What is happening in the UK housing market?

There are always a multitude of factors to consider here but one has changed if the “unreliable boyfriend” can finally go steady. That is the Open Mouth Operations from various members of the Bank of England about a Bank Rate ( official interest-rate) increase in November presumably to 0.5%. This would be the first time since the summer of 2013 and the introduction of the Funding for Lending Scheme that there has been upwards pressure on mortgage rates. Indeed the FLS was designed to drive them lower ( albeit being under the smokescreen of improving small business lending) and if we throw in the more recent Term Funding Scheme the band has continued to play to the same beat. From Bank of England data for July.

Effective rates on new individual mortgages has decreased by 10bps from 2.05% to 1.95%, this is the first time the series has fallen below 2%;

The current table only takes us back to August 2015 but it does confirm the theme as back then the rate was 2.57%. Noticeable in the data is the way that fixed-rate mortgages (1.99%) have become closer to variable-rate ones (1.73%) and if we look at the combination it looks as though fixed-rate mortgages have got more popular. That seems sensible to me especially if you are looking beyond the term of office of the “unreliable boyfriend.” From the Resolution Foundation.

The vast majority (88%) of new loans are taken with fixed interest rates, meaning 57% of the stock of loans are now fixed.

Has Forward Guidance had an impact?

That depends where you look but so far the Yorkshire Building Society at least seems rather unimpressed.

0.89% variable (BoE Base rate + -3.85%) variable (YBS Standard Variable Rate -3.85%) fixed until 30/11/2019

There is a large fee ( £1495) and a requirement for 35% of equity but even so this is the lowest mortgage-rate they have even offered. You can get a fixed rate mortgage for the same term for 0.99% with the same fee if you have 40% of equity.

So we see that so far there has not been much of an impact on the Yorkshire Building Society! Perhaps they had a tranche of funding which has not yet run out, or perhaps it has been so long since interest-rates last rose that they have forgotten what happens next? If we move to market interest-rates Governor Carney will be pleased to see that they have taken more notice of him as the 2 year Gilt yield was as low as 0.15% on the 7th of this month and is now 0.45%. The 5 year Gilt yield rose from 0.39% on the 7th to 0.77% now.

Thus there should be upwards pressure on future mortgage rates albeit of course that funding is still available to banks from the Term Funding Scheme at 0.25%. But don’t take my word for it as here are the Bank of England Agents.

competition remained intense, driven by new market entrants and low funding costs

What about valuations?

There have been a lot of anecdotal mentions of surveyors lowering valuations ( which is a forward indicator of lower prices ahead) but this from the Bank of England Agents is the first official note of this.

There were more reports of transactions falling through due to surveyors down-valuing properties, reflecting concerns about falling prices.

This could also be considered a sign of expected trouble as they discuss mortgages.

However, this competition was mainly concentrated on customers with the cleanest credit history.

Affordability and Quality

This issue has also been in the news with the Resolution Foundation telling us this.

While the average family spent just 6 per cent of their income on housing costs in the early 1960s, this has trebled to 18 per cent. Housing costs have taken up a growing proportion of disposable income from each generation to the next. This is true of private and social renters, but mortgage interest costs have come down for recent generations. However, the proportion of income being spent on capital repayments has risen relentlessly from generation to generation thanks to house price growth.

As someone who can recall his maternal grandparents having an outside toilet and paternal grandmother not having central heating I agree with them that quality improved but is it still doing so?

millennial-headed households are more likely than previous generations to live in overcrowded conditions, and when we look at the distribution of square meterage we see today’s under-45s have been net losers in the space stakes

I doubt many are as overcrowded as the one described by getwestlondon below.

A dawn raid on a three-bedroom property in Brentt found 35 men living inside……..The house was packed wall-to-wall with mattresses, which the men living there, all of eastern European origin, had piled into every room except the bathrooms.

But their mere mention of overcrowded raises public health issues surely? As ever the issue is complex as millennials are likely to be thinking also of issues such as Wi-Fi connectivity and so on. Still I guess the era of smartphones and tablets may make this development more palatable albeit at a price.

More recent generations have also had longer commutes on average than previous cohorts, despite spending more on housing.

Recent Data

The news from LSL Acadata this week was as follows.

House price growth fell marginally in August (0.2%), which left the average England and Wales house price at £297,398. This is still 2.1% higher than this time last year, when the average price was £5,982 lower. In terms of transactions, there were an estimated 80,500 sales completed – an increase of 5% compared to July’s total, and up 6% on a seasonally adjusted basis.

Interesting how they describe a monthly fall isn’t it? The leader of that particular pack is below.

House prices in London fell by an average of 1.4% in July, leaving the average price in the capital at £591,459. Over the year, though, prices are still up by £4,134 or 0.7% compared to July 2016. In July, 21 of the 33 London boroughs saw price falls.

An interesting development

Bloomberg has reported this today.

More home buyers are resorting to mortgages to purchase London’s most expensive houses and apartments as rising prices drag them into higher tax brackets.

Seventy-four percent of homes costing 1 million pounds ($1.3 million) or more in the U.K. capital were bought with a mortgage in the three months through July, up from 65 percent a year earlier, according to Hamptons International. The figure was as low as 31 percent during the depths of the financial crisis in 2009.

Perhaps they too think that over time it will be good to lock in what are historically low interest-rates although that comes with the assumption that they are taking a fixed-rate mortgage.

