Why does the Bank of England lack credibility these days?

As it is open season at the Bank of England in terms of media appearances and speeches even the absent-minded professor has been spotted. Actually these days he seems to be performing the role of Governor Carney’s messenger boy and as you can see below this was in evidence yesterday,

The effects of Brexit on inflation, and ultimately on the appropriate level of interest rates, are altogether more
uncertain and more complex. They’re certainly too complex to justify the simple assertion that Brexit necessarily implies low interest rates.

I am not sure what world Ben Broadbent lives in as of all the things Brexit might effect I would imagine low interest-rates was a long way down most people’s lists. Also as to the direction of travel well we were told before the referendum by Governor Carney that interest-rates were likely to rise should the vote be to leave.  Of course he then cut them!

But if we continue with what was supposed to be the theme of yesterday’s speech there was also this.

The MPC explained over a year ago that
there were “limits to the extent to which above-target inflation [could] be tolerated” and that those limits
depended on the degree of spare capacity in the economy. In March, eight months ago, it said in its
Monetary Policy Summary that, if demand growth remained resilient, “monetary policy may need to be
tightened sooner” than the market expected. Similar points were made in the intervening months.
Yet, even as inflation rose, and the rate of unemployment fell further, interest-rate markets continued to
under-weight the possibility that Bank Rate might actually go up this year.

This bit is significant because interest-rate markets are again saying “we don’t believe you” to the Bank of England. The clearest example of that is the two-year Gilt yield which at 0.48% is below the current Bank Rate let alone any possible increases. Even the five-year Gilt yield at 0.75% is only pricing in maybe one increase. Thus the message that further Bank Rate increases are on the cards has not convinced.

Mixed Messages

The problem with sending out an absent-minded professor to deliver a message is that they are likely to be, well, absent-minded!

I’m certainly not going to argue here that interest rates will inevitably rise as Brexit proceeds.

If we skip his apparent Brexit obsession that rather contradicts the message he was sent out to put over and later there was more.

However, my main point is that, given all the moving parts, even the marginal impact of EU withdrawal on the
appropriate level of UK interest rates is ambiguous

And more.

These pull in different directions: holding fixed the other two, weaker demand tends to
depress inflation and interest rates, declines in productivity and the exchange rate do the opposite. There
are feasible combinations of the three that might require looser policy, others that lead to tighter policy.

This is classic two handed economics as in one the one hand interest-rates might rise but on the other they might fall.

And more.

Predicting others’ predictions isn’t easy, and I don’t think the balance of risks to inflationary pressure, and
therefore future interest rates, is obvious.

The essential problem faced here is back to the credibility issue that Sir Jon Cunliffe was boasting about in his speech on Tuesday. You see markets have problems but are usually not stupid and they will see through this.

It won’t have escaped your attention that the MPC raised interest rates earlier this month. It did so, in part,
because of the referendum-related decline in sterling’s exchange rate. That has pushed up CPI inflation and
will continue to do for some time yet, as the rise in import costs is passed through to retail prices.

When the Bank of England raised Bank Rate the effective or trade-weighted index for the UK Pound £ was 78 but it had cut Bank Rate in August 2016 when it was 79! So if it raised Bank Rate in response to a one point fall why did it cut it in the face of the 9 point fall that has followed the EU leave vote? Best to leave our absent-minded professor in his land of confusion I think. The statement also ignores that fact that to defeat an inflationary push you need to get ahead of events not be some form of tail end charlie chasing them.

Back in August 2016 Ben Broadbent and his colleagues gambled and we lost.

The MPC eased policy in August 2016 not because of the referendum result but because of the steep fall in measures of business and consumer confidence that followed it.

So in terms of credibility I would say that in modern language they are in fact uncredible.

Retail Sales

These numbers remind us of why Ben Broadbent is so uncredible. You see after the EU Leave vote he decided to ignore signals that the Bank of England previously used and concentrate on business surveys. Markit reported this in July.

UK economy contracts at steepest pace since early-2009

Both they and Ben are probably desperately hoping that people will be absent minded about this as of course the UK economy in fact continued to grow. In particular we saw this happen towards the end of the year as we focus in on Retail Sales.

In October 2016, the quantity of goods bought (volume) in the retail industry was estimated to have increased by 7.4% compared with October 2015; all store types showed growth with the largest contribution coming from non-store retailing. This is the highest rate of growth since April 2002.

That is one of the biggest booms we have ever had and thank you ladies as it your enthusiasm for clothes and shoes shopping that helped give the numbers a push.

That perspective brings us to today’s numbers which reflected the boom last year.

The longer-term picture as shown by the year-on-year growth rate shows the quantity bought fell by 0.3% in comparison with a strong October 2016;

At this point a cursory glance might make you think that the numbers are badly and are in line with some of the surveys we have seen. Except if we look closer maybe not.

