgage approvals were 2% lower than in the same period in 2016.

Comment

There is a fair bit to consider here as we only get partial glimpses of the market. What I mean by that is that it is estimated that 30%- 40% of property purchases these days do not involve a mortgage. Thus places like the Halifax only see 60/70% of the market. It is also true that the Nationwide numbers were more upbeat last week. But we do see signs of ever more stress in London and it would be logical for lower real wages to be having an effect.

We need some falls especially in London in my opinion as prices became ever more unaffordable as intriguingly even Professor David Miles admits in VoxEU.

Average house prices in the UK have risen much faster than average incomes over recent decades. Relative to average disposable incomes, houses are not far off three times as expensive now as they were in the early 1980s; relative to median incomes, they have risen even more.

I say intriguingly because missing from the piece and his description as a Professor at Imperial College is his role in all of this . You see he was a policymaker at the Bank of England from 2009 until 2016  who could be described as an uber dove. He even wanted to ease monetary policy just as the UK economy was picking up in 2013. Yet all the monetary easing seems to be missing from his explanation of higher house prices. Is he not proud of the consequences of his actions?

What next for the UK economy and Bank of England policy?

Later this week the bank of England meets and votes on monetary policy. It will do this on Wednesday and announce the result on Thursday which is a newish innovation which frankly can only go wrong by being leaked. Also we will receive the quarterly Inflation Report so it is what you might call a “live” meeting as a policy move is more likely than at other meetings because of this. Last Tuesday Governor Carney made an effort to raise the rhetoric on the subject of inflation  From the House of Lords transcript.

We have further to go. The experience, particularly
over the course of the past decade, with large and persistent exchange rate moves is that there has been quite material pass-through to consumer prices and that that pass-through has come through over time.

In fact he expects the lower value of the UK Pound £ to continue to have an upwards effect on inflation for another couple of years or so.

Using a broad brush to describe how it flows through to CPI and people’s shopping baskets, we had about 40% of the effect in the first year, then 30%, 20% and 10%, so that it is tiny by year four……….We are about 18 months into this. Again, the rule of thumb is that in a big exchange rate move, about 60% goes to a first stage passthrough—in
other words, import prices—and the weight in the
consumption basket is just under 30%; or 30%, which I will use for the sake of argument. Given a 15% fall in the trade-weighted exchange rate, we should think about a 2.75% rise in the price level over time. Around 1.1% to 1.3% of the pass-through has shown up.

This is interesting as it would in itself justify an increase in Bank Rate to respond to this as there would be time for it to have some effect. Personally I doubt that as it looks yet again like something which might look neat in an economic model but has little contact with reality. I can see years one and two with the latter being where exchange-rate hedges and the like run off and lead to price rises but much much less if any for years 3 and 4. After companies like Apple and Unilever could hardly wait to raise prices as the Pound £ fell could they?Also I think it is important to remember that the main issue for price rises is the US Dollar because of the way that so many commodities are priced in it which leads me to this sentence.

. Of course, the farther out you go, the more other things are affected in terms of inflation and offsetting.

This at a later date can be used to cover the fact that there has been no mention that the UK Pound £ is now much higher against the US Dollar and at US $1.41 and a bit as I type this. This matters as the UK Pound £ has improved by a bit more than double ( ~17%) on my measure than on the effective one (~8%).

Wages

Bank of England optimism in this area is like a hardy perennial where even the bitterly cold winds provided by reality seem not to affect it.

We see it in the gradual firming of wages, particularly private sector wages, and particularly of people who are
shifting work.

The 3 monthly average has risen from 1.9% to 2.5% but that means that it was still lower than the 2.7% of the same month ( November) a year before. Also the single month data going 2.8%, 2.4% and then 2.3% hardly suggests a firming of any sort. Actually if you look at the issues with the data then the dip was the bonus season (April) and ordinary wage growth may well be pretty much where it was all along. A troubling answer but one which has fitted reality vastly better than the Bank of England’s modelling.

The economy

This has been doing well again to the dismay of economic modellers but this week has brought a couple of factors which are downbeat. One will be very familiar to regular readers. From the UK SMMT.

The UK new car market declined in the first month of the year, according to figures released today by the Society of Motor Manufacturers and Traders (SMMT). 163,615 cars were driven off forecourts in January, a -6.3% fall compared with the same month in 2017.