Comment

As we look at 2017 so far we see that  rental inflation has both fallen and according to most measures so has house price inflation although the official measure bounced in the spring . We have seen some monthly falls especially in London but so far the various indices continue to report positive inflation for house prices on an annual basis. Putting it another way it has been higher priced houses which have been hit the most ( which is why the official data has higher inflation). In general this has worked out mostly as I expected although I did think we might see negative inflation in house prices. Perhaps if Governor Carney for once backs his words with action we will see that as the year progresses. The increasing evidence of “down valuations” does imply that.

If we look at the overall situation we find ourselves arriving at one of the themes of my work as I am not one of those who would see some house price falls as bad. The rises have shifted wealth towards existing home owners and away from first-time buyers on a large-scale and this represents a factor in my critiques of central bank actions. Yes first time buyers see cheaper current mortgage costs but we do not know what they will be for the full term and they are paying with real wages which have fallen. On the other side of the coin existing home owners especially in London have been given something of a windfall if they sell.

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Can the “unreliable boyfriend” settle down in November?

On the face of it yesterday was an example of “the same old song” at the Bank of England in more than one respect. Firstly something that seemed to get ignored in the melee was that the vote was the same as the last time around which was to continue with the QE ( Quantitative Easing) programme and 7 votes to keep interest-rates unchanged with 2 for a 0.25% hike. The QE vote was apposite as it is currently ongoing with around £3.3 billion being reinvested earlier this week.

The next example of the “same old song” came with a somewhat familiar refrain in the official Minutes of the policy meeting.

All MPC members continued to judge that, if the economy were to follow a path broadly consistent with the August Inflation Report central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than current market expectations.

This has the familiar promise but as usual had “if” and “could” as part of it. But then there was something new.

A majority of MPC members judged that, if the economy continued to follow a path consistent with the prospect of a continued erosion of slack and a gradual rise in underlying inflationary pressure then, with the further lessening in the trade-off that this would imply, some withdrawal of monetary stimulus was likely to be appropriate over the coming months in order to return inflation sustainably to target.

As they are currently refilling the QE programme and in the past have said that they would raise Bank Rate before changing the QE total this was “central bankingese” for an interest-rate rise. There are obvious issues here but let us park them for now and look for an explanation of why?

The economy is doing better than expected

The initial explanation trips over its own feet.

Since the August Report, the relatively limited news on activity points, if anything, to a slightly stronger picture than anticipated. GDP rose by 0.3% in the second quarter, as expected in the MPC’s August projections,

So we simultaneously did better and the same as expected?! Let us move onto something where this may actually be true.

The unemployment rate has continued to decline, to 4.3%, its lowest in over 40 years and a little lower than forecast in August. Survey indicators are consistent with continued strength in employment growth.

Also no matter how often the output gap theories of the Ivory Towers are proved wrong they are given another throw of the dice just in case.

Overall, the latest indicators are consistent with UK demand growing a little in excess of this diminished rate of potential supply growth, and the continued erosion of what is now a fairly limited degree of spare capacity.

Problems with this view

If you take that as a case for a Bank Rate rise there are two immediate issues to my mind. Let us return to the “output gap”.

Evidence continues to accumulate that the rate of potential supply growth has slowed in recent years.

Actually if you look at the employment situation in the UK exactly the reverse has been true as I pointed out in my “the boy who cried wolf” article on Monday. We have been told that unemployment rates of 7%, 6-6.5%, 5% and then 4.5% are significant as the Bank of England theorists attempt to run in quicksand. If we look at the flip side of this potential supply growth in terms of employment has surged as we have moved to record levels.

Also there is the issue of wage growth which of course is interrelated to the paragraph above. We are told this.

Underlying pay growth had shown some signs of recovery, albeit remaining modest.

They have also looked into the detail and concluded this.

Empirical estimates by Bank staff suggested that these may have depressed annual growth of average weekly earnings by around 0.7 percentage points ( New data from the ONS suggested that compositional effects related to factors including the skills, industry and occupational mix of the workforce had pushed down average pay growth in the year to Q2. )

Let me bring this up to date as Gertjan Vlieghe is giving  a speech as I type this and he has reinforced this theme.

Wage growth is not as weak as it was earlier in the year: over the past 5 months, annualised growth in private sector pay has averaged just over 3%. And some pay-related surveys also suggest a modest rise in wage pressure in recent months.

Let me give you a critique of that firstly as shown below.

Actually that is the overall rather than just the private-sector picture but if we look at that and use Vlieghe’s figures it looks to me that he has not include the latest numbers for July where there was a dip in bonus payments as I pointed out on Wednesday. So total annualised wage growth fell from 3.2% to 1.4% and it is odd that Gertjan has apparently missed this as you see he was given the data early.

As to the possible compositional effects let me explain with an example sent to me on twitter.

Janet & John are each paid 100. After good year pay goes to 110; so good they employ Timmy and pay him 80. Ave pay (now for 3) unch at 100 ( @NelderMead ).

Nice to see I am not the only person who was taught to read with the Janet and John books! But the catch is that we keep being told this and then like a mirage it fades away as a different reality emerges. The Bank of England has been a serial optimist on the wages front and has been left red-faced time and time again.