The underlying pattern in the retail industry in October 2017, as suggested by the three-month on three-month measure is one of growth, with the quantity bought increasing by 0.9%………The quantity bought in October 2017 increased by 0.3% compared with September 2017;

If you look at the series it was in fact September which was the weak month as was the opening of 2017 and October was a little better. Also we saw another possible confirmation of my argument that higher inflation leads to weaker volumes.

The main contribution to the overall year-on-year decrease of 0.3% in the quantity bought in retail sales came from food stores, providing a negative contribution of 0.9 percentage points;

The inflation data on Tuesday signalled higher food inflation ( 4.2%) and it may well be more than a coincidence that we are seeing lower volumes. Rather curiously the strong point in October was this.

in particular second-hand goods stores (charity shops, auction houses, antiques and fine art dealers) provided the largest contribution to this growth.

Comment

A theme of my work over the past year and a half or so is to be sanguine about the impact of an EU Leave vote. Yes there are impacts due to higher inflation reducing real wage growth but the economy has in fact grown fairly steadily albeit at no great pace. Regular readers will recall that I pointed out that UK economic history showed that a lower Pound £ has a powerful impact. Ironically that is only partly shown by the trade figures where you might expect to see it first but we do seem to have seen it elsewhere. As to the statistics we receive well they can be solved by a stroke of the pen apparently.

Having carried out an assessment on the additional information, ONS has determined that if the
proposed regulations come into force as proposed then local authority and central government influence
in combination with the existence of nomination agreements would not constitute public sector control,
and English PRPs would be reclassified as Private Non-Financial Corporations (S.11002).

About £60 billion I think and it looks a little like a merry-go-round as they put the national debt up and then change their minds.

Meanwhile I expect the speeches from the Bank of England to get ever more complex so that they paper over the issue that they have got the basic wrong. Let me add one more problem to the list by pointing out something it tries to look away from, here are some wealth effects from what is a fair bit of the QE era.

 

 

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The ongoing UK problem with pensions

Today has brought a piece of news that is another element in an ongoing saga. It also brings into play some economic developments that are interrelated to it. Oh and a past manipulation of the UK public finances. From Reuters.

Royal Mail said on Thursday it would close its defined benefit pension scheme at end-March 2018 after a review found it would need to more than double annual contributions to over 1 billion pounds to keep the plan running.

Royal Mail, the British postal service privatised in 2013, said it was one of only a few major companies that still had employees in a defined benefits scheme, a type of pension that pays out according to final salary and length of service.

The company, which pays around 400 million pounds a year into the scheme, said it was currently in surplus, but it expected the surplus to run out in 2018.

There are various initial consequences such as threats of strike action from the postal union and something to cheer central bankers everywhere. From the Financial Times.

Investors were more positive about the plan, however. Shares in Royal Mail rose 1.6 per cent after the announcement to their highest level since January. JPMorgan Cazenove analysts estimated last month that markets have already priced in a £100m a year step-up in pension charges, and investors have welcomed signs of an end to questions over the scheme’s future.

UK Public Finances

Those who recall my analysis from 2013 will remember that this is another version of the Royal Mail pension scheme that was originally booked in the UK National Accounts for a £28 billion profit! How can you have a profit on acquiring something which is unaffordable? Later the methodology was quietly changed.

This reflects the shortfall between the £28 billion of assets transferred from the RMPP and the £38 billion of future pension liabilities that were consequently assumed by Government…….. Furthermore, the transfer of the assets no longer reduces borrowing as it did under ESA95.

To be fair to our statisticians and indeed Eurostat they did catch up with this manipulation eventually but of course by then the public’s attention had moved elsewhere.

Why are these pension schemes now so unaffordable?

The latest report from HM Parliament describes the problems and issues.

poor investment returns, associated with low underlying interest rates and loose monetary policy following the 2008–09 financial crisis and associated recession;8

 

rises in longevity that have been faster than was widely anticipated;

 

sponsor behaviour, including many employers taking contribution holidays when schemes were in surplus.

Only actuaries and economists can make rising longevity seem a bad thing! But if we move to the effect of low interest-rates there is this evidence from Deputy Governor Ben Broadbent to HM Parliament on this and the emphasis is mine.

First, I don’t think it damages the value of their assets; it pushes up the price of their liabilities. That is what happens when bond yields fall. The price of that bond and the present value of the liabilities go up. But it also pushes up the assets.