This makes us think of the car finance boom and second-hand car prices as well as ironically a fall in car imports which seemed on previous data to be disproportionately affecting French manufacturers. Another factor is the shambles around diesels which I doubt will improve as we learn that Volkswagen has been using monkeys in its tests.

However, this growth failed to offset a significant decline in demand for new diesel cars, which fell -25.6% as confusion over government policy continued to cause buyers to hesitate.

Also the latest business survey from Markit or PMI suggests that the UK economy slowed in January.

While the fourth quarter PMI readings were
historically consistent with the economy growing at
a resilient quarterly rate of 0.4-0.5%, in line with the
recent GDP estimate, the January number signals a
growth rate of just under 0.3%.

A little care is needed as the growth rate in the services sector has been erratic so we do not know if this will be a continuing dip or is an outlier.

Comment

Governor Carney was under pressure from the off as he faced the Lords Select Committee on Economic Affairs.

perhaps I may start by asking about the Bank’s projections for the economy in August 2016, particularly for business and housing investment and for imports and exports. Why did they turn out to be so wrong, relative to what has
actually happened?

This is much more than an idle question because these predicated the Bank Rate cut of August 2016 and the “Sledgehammer” bond purchases (QE). The Governor suggested that context was needed but was unable to shake off the issue completely in his reply.

On an annual average basis, not a calendar-year basis, there was 1.8% growth versus the 0.8% forecast.

If this was a boxing match then the Governor was trapped on the rails for a while.

I was struck by the fact that business investment, for example, which you suggested would fall by 2% in 2017, actually went up by 2.25% for the 11 months. You predicted that housing investment would fall by 4.7%, but it actually
went up by 4%.

It would appear that the Bank of England seems to be trying to set up something of an inflation scare after most if not all of it has passed. Maybe if we add in its optimism on wages it is tilling the ground for an interest-rate increase or two but this has problems one of which was highlighted by Markit earlier.

The January slowdown pushes the all-sector PMI
into dovish territory as far as Bank of England
monetary policy is concerned, historically consistent
with a loosening bias. With the survey also
indicating weaker upward price pressures, the data
therefore cast doubts on any imminent rise in
interest rates.

I think that the latter sentence reflects my view on inflation prospects more accurately than the Bank of England one but only time will tell. What we do know is that if we remain around US $1.41 then it will be an increasing brake on inflation trends. That should be good news as 2018 develops as it will help real wages and there should be an economic boost as real wages stop falling and hopefully rise from this source. It remains unclear whether wage growth will pick up.

Meanwhile the film industry seems to be continuing its recent boost to UK economic output if last night in Battersea Park was any guide.

 

 

 

The UK establishment dislikes the RPI because it produces a higher inflation number

Yesterday saw a new phase in a battle I have been fighting since 2012 with roots back to 2009. Back then some changes were made to the way the UK measured inflation in clothing and footwear that led to some uncomfortable answers. This triggered a debate about how we should measure inflation and the UK establishment immediately became fans of Steve Winwood.

While you see a chance take it
Find romance fake it
Because its all on you

You see over this period their behaviour can be summed up simply they are against inflation measures which give a HIGHER answer and in favour of ones which give a LOWER answer. Every time.

Governor Carney joins the party

It must have been party time for Chris Giles the economics editor of the Financial Times as he reported this.

Speaking to the House of Lords economic affairs committee, Mr Carney said the UK “wouldn’t want to be in the same position 10 years from now” using an inflation measure with “known errors” to uprate government bonds, student loan contracts and rail fares.

Indeed Governor Carney went further.

Mark Carney, Bank of England governor, on Tuesday called for a “deliberate and carefully timed” withdrawal of the retail prices index from its use in government contracts because “most would acknowledge, [the RPI] has no merit”.

There are some familiar features here of which the first is usually a combination of hyperbole and arrogance. For example to say that the RPI has “no merit” is plainly silly as whilst it has flaws it also has strengths of which more later. Also if it has “no merit” this should have been obvious from the start of Governor Carney’s term in July 2013 so why has he taken getting on for five years to notice it and then point it out? To use the Bank’s own language he has been “vigilant” with all that implies.

The next bit is maybe even more breathtaking.

He is the first senior official, outside of the UK’s statistics office, to call for the retirement of the RPI and to suggest a way to remove it in long term contracts, some of which stretch so far into the future that they mature in the second half of this century.