Comment

One thing I welcome about the news flow over the past 24 hours from the Bank of England is the way that it has pushed the UK Pound £ higher. It has gone above 1.13 versus the Euro and 150 to the Japanese Yen and most importantly above US $1.35 which influences what we pay for most commodities. This response to a possible tightening embarrasses those who claimed the Bank of England easing did not weaken the Pound £ last summer. Not the best timing for those saying parity with the Euro was just around the corner either.

Moving onto the economics then there is something more than a little awkward in 9 supposedly independent people suddenly having the same thoughts. It is almost as if they are Carney’s cronies. It is hard not to sing along with Luther Vandross on their behalf.

I told my girl bye-bye
But I really didn’t mean it
Said, ?I met somebody new so fine?
But I really didn’t mean it

If you read the final part of the Gertjan Vlieghe speech there are grounds for him to change his mind.

If these data trends of reducing slack, rising pay pressure, strengthening household spending and robust global growth continue, the appropriate time for a rise in Bank Rate might be as early as in the coming months.

After all he told us this only in April.

I will argue that there is an important distinction to be drawn between good monetary policy and making accurate forecasts

Remember when Ben Broadbent told us he would pick and choose amongst the data ( just after being wrong yet again).

Also it is hard to forget these previous episodes.

Mark Carney Feb 2016 “the MPC judges that it is more likely than not that Bank Rate will need to rise over our forecast period”

He of course later cut Bank Rate and before that there was this.

Mark Carney June 2014 An interest-rate rise ” could happen sooner than markets currently expect. ”

So let us welcome a stronger Pound £ as we note that Forward Guidance has been anything but. Let me finish with some Friday music from Prince which has been removed from the Bank of England play list.

This is what it sounds like
When doves cry

What are the prospects for the UK house prices and rents?

One of the features of economics and economics life is that no matter how unlikely something is if it suits vested interests it will keep being reinvented. On that topic let us see what the Royal Institute of Chartered Surveyors or RICS has reported this morning.

Nationally, 61% felt landlords would exit the market over the coming year, while only 12% felt there would be a greater number of entrants. Moreover, for the next three years, 52% felt there would be a net reduction in landlords, with only 17% suggesting a rise.

Those of us who feel that the UK economy has been tilted too much towards the buy to let sector will be pleased at that but not the RICS which gives a warning.

Given the likely resulting supply and demand mismatch in this area, respondents predict that over the next five years rental growth will outpace that of house prices, averaging 3%, per annum (against 2% for house price inflation).

As to the deja vu element well let me take you back to November 4th last year.

Rents in Britain will rise steeply during the next five years as a government campaign against buy-to-let investing constrains supply, estate agencies have forecast.

Okay how much?

London tenants face a 25 per cent increase to their rents during the next five years, said Savills, the listed estate agency group. Renters elsewhere in the country will not fare much better, it said, with a predicted 19 per cent rise.

Whilst we are looking back to then there was also this.

JLL, another estate agency group, predicted a 17.6 per cent increase across the UK by 2021, with London rents rising 19.9 per cent, far outstripping predicted rates of inflation.

What has happened since last November?

If we look back I was very dubious about this and pointed out a clear problem.

If you look at the pattern of rental growth it follows the improvement in the UK economy with a lag ( of over a year which is another reason why it is a bad inflation measure) which means that it looks to be driven by improving incomes and probably real incomes rather than the underlying economy. Thus if you expect real income growth to fade (pretty much nailed on with likely inflation) or fall which seems likely then you have a lot of explaining to do if you think rents will rise.

In essence there is a strong correlation between income growth and real income growth and rental growth in my opinion. We now know that so far this has worked because back in November I pointed out that the official measure of rental inflation was running at 2.3% and yesterday we were updated on it.

Private rental prices paid by tenants in Great Britain rose by 1.6% in the 12 months to August 2017; this is down from 1.8% in July 2017.

Shall we check in on London?

The growth rate for London (1.2%) in the 12 months to August 2017 is 0.4 percentage points below that of Great Britain.

So we see that my methodology has worked much better than those in the industry as the phrase “vested interest” comes to mind. If you are struggle to predict capital profits ( house price rises) for your customers then promising some increased income (rents) works nicely especially at a time of such low interest-rates and yields elsewhere. The problem with this was highlighted by Supertramp some years ago.

Dreamer, you know you are a dreamer

If you look at the chart then it looks like the only way is down which looks awkward for the vested interests squad. Care is needed as it is a diverse market with rents in Wales rising albeit from a low-level and a variety of levels as shown below.

the largest annual rental price increases were in the East Midlands (2.8%),…….The lowest annual rental price increases were in the North East (0.4%),

But until we see a rise in real incomes then there seems to be little or no case for a recovery overall. At this point the UK establishment will be getting out the champagne as they will feel they put rents into the “most comprehensive” inflation measure CPIH at exactly the right time.

What about house prices?

As today is a policy announcement day for the Bank of England let us look at what house prices have done during the term of the present Governor Mark Carney. When he arrived in July 2013 the average house price in the UK was £174,592 whereas as of July this year it was £226,185 according to the Office for National Statistics. This replaced a three-year period of stagnation where prices had first fallen a bit and the recovered. So he has been the house owner and buy to let investors friend.

