How long will it be before the Bank of England cuts interest-rates?

This morning has opened with some good news for the UK economy and it has come from the Nationwide Building Society. So let us get straight to it.

Annual house price growth slows to its
weakest pace since February 2013. Prices fell 0.7% in the month of December,after taking account of seasonal factors.

I wish those that own their own house no ill but the index level of 425.7 in December compares with 107.1 when the monthly series first began in January of 1991, so you can see that it has been a case of party on for house prices. If you want a longer-term perspective then the quarterly numbers which began at 100 at the end of 1952 were 11.429.5 and the end of the third quarter of 2018. I think we can call that a boom! Putting it another way the house price to earnings ratio is 5.1 which is not far off the pre credit crunch peak of 5.4.

The actual change is confirmed as being below both the rate of consumer inflation and wage growth later.

UK house price growth slowed noticeably as 2018 drew to a close, with prices just 0.5% higher than December 2017.

Also the Nationwide which claims to be the UK’s second largest mortgage lender is not particularly optimistic looking ahead.

In particular, measures of consumer confidence weakened
in December and surveyors reported a further fall in new
buyer enquiries towards the end of the year. While the
number of properties coming onto the market also slowed,
this doesn’t appear to have been enough to prevent a
modest shift in the balance of demand and supply in favour
of buyers.

Although they then seem to change their mind.

It is likely that the recent slowdown is attributable to the
impact of the uncertain economic outlook on buyer
sentiment, given that it has occurred against a backdrop of
solid employment growth, stronger wage growth and
continued low borrowing costs.

The economic environment is seeing some ch-ch-changes right now but let us first sort out some number-crunching where each UK country has done better than the average.

Amongst the home nations Northern Ireland recorded the
strongest growth in 2018, with prices up 5.8%, though
Wales also recorded a respectable 4% gain. By contrast,
Scotland saw a more modest 0.9% increase, while England
saw the smallest rise of just 0.7% over the year.

They have I think switched from the monthly to the quarterly data here as that average was up by 1.3%.

The UK economy

We have now received the last of the UK Markit Purchasing Manager Index surveys so let us get straight to it.

At 51.6 in December, the seasonally adjusted All Sector
Output Index was up slightly from 51.0 in November.
However, the latest reading pointed to the second-slowest
rate of business activity expansion since July 2016.

I am a little surprised they mention July 2016 so perhaps they are hoping we have short memories and do not recall how it turned into a lesson about being careful about indices driven by sentiment. This was mostly driven by the manufacturing sector which had Markit looking for a scapegoat.

December saw the UK PMI rise to a six-month high,
following short-term boosts to inventory holdings and
inflows of new business as companies stepped up their
preparations for a potentially disruptive Brexit.
Stocks of purchases and finished goods both rose
at near survey-record rates, while stock-piling by
customers at home and abroad took new orders growth
to a ten-month high.

So preparation is bad as presumably would be no preparation. It is especially awkward for their uncertainty theme which was supposed to be reducing output. But let us move onto the main point here which is that the UK is apparently managing some economic growth but not a lot. This matters if we now switch to the wider economic outlook.

The world economy

As I have been typing this the Chinese cavalry have arrived. Reuters.

China’s just cut bank reserve requirement ratios by 100 bps, releasing an estimated RMB1.5t in liquidity by Jan 25. expected this, but argues the central bank can do a lot more – like cutting benchmark guidance lending rates.

Reuters are understandably pleased about finding someone who got something right. But the deeper issue is the economic prognosis behind this which we dipped into on Wednesday and is that the Chinese economy is slowing. For those wondering about what the People’s Bank of China is up to it is expanding the money supply via reducing the reserves banks have to hold which allows them to lend more. So they are acting on the quantity of money rather than the price or interest-rate of it. This relies on the banks then actually lending more. Or more specifically not just lending to those in distress.

Then there is the Euro area which according to the Markit PMIs is doing this.

The eurozone economy moved down another gear
at the end of 2018, with growth down considerably
from the elevated rates at the start of the year.
December saw business activity grow at the
weakest rate since late-2014 as inflows of new
work barely rose……….The data are consistent with eurozone GDP rising by just under 0.3% in the fourth quarter, but with quarterly growth momentum slowing to 0.15% in December.

We need to rake these numbers as a broad sweep rather than going for specific accuracy as, for example, Germany is described as being at a five-year low which requires amnesia about the 0.2% GDP contraction in the third quarter of this year.

Comment

If we switch to our leading indicator for the UK which is money supply growth we see a by now familiar pattern. The two signals of broad money growth have diverged a bit but neither M4 growth at 2.2% in November or M4 lending growth at 3.5% are especially optimistic. That only gets worse once you subtract inflation from it. Or to put it another way in ordinary times we would be in a situation where a bank rate cut would be expected.