Is there an implication that existing contracts will be changed by a sort of force majeure? Care is needed here as the current landscape exists into the 2060s. Anyway the rhetoric continues.

The RPI has lost its status as a trusted inflation measure since 2012 when the Office for National Statistics found that an obscure change in the way it collected the price of clothing exaggerated the difference between it and other measures of inflation which show prices rising at a slower pace.

The use of “trusted” again overreaches. What happened it was declared as “not a national statistic” but it was also true that in the debate the RPI found support at places like the Royal Statistical Society from people like me. Actually some who have looked at this think that it was RPI which behaved more accurately over this period. So there has been a debate ever since and this raises a wry smile.

The ONS agreed that the RPI had errors, but the statistical office still refuses to improve its measurement after rejecting an expert committee’s advice to change the index in 2012. “RPI is not a good measure of inflation and we do not recommend its use,” an ONS spokesperson said.

I will leave you to decide whether Chris Giles is in fact an “expert” as he describes himself as he was on that committee ( CPAC) and voted  for imputed rents rather than house prices in CPIH. The problem with the “expert” description is that CPIH was later also declared not to be a national statistic because the rents numbers used in the imputed rents data were found to be wrong. This was something I predicted to Chris some 5 years ago when he spoke at the Royal Statistical Society.

The problems with inflation measurement

Let me give you some illustrations of good and bad features of UK inflation measures.

RPI

A good feature is that it covers owner-occupied housing mainly via the use of house prices via the depreciation component and mortgage interest-rates. It also covers the “average” better than most other measures by excluding some extremes. Apparently these have “no merit”.

The argument against centers on the “formula effect”

Mr Carney said the upward bias in the RPI was 0.7 percentage points a year.

Arguments have raged over the issue of a geometric mean versus an average one. This lead to the calculation of a variant called RPIJ  which was RPI without the “formula effect” and regular readers will have seen Andrew Baldwin’s eloquent arguments in favour of it in the comments section. Yet the UK establishment pressed the delete button on it after only a couple of years or so . Would it be rude to point out that it had consistently given higher readings than their preferred measures?

CPI

The arguments in favour of this are that it is consistent with national accounts methodology and that it avoids the formula effect. Against is the way that it omits owner-occupied housing and that it covers the better-off rather than the average person. This is because it is expenditure weighted and the fact that the better off spend more means it ends up about 2/3rds of the way up the income spectrum as opposed to the average,

CPIH

This variant of CPI above, does cover owner occupied housing but as even the FT hints there is an enormous flaw in the way it does so.

includes an estimate of the housing costs of owner occupiers

That is simultaneously true and untrue. What it has via the use of imputed rent is an estimate of something which is never paid as home owners do not pay themselves rent as assumed. Again this fits with national accounts methodology at the expense of reality.

 

Comment

The truth is that there is no perfect inflation measure as every measure tries to measure the “typical” experience and we all vary in some way or another. There is a further nuance in that we can try to measure the cost of living or try to follow a purist economics/statistic measure based on consumption. Personally I think that the former is a better route as the Bank of England regularly finds out when it conducts its expectations survey.

Asked about expectations of inflation in the longer term, say in five years’ time, respondents gave a median answer of 3.5%, compared to 3.4% in August.

Another way of putting this is from a reply to the FT from Lu Xun.

The average 25 year old living independently of parents is spending 50-75 % of post tax income on rent in London.  Official inflation  of 2 % , 3 % , no matter if  RPI  or CPI ,  is entirely meaning less for the average punter.

The sad reality of the UK experience has gone as follows and see it you can spot a trend. We were told RPI ( 4.1%) was bad and was replaced by CPI (3%). For a while we were told RPIJ (~3.4%  ) was a possible way ahead but it got dropped whilst CPIH ( 2.7%) with its fantasy rents for owner-occupiers carries on as the “preferred” measure.

Meanwhile RPI carries on with more believers in it than the claim of it losing “trusted” status would have you believe. Yet it is not being updated ( a rather petulant act in my opinion) so it will over time increasingly have issues which when you consider it will be used into the 2060s is a decision of which those who made it should be thoroughly ashamed. Also let me agree with Chris Giles on one issue its use in areas where the government benefits and we lose but not the reverse is simply indefensible and wrong.

student loan contracts and rail fares.