Some of the policy changes to achieve this preceded him as it was under the tenure of the now Baron King of Lothbury that the Funding for ( Mortgage) Lending Scheme was introduced. But Governor Carney could have changed course as he did in other areas. However he did not and I noted back then a fall in mortgage rates of around 1% quite quickly and the Bank of England later calculated a total impact on mortgage rates of up to 2%.

There are of course differences across the country as I looked at on Tuesday where the surges in London have been accompanied by much weaker recoveries all in other areas of which the extreme case is Northern Ireland  But the overall move has been higher and not matched by the lending to small businesses which the policy effort was badged as being for.

So if we now look ahead we see wage growth but real wage declines. We see that there has been an extraordinary effort to reduce mortgage rates from the Bank of England. There was also the Help To Buy programme of the government. All of these factors point to stagnation looking ahead and if anything the surprise has been that the various indices have not fallen further. Should London continue to be a leading indicator then perhaps more patience is needed.

The London* price gauge remains stuck firmly in negative territory, posting the weakest reading since 2008. Furthermore, the price indicator has turned a little softer in the South East of England,  ( RICS)

Comment

There are unknown factors here as for example we could see another wave of foreign purchases in London. The Bank of England could ease policy again however the power of Bank Rate cuts and indeed QE has weakened considerably in this regard. This is because if you look at countries like Sweden and Switzerland then with individual exceptions the bulk of mortgage rates hit a bottom higher than you might imply from the official negative interest-rates. This is in my opinion because banks remain unwilling to pass negative interest-rates onto the retail depositor as they fear what might happen next. So if the Bank of England wants to do more its action would have to be direct I think.

The other road that the Bank of England has been hinting at via its house journal the Financial Times is Forward Guidance about an interest-rate rise. Perhaps we will see more of this today and this is unlikely to support house prices as it would be the doppelganger of the last four years or so, especially of the “Sledgehammer QE” of August 2016. This means that today’s policy move could yet be putting Jane Austen on the new ten pound note. Perhaps the PR spinning around this will manage to put a smoke screen around the fact that there seems to have been a “woman overboard” problem at the higher echelons of the Bank.

 

 

The Bank of England gets ready to cry wolf again

This morning has seen a clarion call from the Bank of England using its house journal the Financial Times. Its economics editor Chris Giles has reported this.

The Bank of England will this week step up its warnings that households, businesses and investors are underestimating how soon interest rates will rise.

Okay let us park for the moment the feeling of “deja vu all over again” and look for the explanation.

 

A strong body of opinion in the central bank, including the governor, believes that the economy is more vulnerable to inflation, so even a small improvement in its forecast for growth would require higher borrowing costs to stave off rising prices.

The last set of Monetary Policy Committee Minutes are mentioned and let me give a longer quote from them than used by the Financial Times.

some tightening of monetary policy would be required to achieve a sustainable return of inflation to the target. Specifically, if the economy were to follow a path broadly consistent with the August central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than the path implied by the yield curve underlying the August projections.

This was all really rather mealy-mouthed and was so unconvincing that the 5 year Gilt yield which opened that day at 0.62% ( if we look back at the behaviour of the Pound £ back then some seemed to actually believe the Bank of England might act that day) fell sharply on the day. Other events have intervened ( North Korea) but it is now 0.45% which does not have much scope for Bank Rate rises to say the least.

We are also directed by the Financial Times to this in the August Quarterly Inflation Report.

 

Mark Carney, governor, backed this message up in the inflation report press conference saying that the BoE’s assumption at the time of “more than one interest rate hike over the course of three years . . . would be insufficient” to control inflation. Ben Broadbent, his deputy, added: “The important point is that one should not think that the economy, at the moment, can grow at the sort of rates we used to enjoy, certainly before the crisis before running into inflationary pressure”.

As you can see from the Gilt yield changes I pointed out above these two gentlemen could have saved themselves the embarrassment of everybody yawning and ignoring them.

Why might this be?

One problem is the Bank of England’s poor forecasting record combined with its problems with economics highlighted by this from my update on February 3rd.

Specifically, the MPC now judges that the rate of unemployment the economy can achieve while being consistent with sustainable rates of wage growth to be around 4½%, down from around 5% previously.

Remember when Governor Carney suggested that an unemployment rate of 7% was significant? We can argue now about how much significance but by signalling it one might reasonably expect action especially as it was not long before we were given more forward guidance about the unemployment rate.

an estimate of its medium-term equilibrium rate of 6%–6½%.

Of course it is now 4.4% and the output gap theories of the Bank of England have collapsed like Mordor’s Tower of Doom. Although the Ivory Tower thinkers that proliferate in Threadneedle Street continue to believe it is just around the corner.

Also there seems to be a problem with mathematics at the Bank of England as this from the FT highlights.

 

Bank officials say these views have not changed and the argument for rate rises to tame price rises will have strengthened since the last meeting following sterling’s 2 per cent drop, which will further increase the cost of imports and edge inflation higher in the months ahead.

Okay so a 2% drop is important but apparently this from February 3rd was not.

the 18% fall in sterling since its November 2015 peak,

Of course they actually cut interest-rates and added to QE by £70 billion when the UK Pound £ was very weak. This hyping a 2% move rips over its own feet. There is also the problem that the most important exchange rate for inflation purposes is against the US Dollar as so many commodities are priced in it and it is as I type this where it was before the last meeting.