What does the Bank of England crystal ball or what is called Forward Guidance in one of Governor Mark Carney’s policy innovations tell us?

The MPC had judged in November that, were the economy to develop broadly in line with its Inflation
Report projections, an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a
limited extent, would be appropriate to return inflation sustainably to the 2% target at a conventional horizon.

So “I agree with Mark” seems to be the most popular phase which should make taxpayers wonder why we bother with the other 8 salaries? Indeed one of them will be in quite a panic now as back in May Deputy Governor Ramsden told us that 8.8% consumer credit growth was “Weak” so I dread to think what he makes of the current 7.1%. Although @NicTrades has a different view.

that’s China fast!

So that is how a promised Bank Rate rise begins to metamorphose into a Bank Rate cut which will be presented as “unexpected” ( as opposed to on here where we have been watching the journey of travel for nearly a year) and a “surprise”, just like the last time this happened just over 2 years ago.

Let me finish by welcoming the addition of two women to the Financial Policy Committee as there is of course nothing like a Dame.

Dame Colette Bowe and Dame Jayne-Anne Gadhia have been appointed as external members of ‘s Financial Policy Committee (FPC)

So sadly the diversity agenda only adds female members of the establishment to the existing list of male establishment appointees. That went disastrously with the Honorable Charlotte Hogg who proved that even being the daughter of an Earl and a Baroness cannot allow you to avoid family issues, especially when you forget you have a brother.

Weekly Podcast

Including my answer to this question from Rob Wilson.

How can economies such as Italy and Japan endures decades of virtually zero growth and yet the general population don’t seem to be suffering compared to other economies with growth?

 

 

 

 

 

 

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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.

 

 

 

 

 

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

 

 

The Mark Carney Show has misfired again

Yesterday was something of an epoch-making day for the UK but it also turned into a rather odd one. Also this morning has produced another piece of evidence for my argument that we finally got a rise in official interest-rates above the emergency 0.5% level because the Bank of England finally thought the banks have recovered enough to take it. From the Financial Times.

Royal Bank of Scotland will pay its first dividend since it was bailed out during the financial crisis, marking a major milestone on the bank’s road to recovery and paving the way for a further reduction of the government’s 62.4 per cent stake. The bank will pay an interim dividend of 2p per share after it confirms a final agreement on a recent fine with the US Department of Justice.

So even RBS has made some progress although it remains attracted to disasters like iron filings to a magnet as this seems a clear hint that it managed to be long Italian bonds into the heavy falls.

 RBS blamed “turbulence in European bond markets” for a 20 per cent drop in income at Natwest Markets.

As an aside the Italian bond market is being hit again today with the ten-year yield pushing over 3%.

Returning to the UK we also saw a 9-0 vote for a Bank Rate rise as I predicted in my podcast. This was based on my long-running theme that they are a bunch of “Carney’s Cronies” as five others suddenly changed their mind at the same moment as him, making the most popular phrase “I agree with Mark”. As some are on larger salaries added to by generous pension schemes we could make savings here.

A Space Oddity

This was provided by the currency markets which initially saw the UK Pound £ rally but then it fell back and at the time of writing it has dipped just below US$1.30. The US Dollar has been strong but at 1.122 we have not gained any ground against the Euro either at 145 we lost ground against the Japanese Yen.Why?

At first Governor Carney backed up his interest-rate rise with talk of more as in the press conference he suggested that 3 rises over the next 3 years was his central aim. Of course his aim has hardly been true but this disappeared in something of a puff of smoke when he later pointed out that he could keep interest-rates the same or even cut them. This rather brain-dead moment was reinforced by pointing out that he had cut interest-rates after the EU leave vote. This left listeners and viewers thinking will he cut next March?

Then he told Sky News this.

Mark Carney tells me is prepared to cut interest rates back again depending on how Brexit negotiations go. ( Ed Conway)

This morning he has managed to end up discussing interest-rate cuts with Francine Lacqua of Bloomberg after a brief mention of further rises. Then he added to it with this.

Mark Carney threw himself back into the thick of the Brexit debate on Friday, saying the chance of the U.K. dropping out of the European Union without a deal is “uncomfortably high.”

He also spoke to the Today programme on Radio Four which of course has its own audience troubles and here is the take away of Tom Newton Dunn of The Sun,

Blimey. Carney reveals the BoE recently ran a Brexit no deal exercise that saw property prices plummet by a third, interest rates go up to 4%, unemployment up to 9%, and a full-blown recession.