Some care is needed though as some pensioners will have it in their contracts and of course what on earth will the Bank of England pension fund invest in going forwards ( 90% last time I checked)? A bit of a gap there between its rhetoric and behaviour.

However all is not lost as we do not have to go down the slippery slope from RPI to the CPIH as you see there is a new measure called HCI on its way. It looks like it will be a proper replacement for RPI as it does cover house prices so in a few years time once it begins to have a track record we could perhaps suggest beginning to move from RPI to it. It would have been much better if Governor Carney said that and also argued for the RPI to be properly updated in the meantime.

Those of you interested in finding out more about the proposed HCI will find more at the link below.

https://notayesmanseconomics.wordpress.com/2017/12/19/welcome-to-the-uk-household-cost-index-bringing-hope-for-a-better-inflation-measure/

Number Crunching

You may be intrigued to know that an estimate of the effect of switching from RPI to CPI was that it raised GDP by around 0.5% a year. How? Well for the same outcome lower inflation means a higher recorded real output.

 

Can Britain solve its credit problems and debt addiction?

A long-standing feature of the UK economy has been a problem with credit. This has several features. A major one is our obsession with the housing market and the establishment view that the economy can best be boosted by pumping it up and claiming the higher house prices as higher wealth and evidence of economic well-being.

Figure 2 shows the value of land in 2016 is estimated to be £5.0 trillion, which is 51% of the total net worth of the UK. Land increased in value by £280 billion from 2015, a 5.9% increase. This is a notably smaller increase than in 2014 and 2015, when it increased by 15% and 10% respectively. Since the land underlying dwellings is a major contributor to the value of land, the House Price Index reflects this with house prices rising at a lower rate compared with 2014 and 2015.

So £5 trillion out of this.

The total net worth of the UK at the end of 2016 is estimated at £9.8 trillion, an increase of £803 billion from 2015 and the largest annual rise on record.

I hope you are all feeling much better off! If you are a home owner then this is rather likely to be the case.

The value of land has grown rapidly from 1995, increasing by 412% compared with an average increase of 211% in the assets overlying the land.

You may have noted the swerve here which is that we have switched from the value of houses to land which presumably sounds much more secure and safe. Also if we add the value of the houses back in then £1.77 trillion added to £5 trillion means the sector is £6.8 billion or so of UK national wealth and everything else is £3 billion. Even the most unobservant may start to wonder if that is a trifle unbalanced?!

Mortgage Debt

This is something which the Bank of England put a lot of effort into increasing back in the darker days of 2012 when there was talk of a “triple-dip” in the UK economy. As I pointed out above the traditional “remedy” is to do this to the housing market.

Pump it up when you don’t really need it.
Pump it up until you can feel it. ( Elvis Costello)

They were so keen on this that we got an official denial and the Funding for Lending Scheme was badged as something to boost small business lending something which has not gone well but more of that later. What it actually achieved was to boost net mortgage lending which then when positive and now is running at a net rate of around £3 billion per month. House prices were boosted across the UK although with widely varying impacts as London boomed but other areas struggled at least relatively. Thus we end up with a claimed asset value of £6.8 billion versus a mortgage debt of £1.37 billion. What could look safer?

The catch is that there are a litany of problems with this.

  1. The economy has been tilted towards the housing sector as we note Bank of England and government support ( Help To Buy) as well as ( capital gains) tax advantages. This has shifted resources to this sector.
  2. This would not look so good should house prices fall, what would the asset value and “wealth effects” be then?
  3. Those looking to enter the housing market or to trade up are not seeing a wealth increase but instead facing inflation. This is so worrying to the UK establishment they go to pretty much any effort to keep such inflation out of the official inflation numbers.

Accordingly we know that the Bank of England will be worried by this development at the beginning of the food chain for this area.

Mortgage approvals decreased in December (Table I), with falls for both house purchase and remortgaging approvals. House purchase approvals were the weakest since January 2015 and remortgaging approvals fell to 46,475, following strength in October and November. 

Unsecured Credit

This is something of an overflow area for UK credit. What I mean by this is that when the Bank of England gives the banks the green light to lend as evidenced by the Funding for Lending Scheme in the summer of 2012 or the Bank Rate cut and “Sledgehammer” QE of August 2016 this is the easiest area to expand. After all there is a flow of people into their branches or website wanting to borrow and saying yes is relatively simple. The tap gets turned on much more quickly than mortgage or business lending.