Forward Guidance

The next problem is that Forward Guidance has been a catalogue of misguidance in this area. There was this from Chief Economist Andy Haldane on the 20th of June this year.

I considered the case for a rate rise at the MPC’s June meeting

This provoked a shock as it would have been a road to Damascus turn around for the architect of the “Sledgehammer” monetary easing of August 2016. Yet he has yet to vote for this and whilst he pointed towards later in the year what has happened to change his mind? Nothing really. The problem with dithering and delay is the lags in monetary policy as raising interest-rates now because you expect higher inflation in November is none to bright.

If we look back there was this from Governor Mark Carney back on the 12th of June 2014 in his Mansion House speech.

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.

We are still waiting Mark! Indeed “sooner than” has gone into my financial lexicon for these times alongside “temporary”. As he thought the economy back then was doing this it would be odd to act now rather than then.

with the economy expanding at an annualised rate of 4% and jobs growing at a record pace.

Oh and tucked away in that Mansion House speech was a critique of the policy easing of August 2016.

The economy is still over-levered. The housing market is showing the potential to overheat.

Quantitative Easing

If you wish to start tightening policy then as I suggested several years ago in City-AM it would be best to stop this.

As set out in the MPC’s statement of 3 August 2017, the MPC has agreed to make £10.1bn of gilt purchases, financed by central bank reserves, to reinvest the cash flows associated with the maturities on 25 August and 7 September 2017 of gilts owned by the Asset Purchase Facility (APF).

Some £1.125 billion will be reinvested today in some short-dated UK Gilts.

Comment

Mark Carney faces quite a list of problems right now. His policy of Forward Guidance has in fact been misguidance and in spite of the supposed reforms its efforts at economic forecasting remain woeful. It is hard not to have a wry smile at this from the Guardian.

The Bank of England enforced a 1% rise on striking staff yet its fantasy forecasts claim a 3% rise for the UK as a whole is just around the corner. Really? How?

Actually if the hints of a change in the public-sector pay cap are true then we may see a modest rise in wages but that does nothing for the years of over optimism based you guessed it on the “output gap”. The deeper question is dodged that via underemployment and self-employment the situation is weaker than the official figures suggest and imply.

Perhaps we will be told the truth in a decade like these words on the BBC today from former Bank of England Governor Mervyn King.

My advice was very clear – we should not reveal publicly the fact we were going to lend to Northern Rock.

Although an ex-colleague of mine still does not seem keen.

The FSA’s former head, Sir Hector Sants, said it would be “inappropriate” for him to comment.

A Break

I plan to take at least a couple of days off as I will be attending Chelsea & Westminster Hospital tomorrow for some keyhole surgery on my knee. It has been a long story as I first ruptured my ACL well over 20 years ago but earlier this year I had another injury and decided this time that (hopefully) improvements in surgery and technology outweighed the risks of a reconstruction. Fingers crossed.

 

 

 

The problems of the boy who keeps crying wolf

Yesterday saw the policy announcement of the Bank of England with quite a few familiar traits on display. However we did see something rather familiar in the press conference from its Governor Mark Carney.

The Committee judges that, given the assumptions underlying its projections, including the closure of drawdown period of the TFS and the recent prudential decisions of the FPC and PRA, some tightening of monetary policy would be required in order to achieve a sustainable
return of inflation to target.

Yes he is giving us Forward Guidance about an interest-rate rise again. In fact there was more of this later.

Specifically, if the economy follows a path broadly consistent with the August central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than the path implied by the yield curve underlying those projections.

Yep not only is he promising an interest-rate rise but he is suggesting that there will be several of them. Actually that is more hype than substance because you see even if you look out to the ten-year Gilt yield you only get to 1.16% and the five-year is only 0.54% so exceeding that is really rather easy. Also as I have pointed out before Governor Carney covers all the bases by contradicting himself in the same speech.

Any increases in Bank Rate would be expected to be at a gradual pace and to a limited extent

So more suddenly becomes less or something like that.

Just like deja vu all over again

If we follow the advice of Kylie and step back in time to the Mansion House speech of 2014 we heard this from Governor Carney.

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.

The print on the screen does not convey how this was received as such statements are taken as being from a coded language especially if you add in this bit.

Growth has been much stronger and unemployment has fallen much faster than either we or anyone else expected at last year’s Mansion House dinner.

Markets heard that growth had been better and that the Bank of England was planning a Bank Rate rise in the near future followed by a series of them. Tucked away was something which has become ever more familiar.

 we expect that eventual increases in Bank Rate will be gradual and limited

Although to be fair this bit was kind of right.

The MPC has rightly stressed that the timing of the first Bank Rate increase is less important than the path thereafter

Indeed the first Bank Rate increase was so unimportant it never took place.

Ben Broadbent

he has reinforced the new Forward Guidance this morning. Here is the Financial Times view of what he said on BBC Radio 5 live.

“There may be some possibility for interest rates to go up a little,” said Mr Broadbent.

It sounds as though Deputy Governor Broadbent is hardly convinced. This is in spite of the fact he repeated a line from the Governor that is so extraordinary the press corps should be ashamed they did not challenge it.

adding the economy was now better placed to withstand its first interest rate rise since the financial crisis…….Speaking to BBC radio, Mr Broadbent said the UK was able to handle a rate rise “a little bit” better as the economy is still growing, unemployment is at a more than 40-year low, and wages are forecast to rise.