Even with such analysis Dr.Ben was forced to admit that schemes in deficit were net losers. But I find the overall idea that they lose on the swings but gain on the roundabouts simply extraordinary! Another example of Ivory Tower thinking. You see they have present gains although of course they will be across many markets but the real issue is that they have to pay for future liabilities and the answer misses of the fact that pension funds have going forwards to buy assets such as bonds which are much more expensive. Indeed in an odd but true development pushing up the price of ordinary UK Gilts via QE has in some ways had more of an effect on index-linked Gilts which are not bought! This matters because most defined benefit schemes have inflation based liabilities to pensioners.

The odd case of index-linked Gilts

Because ordinary Gilts offer so little interest these days and index-linked Gilts offer annual coupons based on the Retail Price Index ( 3.1%) if you need income then linkers look more attractive. Of course the price adjusted to this but this means that the Index-Linked Gilt market is in quite a bubble right now. It also means that it is in a way not fit for purpose as it is being priced on annual cash returns rather than inflation prospects as we see yet another market which has been turned into a false one by the central planners.

I have written before about how you could lose money by being right about UK inflation and this is why. So how do pension funds now hedge inflation risk?

The UK Gilt market

This has been on something of a surge recently or perhaps I should say another surge. Let me put an apology in with that because that has wrong-footed my stated view on here as I expected it to fall as inflation prospects deteriorated.  But  the ten-year Gilt yield is quite near to 1% and the two-year yield is 0.1% which is insane in terms of real yield with inflation heading to 3/4% depending on the measure used. Pension funds look a long way ahead so if we look at the thirty-year yield we see it has fallen to 1.63%.

Thus if we switch to prices we see that any investment now is at an extraordinarily expensive level. What could go wrong?

Actually according to HM Parliament defined benefit schemes tend to value themselves versus the higher quality end of the Corporate Bond market.

scheme funding statistics show that discount rates used by DB pension schemes for calculating liabilities since 2005 have consistently been around 1 per cent above gilt yields.

Can anybody spot a flaw in the Bank of England buying £10 billion of these ( £9.1 billion so far) to raise the price and reduce the yield?

Pre pack problems

Another issue was raised by Josephine Cuombo in the Financial Times.

Companies in the UK have used a controversial insolvency procedure to offload £3.8bn of pension liabilities, often as part of a sale to existing directors or owners, a Financial Times investigation has found…….

The FT investigation found that two in three pre-pack schemes entering the PPF involved sales to existing owners or directors. A string of prominent cases that used pre-pack arrangements, but where companies are still trading, include the turkey producer Bernard Matthews, the bed company Silentnight and the textile group Bonas.

In essence the schemes have found their way into the Pension Protection Fund which is backed by the industry thus raising costs for other schemes and pensioners get reduced benefits.

Comment

When the Bank of England looks at pensions it is hard to avoid the thought that views are influenced by their own more than comfortable position. For example in its latest accounts Ben Broadbent had received pension benefits valued at £104,586 in the preceding year. It is also hard to forget that just as it was telling everyone inflation was going lower back in 2009 the Bank of England piled into index-linked Gilts in its own scheme! But for everyone else involved there are no shortage of sharks in the water.

As to the befuddled and bemused Ben Broadbent he has views which question why we pay him at all!

One thing I want to get across today is not to confuse the low level of interest rates with monetary policy…….

Even though we are that last link and even though it is the MPC that sets interest rates, it is not a realistic question—I do not think it is a realistic premise to say low interest rates are because of monetary policy.

Until of course he can claim gains from his policies….

Let me sign off for a few days by wishing you all a very Happy Easter.

 

 

 

Does anybody believe the Bank of England hints of an interest-rate rise?

Firstly let me open with my best wishes to those caught up in the terrible event at Westminster yesterday which is somewhere I pass through regularly. Let us then review some better economic news in a period where the UK statisticians overload particular days. If we go back to Tuesday where there was a panoply of inflation data there was also this about the public finances.

Public sector net borrowing (excluding public sector banks) decreased by £2.8 billion to £1.8 billion in February 2017, compared with February 2016; this is the lowest February borrowing since 2007.

I recall that the January numbers were also more positive and this led to this.

In January and February 2017, the government received £13.4 billion and £4.7 billion respectively in self-assessed Income Tax, giving a combined total of £18.1 billion. These represent the highest combined self-assessed Income Tax receipts on record (records begin in 1998).

So good news and other forms of revenue were good too.

Similarly, in January and February 2017, the government received £6.2 billion and £2.2 billion respectively in Capital Gains Tax, giving a combined total of £8.4 billion. These represent the highest combined Capital Gains Tax receipts on record (records begin in 1998).

It would seem that Capital Gains Tax is more significant than might be assumed. I guess the higher house prices ( it is paid on second homes and therefore buy to lets) and maybe profits from the equity market are driving this. I am surprised that the Bank of England has not been trumpeting this as part of its wealth effects, have they missed it?

Also the overall tax situation for the financial year so far has been strong.