This how we found ourselves with unsecured credit running at an annual rate of around 10% per annum. The new feature this time around was the growth of borrowing for vehicle purchase via the growth of personal contract purchase and the like, so much so that very few people actually buy a car now.

 Over 86% of all private new car registrations in the UK were financed by FLA members.

Of course central bankers desperate to calm their fears about a possible recession were pleased at all the car buying but the ordinary person will be wondering what happens when the music stops? Actually according to the banking sector this is already taking place if you recall the survey the Bank of England published and of course the Financial Policy Committee is “vigilant”. This has led more than a few economists to tell us growth is over here. Meanwhile.

Consumer credit net lending was £1.5 billion in December, broadly in line with outturns during 2017 (Table J).  The annual growth rate ticked up to 9.5% in December. 

November was revised up from £1.4 billion to £1.5 billion as well. So we have growth of 9.5% with economic growth of around 2% and wages growth of a bit over 2%. What could go wrong?

The total for this category is now £207.1 billion.

Business Lending

Lending to smaller businesses was supposed to be the rationale for this and the official view was this.

The extension builds on the success of the FLS so far

The extension continued the rhetoric.

 to increase the incentive for banks to lend to small and medium‐sized enterprises (SMEs) both this year and next;

How is that going?

Lending to non-financial businesses fell by £1.0 billion in December (Table M).  Loans to small-and-medium sized enterprises fell by £0.4bn, the largest decline since December 2014. 

Comment

There is a fair bit to consider here. But let me look at this from the point of the Bank of England. It opened the credit taps via credit easing in the summer of 2012 and added to it with the Term Funding Scheme in August 2016. This of course added to the Bank Rate cuts and QE bond buying. This was supposed to boost small business lending but in fact in spite of the economic growth we have had in recent years there has been very little of that. Indeed even the better numbers were below the economic growth rate and if anything new lending to smaller businesses is stagnant at best.

Meanwhile net mortgage lending was pushed into the positive zone and more latterly unsecured credit has been on quite a tear. So if the Bank of England was a centre forward taking a penalty kick it has not only missed the goal if we looked at the unsecured credit data it may even have cleared row Z and the stands. Or of course its true intentions were always different to what it has claimed.

 

 

 

Have Apple Unilever and the makers of Digestive biscuits somehow missed the rally in the £?

This morning brings us the first official data covering December and in particular the retail sector and how it performed over Christmas. So after yesterday’s rays of sunshine which boosted the recorded performance of the telecoms sector over the past decade or so we wonder if a winter chill has arrived today? But before we get there we have much to look at and the opening salvo is fired by this.

GBP back to pre-Brexit levels against the USD. Interesting. ( @ericlonners )

To be more specific it has risen over US $1.39 this morning which does mark a change in UK economic conditions. We are now 15 cents higher than we were a year ago which means that we have switched from the boost to inflation from the past fall to a brake on it from the new higher level. I note he sent this to various journalists perhaps mulling how so many of them told us the only way was down for the UK Pound or perhaps noting the disappearance of polls asking if we are going to parity with the US Dollar? So lesson one is to get very nervous if places like the Financial Times and Wall Street Journal go bullish on the UK Pound £!

But before I move on an excellent question was asked.

So will Apple and Unilever be dropping their prices then, Eric? ( @AndrewaStuart )

After all they did raise prices when the UK Pound £ fell.

Monetary Policy

There is less impact here than you might think. There has been an overall tightening of monetary policy but only by the equivalent of a 0.5% Bank Rate rise as the effective or trade-weighted index has risen from 77 to 79. If you are wondering where the rise against the US Dollar has gone well some of it has been offset by the fall against the Euro where the 1.19+ of last April is 1.13 or so now.

This is something which economists who look at the UK economy have dreamed of in the past and today’s test if you will is to see if any mention it?! What we wanted was a rally against the US Dollar to reduce inflation via its role as the base for commodity prices and a fall against the Euro to improve our price competitiveness for trade. In essence we have had that over the past year or so albeit after the fall in the UK Pound £ after the EU Leave referendum.