Sadly for Ben he is acting like the absent-minded professor he so resembles. After all on that score he should have raised interest-rates last summer when growth was a fair bit higher than now.Sadly for Ben he voted to cut them! In addition to this there is a much more fundamental point which is if we are in better shape for rate rises why do we have one which is below the 0.5% that was supposed to be an emergency rate and of course was called the “lower bound” by Governor Carney?

Forecasting failures

These are in addition to the Forward Guidance debacle but if we look at the labour market we see a major cause. Although he tried to cover it in a form of Brexit wrap there was something very familiar yesterday from Governor Carney. From the Guardian.

 

We are picking up across the country that there is an element of Brexit uncertainty that is affecting wage bargaining.
Some firms, potentially a material number of firms, are less willing to give bigger pay rises given it’s not as clear what their market access will be over the next few years.

Actually the Bank of England has been over optimistic on wages time and time again including before more than a few really believed there would be a Brexit vote. This is linked to its forecasting failures on the quantity labour market numbers. Remember phase one of Forward Guidance where an unemployment rate of 7% was considered significant? That lasted about six months as the rate in a welcome move quickly dropped below it. This meant that the Ivory Tower theorists at the Bank of England immediately plugged this into their creaking antiquated models and decided that wages would rise in response. They didn’t and history since has involved the equivalent of any of us pressing repeat on our MP3 players or I-pods. As we get according to the Four Tops.

It’s the same old song
But with a different meaning

Number Crunching

This was reported across the media with what would have been described in the Yes Minister stories and TV series as the “utmost seriousness”. From the BBC.

It edged this year’s growth forecast down to 1.7% from its previous forecast of 1.9% made in May. It also cut its forecast for 2018 from 1.7% to 1.6%.

Now does anybody actually believe that the Bank of England can forecast GDP growth to 0.1%? For a start GDP in truth cannot be measured to that form of accuracy but an organisation which as I explained earlier has continuously got both wages and unemployment wrong should be near the bottom of the list as something we should rely on.

Comment

There is something else to consider about Governor Carney. I have suggested in the past that in the end Bank of England Governors have a sort of fall back position which involves a lower level for the UK Pound £. What happened after his announcements yesterday?

Sterling is now trading at just €1.106, down from €1.20 this morning, as traders respond to the Bank of England’s downgraded forecasts for growth and wages…..The pound has also dropped further against the US dollar to $1.3127, more than a cent below this morning’s eight-month high.

They got a bit excited with the Euro rate which of course had been just below 1.12 and not 1.20 but the principle of a Bank of England talking down the Pound has yet another tick in any measurement column. Somewhere Baron King of Lothbury would no doubt have been heard to chuckle. There is a particular irony in this with Deputy Governor Broadbent telling Radio 5 listeners this earlier.

BoE Broadbent: Faster Inflation Fuelled By Pound Weakness ( h/t @LiveSquawk )

Oh and I did say this was on permanent repeat.

BoE Broadbent: Expects UK Wage Growth To Pick Up In Coming Years ( h/t @LiveSquawk )

 

Oh and as someone pointed out in yesterdays comments there has been yet another Forward Guidance failure. If you look back to the first quote there is a mention of the TFS which regular readers will recognise as the Term Funding Scheme. Here are the relevant excerpts from the letter from Governor Carney to Chancellor Hammond.

I noted when the TFS was announced that total drawings would be determined by actual usage of the scheme, and could reach £100bn………. Consistent with this, I am requesting that you authorise an increase in the total size of the APF of £15bn to £560bn, in order to accommodate expected usage of the TFS by the end of the drawdown period.

Who could have possibly expected that the banks would want more of a subsidy?! Oh and the disinformation goes on as apparently they need more of it because of a “stronger economy”.

Also this seems to be something of a boys club again as my title suggests. We have had something of what Yes Minister might call a “woman overboard” problem at the Bank of England.

 

 

 

The Mark Carney experience at the Bank of England

This morning Mark Carney has given his Mansion House speech which was delayed due to the Grenfell Tower fire tragedy. One thing that was unlikely to be in the speech today was the outright cheerleading for the reform of the banking sector which was the basis of his speech back on the 7th of April as the news below emerged.

Barclays PLC and four former executives have been charged with conspiracy to commit fraud and the provision of unlawful financial assistance.

The Serious Fraud Office charges come at the end of a five-year investigation and relate to the bank’s fundraising at the height of 2008’s financial crisis.

Former chief executive John Varley is one of the four ex-staff who will face Westminster magistrates on 3 July.

Firstly let me welcome the news that there will be a trial although the conviction record of the Serious Fraud Office is not good. The problem is that this has taken around nine years about something ( £7 billion raised from Qatar ) which frankly looked to have dubious elements when it took place. What you might call  slooooooooooooow progress of justice.

What about UK interest-rates?

We first got a confession about something we discovered last week.

Different members of the MPC will understandably have different views about the outlook and therefore on the potential timing of any Bank Rate increase.

Actually that is an odd way of saying it as five members voted for no change with some more likely to vote for a cut that a rise in my opinion. Although of course Mark Carney has had trouble before with rises in interest-rates which turn out to be cuts!

Next we got a confirmation of the Governor’s opinion.