In the current financial year-to-date, central government received £616.1 billion in income; including £465.6 billion in taxes. This was around 6% more than in the previous financial year-to-date.

There was a change to National Insurance rates but even allowing for that we are seeing a pretty good performance and ironically after the talk of extra spending and fiscal expansionism the numbers may well be telling a different story.

Over the same period, central government spent £638.1 billion; around 2% more than in the previous financial year-to-date.

With inflation rising that is of course less in real terms than it first appears and meant that we did better here.

Public sector net borrowing (excluding public sector banks) decreased by £19.9 billion to £47.8 billion in the current financial year-to-date (April 2016 to February 2017), compared with the same period in the previous financial year;

Retail Sales

There was good news as well in the February data for Retail Sales.

Estimates of the quantity bought in retail sales increased by 3.7% compared with February 2016 and increased by 1.4% compared with January 2017; this monthly growth is seen across all store types.

However the monthly numbers are erratic and the seasonal adjustment is unconvincing. February was partly so good because January was revised even lower. But the year on year comparison was strong.

In February 2017 compared with February 2016, all main retail sectors, except petrol stations saw an increase in the quantity bought (volume) while all sectors saw an increase in the amount spent (value). The largest contribution in both the quantity bought and amount spent came from non-store retailing.

However because of the week December and January data the trend remains for a fading of the year on year growth.

The underlying pattern as suggested by the 3 month on 3 month movement decreased by 1.4% for the second month in a row; the largest decrease since March 2010 and only the second fall since December 2013.

Actually we get a confirmation of some of the themes of this blog. For a start in something which central bankers and inflationistas will overlook higher inflation leads to lower consumption. The higher oil price has led to less petrol consumption.

the largest contribution came from petrol stations, where year-on-year average prices rose by 18.7%……..The underlying trend suggests that rising petrol prices in particular have had a negative effect on the overall quantity of goods bought over the last three months.

Over time I expect this to feed into retail sales as you see that prices are rising overall as the higher oil price feeds through.

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

So sadly I expect the retail sales growth to fade away as higher inflation erodes real wages.  Also whilst it is only one sector we have yet another inflation measure (2.8% here) running higher than the official one, how many do we need?

Royal Statistical Society

I am pleased that it has expressed its misgivings about the new UK inflation infrastructure in a letter to The Times today. Here are the main points.

For several years, the Royal Statistical Society (RSS) has been advocating the introduction of a proper household inflation index. We believe the answer lies in the proposed Household Costs Index (HCI) that is currently being developed by the Office for National Statistics, with expert input from some RSS members.
Paul Johnson is right that government should not be cynical in its use of different inflation measures. We would also argue, however, that the government should use the appropriate inflation index for the job at hand. CPIH makes sense as an index for economic policy matters (such as potentially interest rate setting by the Bank of England) but it is HCI that, once fully developed and proven, should be used for uprating purposes and for assessing real incomes in the UK.

Good for them! I have spent quite some time taking my arguments to the RSS and am pleased that the message is at least partly not only being received but also transmitted. My only quibble would be that CPIH results from national accounts methodology and not economic principles.

Ben Broadbent

Ben spoke at Imperial College earlier and as ever his Forward Guidance radar misfired.

We may already be seeing the impact of that squeeze on retail spending, which in real terms fell quite sharply around the turn of the year.

Some felt it was a hint for the 9:30 numbers but if it was Ben had misread them. He gives some more Forward Guidance by telling us the UK Pound £ may go up or down!

Either the currency market is too pessimistic, in which case sterling’s depreciation is likely to be reversed over time. Or it’s not, in which case the costs of exporting will eventually go up.

Actually after the last Forward Guidance debacle Ben has either completely lost the plot or has developed a sense of humour as whilst not in the speech this was being widely reported..

It’s quite possible we could see rates go up in the UK

Can see scenarios where BOE could raise rates ( h/t FXStreet )

Another issue is that Ben Broadbent seems to follow financial markets and assume they are correct. If you recall when I was on BBC Radio 4’s MoneyBox last September the ex-Bank of England economist Tony Yates repeated the same mantra. They seem to have forgotten that they should not be puppets they should have their own views.

Comment

This week has had a ying and yang to it on UK economic news. The public finance and retail sales numbers remain good but the Sword of Damocles already beginning to swing is higher inflation especially via its effect on real wages. This will affect retail sales as 2017 progresses and that will affect the public finances too albeit there are also gains for the latter. Yet the establishment continues with its objective of inflation measures that ignore as much inflation as possible. Does anybody actually believe this new Forward Guidance from the Bank of England? After all back in 2011 they ignored inflation which went above 5% with disastrous consequences for real wages.

Me on Official Tip-TV

http://tiptv.co.uk/uk-inflation-property-bubble-boe-response-not-yes-man-economics/