Gilt Yields

Here we do not quite get what you might assume from all the media reports of rising bond yields  or from the Professor ( from Glasgow university I think) who was not challenged on BBC News 24 last night when he claimed the UK could borrow for nothing. Whilst it is hardly exorbitant 1.34% is not the “nothing” that you might argue for Germany or especially Switzerland. As to the change in yields they are lower than a year ago because the real change in world bond markets happened early last September when the UK ten-year Gilt yield was below 1%. So since then monetary policy has tightened via this route as well.

Wealth and House Prices

After offering views likely to upset the digestion of Bank of England Governor Mark Carney let me move onto a subject to make him smile. From the Financial Times today.

 

The value of all the homes in the UK has risen by more than third in the past decade, to £7.14tn, with older homeowners and landlords winning the biggest share of the new wealth as young people continue to be priced out of the market. After several flat years of growth following the financial crisis, the value of the UK’s property market began picking up strongly after 2013, according to analysis by Savills, the estate agent.

Governor Carney  will grin like a Cheshire Cat and perhaps order his favourite Martini as he notes it coincides with his watch.

 

After several flat years of growth following the financial crisis, the value of the UK’s property market began picking up strongly after 2013, according to analysis by Savills, the estate agent.

For newer readers please look up my posts on the Funding for Lending Scheme and its impact. Also there is a signal of a problem in the UK economy which is rather familiar.

Landlords more than doubled the value of their equity from £600bn in 2007 to £1.3tn in 2017.

I have nothing against individual landlords trying to make some money but I do have criticisms for the way that so much UK economic effort is incentivised to flow into this area and arena.

Also in a week where the economics editor of the Financial Times has railed against statistical fake news there are a couple of issues here. Firstly there is the use of marginal prices ( current house prices) to value a stock as for example you would never get those prices if you actually tried to sell the lot. Next there is the issue of pretty much copy and pasting a view on the housing position from an estate agent and turning a blind eye to the moral hazard involved. On those issues let us note they end with a stock of this nature compared to a flow which is government income.

As a type of critique let me point out this from the FT’s twitter feed.

The share of UK families’ budgets devoted to housing costs has more than doubled over the past 60 years.

Retail Sales

This was likely to be an awkward Christmas season for two reasons. Over the year we had seen falling real wages slowly erode UK retail sales growth that had been particularly strong at the end of 2016. Also some of the spending has shifted to November via the advent of what is called Black Friday which only makes an already erratic series harder to analyse. So we are left with this.

In the latest three months the quantity bought in retail sales increased by 0.4% compared with the previous three months; while the underlying pattern remains one of growth, this is the weakest quarterly growth since the decline of 1.2% in Quarter 1 (Jan to Mar) 2017……..In December 2017, the quantity bought increased by 1.4% when compared with December 2016, with positive contributions from all stores except food stores.

So we have some growth but not a lot of it and we had a curiosity because we had been told by individual company reports that it had been food sales which had saved Christmas yet on the collective level we see the opposite. Next we face the prospect that as winter moves into spring the numbers may be okay as we note that it was a rough start to 2017 for retail sales.

Comment

As ever we have much to consider. Let me start with the end of last year where the fourth quarter looked good but retail sales are not helping much and there was the shut down of the Forties pipeline. Thus it seems set to be at the weaker end of expectations followed by a bounce back in the first quarter as the pipeline re-opens all other things being equal.

Meanwhile some and in particular those who invested/punted/bought houses near to my locale may not be enjoying things that much. From Property Industry Eye.

The foreign investor market in London is on its knees – with ‘hundreds’ of buyers of homes purchased off-plan over the last four years nursing huge losses.

The problem, says one large London agent, has been ‘massively under-reported’ by the media.

With values of such properties having dropped like a stone, some investors are unable to complete on their purchases, with the developers taking possession.

Others are having to sell at almost a one-third loss to avoid having to hand back distressed properties to developers, and then risking legal action and greater losses.

Yet some still seem to be taking the blue pills. From Bloomberg.

Malaysia’s Permodalan Nasional Bhd will buy a stake in London’s Battersea Power Station building where Apple Inc. plan to occupy a new U.K. headquarters.

The sovereign wealth fund will own the building with the Employees Provident Fund in a deal which values the power station building at about 1.6 billion pounds ($2.2 billion), Battersea Power Station Development Co. said in a statement Thursday.

Oh and someone seems to have missed the rally in the £ completely.