From my perspective, given the mixed signals on consumer spending and business investment, and given
the still subdued domestic inflationary pressures, in particular anaemic wage growth, now is not yet the time
to begin that adjustment

Indeed he seems keen to kick this rather awkward issue – because it would mean reversing last August’s Bank Rate cut – as far into the future as possible.

In the coming months, I would like to see the extent to which weaker consumption growth is offset by other components of demand, whether wages begin to firm, and more generally, how the economy reacts to the prospect of tighter financial conditions and the reality of Brexit negotiations.

Indeed if we are willing to ignore both UK economic history and the leads and lags in UK monetary policy then you might be able to believe this.

This stimulus is working. Credit is widely available, the cost of borrowing is near record lows, the economy has outperformed expectations, and unemployment has reached a 40 year low.

Missing from the slap on the back that the Governor has given himself is the most powerful instrument of all which is the value of the UK Pound which has given the UK economy and more sadly inflation a boost. Indeed the initial response to the Governor’s jawboning was to add to the Pound’s fall as it fell below US $1.27 and 1.14 versus the Euro. Should it remain there then the total fall since the night of the EU leave vote then it is equivalent to a 2.75% fall in UK Bank Rate which is a bazooka compared to the 0.25% peashooter cut provided by the Bank of England. So if you believe Mark Carney you are likely not to be a fan of Alice In Wonderland.

“Why, sometimes I’ve believed as many as six impossible things before breakfast.”

Also if he is going to take credit for er “Credit is widely available” then he will be on very thin ice when he next claims the surge in unsecured credit is nothing to do with him.

Carney’s Cronies

Ironically in a way the foreign exchange market was a day late as you see the real change came yesterday.

​The Chancellor of the Exchequer has announced the appointment of Professor Silvana Tenreyro as an external member of the Monetary Policy Committee (MPC).  Silvana will be appointed for a three year term which will take effect from 7 July 2017.

There are several issues here, if I start with British female economists then that is another slap in the face for them as none have been judged suitable for a decade. Next came the thought that I had never previously heard of her which turned to concern as we were told she came from “academic excellence” in an era where Ivory Towers have consistently crumbled and fallen along the lines of Mount Doom in the Lord of the Rings. But after a little research one could see why she had been appointed. From a survey taken by the Centre For Macroeconomics.

Question Do you agree that the benefits of reforming the monetary system to allow materially negative policy interest rates outweigh the possible costs?

Agree. Confident. Reforming the monetary system to allow negative policy interest rates will equip the BoE with an additional tool to face potential crises in the future.

Does “reforming the monetary system” sound somewhat like someone who will support restrictions on the use of cash currency and maybe its banning? She is also a fan of QE ( Quantitative Easing ) style policies.

Question Do you agree that central banks should continue to use the unconventional tools of monetary policy deployed in response to the global financial crisis as part of monetary policy under normal economic conditions?

Agree. Confident. A wider set of policy tools would give mature and credible central banks like the BoE more flexibility to respond to changing economic conditions.

What is it about her apparent support for negative interest-rate and QE that attracted the attention of Mark Carney? Of course in a world after the woeful failure of Forward Guidance and indeed the litany of forecasting errors he was probably grateful to find someone who still calls the Bank of England “credible”!

Comment

We have a few things to consider and let me start with the reaction function of foreign exchange markets. The real news was yesterday as a fan of negative interest-rates was appointed to the Bank of England but the UK Pound waited until Mark Carney repeated his views of only Thursday to fall!

Meanwhile there was this from Governor Carney.

Monetary policy cannot prevent the weaker real income growth likely to accompany the transition to new
trading arrangements with the EU. But it can influence how this hit to incomes is distributed between job losses and price rises.

His views on the EU leave vote are hardly news although some are trying to present them as such. You might think after all the forecasting errors and Forward Guidance failures he would be quiet about such things. But my main issue here is the sort of Phillips Curve way we are presented a choice between “job losses” and “price rises” Just as all credibility of such thinking has collapsed even for those with a very slow response function in fact one slow enough to be at the Serious Fraud Office. He is also contradicting himself as it was only a few months ago we were being told by him that wage growth was on the up. Although that February Inflation Forecast press conference did see signs that the normally supine press corps were becoming unsettled about a Governor previously described as a “rockstar central banker” and “George Clooney” look a like.

Governor, back in August the forecast for GDP for this year
was 0.8%. Now it’s being forecast at 2.0%. That’s a really
hefty adjustment. What went wrong with your initial
forecast?

He may not be that bothered as you see much of today’s speech was in my opinion part of his job application to replace Christine Lagarde at the IMF.

With many concerned that global trade is taking local jobs, protectionist sentiments are once again rising
across the advanced world. Excessive trade and current account imbalances are now politically as well as
economically unsustainable.

Number Crunching

Problems mount for Mark Carney at Mansion House

The UK’s central bank announces its policy decision today and it faces challenges on several fronts. The first was highlighted yesterday evening by the US Federal Reserve.

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

UK monetary policy is normally similar to that in the US as our economies often follow the same cycles. This time around however the Bank of England has cut to 0.25% whilst the Federal Reserve has been raising interest-rates creating a gap of 0.75% to 1% now. In terms of the past maybe not a large gap but of course these days the gap is large in a world of zero and indeed negative interest-rates. Also we can expect the gap to grow in the future.

The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate;

There was also more as the Federal Reserve made another change which headed in the opposite direction to Bank of England policy.

The Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.

So the Federal Reserve is planning to start the long journey to what used to be regarded as normal for a central bank balance sheet. Of course only last August the Bank of England set out on expanding its balance sheet by another £70 billion if we include the Corporate Bond purchases in what its Chief Economist Andy Haldane called a “Sledgehammer”. So again the two central banks have been heading in opposite directions. Also on that subject Mr.Haldane was reappointed for another three years this week. Does anybody know on what grounds? After all the wages data from yesterday suggested yet another fail on the forecasting front in an ever-growing series.

Andrew Haldane, Executive Director, Monetary Analysis and Statistics, and Chief Economist at the
Bank of England, has been reappointed for a further three-year term as a member of the Monetary Policy
Committee with effect from 12 June 2017.

For those interested in what Andy would presumably call an anti-Sledgehammer here it is.

( For Treasury Bonds) the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month…… ( for Mortgage Securities) the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.

Whilst these really are baby steps compared to a balance sheet of US $4.46 trillion they do at least represent a welcome move in the right direction.

The Inflation Conundrum

This has several facets for the Bank of England. The most obvious is that it eased policy last August as inflation was expected to rise and this month we see that the inflation measure it is supposed to keep around 2% per annum ( CPI ) has risen to 2.9% with more rises expected. It of course badged the “Sledgehammer” move as being expansionary for the economy but I have argued all along that it is more complex than that and may even be contractionary.

Today’s Retail Sales numbers give an example of my thinking so let me use them to explain. Here they are.

In May 2017, the quantity bought in the retail industry was estimated to have increased by 0.9% compared with May 2016; the annual growth rate was last lower in April 2013…..Month-on-month, the quantity bought was estimated to have fallen by 1.2% following strong growth in April 2017.

So after a strong 2016 UK retail sales have weakened in 2017 but my argument is that the main driver here has been this.

Average store prices (excluding fuel) increased by 2.8% on the year; the largest growth since March 2012.

It has been the rise in prices or higher inflation which has been the main driver of the weakness in retail sales. A factor in this has been the lower value of the Pound which if you use the US inflation numbers as a control has so far raised UK inflation by around 1%. This weakness in the currency was added to by expectations of Bank of England monetary easing which of course were fulfilled. You may note I say expectations because as some of us have been discussing in the comments section the main impact of QE on a currency happens in the expectations/anticipation phase.

On the other side of the coin you have to believe that a 0.25% cut in interest-rates has a material impact after cuts of over 4% did not! Also that increasing the Bank of England’s balance sheet will do more than adding to house prices and easing the fiscal deficit. A ten-year Gilt yield of 0.96% does not go well with inflation at 2.9% ( CPI) and of course even worse with RPI ( 3.7%).

House Prices

I spotted this earlier in the Financial Times which poses a serious question to Bank of England policy.

Since 1980, the compounded inflation-adjusted gain for a UK homeowner has been 212 per cent. Before 1980 house price gains were much tamer over the various cycles either side of the second world war. Indeed, in aggregate, prices were largely unchanged over the previous 100 years, once inflation is accounted for.

A change in policy? Of course much of that was before Mark Carney’s time but we know from his time in Canada and here that house price surges and bubbles do happen on his watch. The article then looks at debt availability.

The one factor that did change, though, and marked the start of that step change in 1980, is the supply of mortgage debt……….has resulted in a sevenfold increase in inflation-adjusted mortgage debt levels since then.

This leads to something that I would like Mark Carney to address in his Mansion House speech tonight.

Second an inflation-targeting central bank, which has delivered a more aggressive monetary response to each of the recent downturns, because of that high debt burden.

On that road we in the UK will see negative interest-rates in the next downturn which of course may be on the horizon.

Comment

There is much to consider for the Governor of the Bank of England tonight. If he continues on the current path of cutting interest-rates and adding to QE on any prospect of an economic slow down then neither he nor his 8 fellow policy setting colleagues are required. We could replace them with an AI ( Artificially Intelligent ) Robot although I guess the danger is that it becomes sentient Skynet style ( from The Terminator films ) and starts to question what it is doing?

However moving on from knee-jerk junkie culture monetary policy has plenty of problems. It first requires both acknowledgement and admittal that monetary policy can do some things but cannot do others. Also that international influences are often at play which includes foreign monetary policy. I have looked at the Federal Reserve today well via the Far East other monetary policy applies. Let me hand you over to some research from Neal Hudson of Residential Analysts on buyers of property in London from the Far East.

However, anecdotal evidence suggests that many of these buyers have been using local mortgages to fund their purchases.  The limited evidence I have suggests that around half of Hong Kong and Singaporean buyers use a local mortgage while the majority of mainland Chinese buyers use one.

Okay on what terms?

The main difference is that the mortgage rate tends to be slightly higher (London Home Loan comparison) and local lenders allow borrowers to have far higher debt multiples.

These people are not as rich as might previously have been assumed and we need to throw in changes in the value of the UK Pound £ which are good for new buyers but bad for existing ones. Complicated now isn’t it?

On a personal level I was intrigued by this.

Last year I visited a development in Nine Elms and the lobby felt more like a hotel than a residential block. There were significant numbers of people appearing to pick up and drop off keys with suitcases in tow.

You see I live in another part of Battersea ( the other side of the park) and where i live feels like that as well.