You can see from that why rather than a rally the UK Pound £ has struggled rather than rallied.  Due to his strong personal views Governor Carney keeps finding himself enmeshed in the Brexit debate which given his views on the subject will always head towards talk of interest-rate cuts. He is of course entitled to his personal views but in his professional life he keeps tripping over his own feet as just after you have raised interest-rates this is not the time for it. He could simply have said that like everyone else he is waiting for developments and will respond if necessary when events change.

Oh and we have heard this sort of thing from Governor Carney before. How did it work out last time?

interest rates go up to 4%

 

Today’s News

This has added to the theme I posited yesterday about the interest-rate increase which can be put most simply as why now?

The latest survey marked two years of sustained
new business growth across the service sector
economy. However, the rate of expansion eased
since June and was softer than seen on average
over this period. ( Markit PMI )

This followed a solid manufacturing report and a strong construction one but of course the services sector is by far the largest. This added to the report from the Euro area.

If the headline index continues to track at its current
level, quarterly GDP growth over the third quarter as
a whole would be little-changed from the softer-than expected expansion of 0.3% signalled by official
Eurostat data for quarter two.

Whilst these surveys are by no mean perfect guides there does seem to be something going on here and as I pointed out yesterday it is consistent with the weaker trajectory for money supply growth.

The UK Pound £

This did get a mention in the Minutes.

The sterling effective exchange rate had depreciated slightly since the Committee’s previous meeting and was down 2.5% relative to the 15-day average incorporated in the May Report.

This is awkward on two fronts. Firstly the fall was at least partly caused by the way Governor Carney and his colleagues clearly hinted at an interest-rate rise back then but then got cold feet in the manner of an unreliable boyfriend. Next comes the realisation that all the furore over a 0.25% interest-rate rise mostly ignores the fact that monetary conditions have eased as the currency fall is equivalent to a ~0.6% cut.

R-Star

This appeared having been newly minted in the Bank of England Ivory Tower. Or at least newly minted in £ terms as the San Francisco Fed put it like this last year.

The “natural” rate of interest, or r-star (r*), is the inflation-adjusted, short-term interest rate that is consistent
with full use of economic resources and steady inflation near the Fed’s target level.

If anyone has a perfect definition of “full use of economic resources” then please send it to every Ivory Tower you can find as they need one. Actually the Bank of England has by its actions suggested it is near to here which is rather awkward when they want to claim it is somewhere above 2%. Actually I see no reason why there is only one and in fact it seems likely to be very unstable but in many ways David Goodman of Bloomberg has nailed it.

They don’t know their r* from their elbow

Comment

This is all something of a dog’s dinner and I mean that in the poetic sense because in reality dog’s in my family  always seem to be fed pretty well. We have monetary policy being delivered by someone who looks as though he does not really believe in it. Even the traditional support from ex Bank of England staff seems to be half-hearted this time around and remember that group usually behave as if The Stepford Wives is not only their favourite film but a role-model.

If this is the best that Mark Carney can do then the extension of his term of tenure by Chancellor Hammond can be summed up by Men At Work.

It’s a mistake, it’s a mistake
It’s a mistake, it’s a mistake

 

 

 

The Bank of England is in a mess of its own making

Today looks as if it may be something of an epoch-making day for the UK as there is finally a decent chance that the 0.5% emergency Bank Rate will be consigned into history. Actually one way or another the decision has already been made as the Monetary Policy Committee voted last night. This was a rather unwise change made by Governor Carney as it raises the risk of leaks or what is called the early wire as the official announcement is not made until midday. As you can see from the chart below the BBC seems to think that the decision is a done deal or knows it is ( h/t @Old_Grumpy_Dave ).

This provides us scope for a little reflection as any move hardly fulfils this from back in June 2014.

This has implications for the timing, pace and degree of Bank Rate increases.
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.

This was taken at the time as a promise and markets responded accordingly as interest-rate futures surged and the UK Pound £ rallied. From time to time people challenge me on this and say it was not a promise. What that misses is that central bankers speak in a coded language and in that language  this was a clear “Tally Ho”. Of course the “sooner than markets currently expect” never happened and whilst you may or may not have sympathy for professional investors and traders it was also true that ordinary people and businesses switched to fixed-rate borrowing in response to this. The reality was that the Bank of England via its credit easing policies and then Bank Rate cut of August 2016 pushed mortgage and borrowing rates lower affecting them adversely. Such has been the record of Forward Guidance.

What about now?

There was something else in that speech which was revealing as a sentence or two later we were told this.

The ultimate decision will be data-driven

Okay so let us take the advice of Kylie and step back in time. If we do so we see that the UK economy was on a bit of a tear which of course was another reason for those who took Governor Carney at his word. In terms of GDP growth the UK economy had gone 0.6%,0.5%,0.9% and 0.5% in 2013 which was then followed by 0.9% in the first quarter of 2014. It did the same in the second quarter which he would not have known exactly but he should have known things were going well.

Let us do the same comparison for now and look at 2017 where GDP growth went 0.3%,0.2%,0.5% and 0.4% followed by 0.1% in the first quarter of this year. If you were “data driven” which sequence would have you pressing the interest-rate trigger? I think it would be a landslide victory. The MPC may not have known these exact numbers due to revisions but a 0.1% here or there changes little in the broad sweep of things.

Some might respond with the pint that he is supposed to achieve an inflation target of 2% per annum. That is true but that has not bothered the MPC much in the credit crunch era as we have just been through a phase of above target inflation which of course they not only cut Bank Rate into but promised a further cut before even they came to the realisation that their Forward Guidance had been very wrong. Also before Governor Carney took office the MPC turned a blind eye to inflation going above 5%. Whereas post the EU leave vote they rushed to ease policy in something of a panic in response to expectations of a weaker economy.

The Speed Limit

The Bank of England Ivory Tower has had a very poor credit crunch. It has clung to outdated theories rather than respected the evidence. Perhaps the most woeful effort has been around the output gap which if you recall led to it highlighting an unemployment rate of 7% which the economy blasted through ( which you might consider was yet another case for an interest-rate rise in 2014). It has clung to equilibrium unemployment rates of 6.5%,6% 5.5% and 4.5% which of course have all been by-passed by reality. Such outdated thinking has led it to all sorts of over optimism on wage growth. Yet is seems to have learned little as this illustrates.

We think our economy can only grow at a new, lower speed limit of around one-and-a-half per cent a year. We also currently think actual demand is growing close to this speed limit. This means demand can’t grow faster than at its current pace without causing prices to start rising too quickly.

This is the MPC rationale for a Bank Rate rise and the problem is that they simply do not know that. They keep trying to build theoretical scaffolding around the reality of the UK economy but seem to learn little from the way the scaffolding regularly collapses.After all we grew much faster in 2014.

The banks

As ever the precious will be at the forefront of the Bank of England’s mind. I cannot help thinking that having noted the apparent improvement shown below maybe the real reason for a change is that the banks can now take it. First Lloyds Banking Group.

Since taking over the reins in 2011, Horta-Osório has presided over a bank which has swung from an annual loss of £260mln to a profit of £3.5bn.  ( Hargreaves Landsdown).

Then Barclays.

Barclays reported pretax profit of 1.9 billion pounds ($2.49 billion) for the three months from April-June, up from 659 million pounds a year ago and higher than the 1.46 billion average of analysts’ estimates compiled by the bank. ( Reuters)

Comment

A Martian observing monetary policy in the UK might reasonably be rather confused by the course of events. He or she might wonder why now rather than in 2014? Furthermore they might wonder why a mere 0.25% change is being treated as such a big deal? After all it is only a small change and the impact of such a move on those with mortgages will be both lower and slower than in the past.

Nationwide: The vast majority of new mortgages have been extended on fixed interest rates. The share of outstanding mortgages on variable interest rates has fallen to its lowest level on record, at c.35% from a peak of 70% in 2001. ( h/t @moved_average )

So if they do move the impact will be lower than in the past which makes you wonder why they have vacillated so much and been so unreliable?

The MPC have got themselves on a road where all the indecision means that the timing is likely to be off. What I mean by that is that whilst I expect economic growth to pick-up from the first quarter this year will merely be an okay year and currently the threats seem to the downside in terms of trade for example. We do not yet know where the Trump trade tariffs will lead but we do know that the Euro area has seen economic growth fall such that the first half of 2018 was required to reach what so recently was the quarterly growth rate. Also the ongoing rhetoric of the Bank of England about Brexit prospects hardly makes a case for a Bank Rate rise now either as it would be impacting as we leave ( assuming we do leave next March).

The next issue is money supply growth which in 2018 so far has been weak and now (hopefully) has stabilised. That does not make much of a case for raising now and would lead to the MPC operating in the reverse way to monetary trends as it cut into strength in August 2016 and now would be raising into relative weakness.

So there you have it on what is an odd day all round. I think UK interest-rates should be higher but also think that timing matters and that a boat or two has sailed already without us on it. Accordingly my view would be to wait for the next one. For the reasons explained above whilst the MPC has managed to verbally box itself into a corner I still  think that there is a chance ( 1/3rd) of an unchanged vote today. It is always the same when logic points in a different direction to hints of direction.

There is also the issue of QE which rarely gets a mention. If we skip the embarrassment all round of the Corporate Bond purchases we could also have taken the chance to trim the QE package when money supply growth was strong. I remember making that case nearly five years ago in City-AM.

Me on Core Finance TV